Measuring GDP

"Not everything that counts can be counted and not everything that can be counted counts." - Albert Einstein

The above quote is so true but humans have a natural tendency to try to place a value on pretty much everything.  When it come to the world of economics, counting is a virtual impossibility because in most instances the things being counted are so vast and changing so regularly (if not every millisecond) that even after time and effort is made to calculate the number it is guaranteed to be wrong!  The thought in economics is that even though it is well known that the number is incorrect it is better than no number at all.

There is no number more relied on and more wrong than GDP.  The estimate of changes in GDP is used to assess whether the economy is growing too slowly or too fast (or not at all) and to gauge whether inflation is rampant, in line with targets or deflationary.  It is used to determine whether we are in an overheated booming economy or a stagnant spluttering economic recession.  Central bankers rely on it to create their strategies for stimulating or cooling down the economy and governments are held to account, particularly at election time, for the their ability to provide good GDP growth.  Currencies swing higher and lower reflecting the strength or weakness of the underlying economy's GDP growth in comparison to everyone else, and interest rates depend to a large extent on the outlook for GDP growth or lack thereof.  To say it is an important number is an understatement however to calculate it is all but impossible.

Created in the 1930s GDP was initially relatively simple to calculate.  Take a basket of goods and services and then revalue them a year later and there's your answer/  Economies in those times were based more on manufacturing and farming than it was on services so computing the change in the inputs was relatively simple.  Fast forward to today and the complexities of the modern world make a mockery of the number.  Examples abound but I will mention only a few:

1. The smart phone in your pocket has more computing power than a PC had in the 90s and the price is lower so is that deflationary or should there be an adjustment for improved productivity?
2. The new smart phone is more pricey than last year's version but it comes with a number of new features so is this inflationary or should the price be adjusted lower so that it incorporates the technological advances that make your life easier?
3. What about the use of your car to take passengers for a paid ride (Uber) or that extra room in your house that is rented to travelers (AriBnB) or all the free entertainment that is available on YouTube or Facebook?  How should this be included in GDP?
4. What about the billions of dollars that are flowing through the black markets of the world?

The case for the basket of goods capturing a change in GDP is so rife with problems that it is starting to make the number of little relevance.  When you start to consider the inflationary aspects of the number and the adjustments that are made for technological advances it becomes even more haphazard.  How can you compare the change in price of say a fax machine and the use of email or crutches with prosthetics or vinyl records with streaming digital music?

The issues are so complex that whatever number is calculated it is far from reality.  This is why everyone should calculate their own inflation rate particularly when it comes to determining a real rate of return on your investment.  Without it you cannot get a clear indication of real portfolio returns and this will have a tremendous impact on your retirement planning.  But for all its problems having a number is better than having no number at all but basing your financial future on this number is akin to failure.  Use it as a loose gauge of economic activity and follow any large swings but do not hang your hat on this number.