Gross Domestic Product and U.S. Inequality

By Karen Petrou

On January 22, Rep. Carolyn Maloney (D-NY) and 18 senior House Democrats reintroduced legislation (now H.R. 707) requiring federal statisticians to provide an equality-focused insight into the gross domestic product (GDP) number all too often considered the arbiter of American prosperity.  Senate Minority Leader Schumer (D-NY) and Sen. Martin Heinrich (D-NM) introduced the same bill last year and are sure to do it again and, then to join Maloney in pressing for action.  This time, it will come quickly in the House and may well pass the Senate in this Congress.  Would it make an equality difference?  No, but at least we’d know more clearly how much trouble we’re in.

What’s Wrong with GDP

Nobel Prize-winner Paul Krugman observed in calling for new ways to think about GDP that, “If Jeff Bezos walks into a bar, the average wealth of the bar’s patrons suddenly shoots up to several billion dollars – but none of the non-Bezos drinkers has gotten any richer.”  

An IMF study on this question is less amusing, but still quite useful as it separates overall relationships between equality and growth – which often average out over lengthy periods of time – to determine which countries support the most sustained, stable recoveries.  The best performers are the most equal nations.  Even when external shocks are added to the duration over which growth is assessed, equality still determines growth, a finding corroborated in an OECD study of developed countries including the U.S. up to 2014.  Another IMF study examining the growth/equality trade-off across many nations over a fifty-year time span finds that, “slow or fragile growth and high inequality seem to be two sides of the same coin, and durable growth at a healthy pace will only be possible if growth itself becomes more inclusive.”

Looking at 141 countries from 1995 to 2011, the World Bank goes beyond GDP as the measure of national prosperity to examine national “balance sheets” to separate the impact of human, physical-infrastructure, natural-resource, and financial assets subsumed within aggregate, unadjusted GDP numbers.  Countries that invest human and financial assets in physical infrastructure or resource development gain in wealth while those who use proceeds for consumption and financial investment get poorer regardless of how aggregate GDP data calculate income and production.

Why?  GDP is flawed because a simple GDP figure such as two percent means no per-capita growth if population growth is also two percent.  If demographic growth is faster than GDP growth – which it has been throughout the recent post-crisis period – than real, per-capita GDP growth is lower – sometimes a lot – than the nominal percentage increase.  Further, GDP is by definition “gross.”  As a result, when a disaster strikes, its cost is not subtracted from growth but rebuilding counts to GDP in ways that suggest prosperity even if we’re just treading water.  Sharp increases in GDP after the late 2017 hurricanes were touted as proof of policy success, but in fact GDP owed much of its strength to reconstruction that, once it was complete, no longer buoyed the economy and employment.

Going from Gross to Heterogeneous

The problem with a “gross” domestic product number is its aggregate approach assuming that prosperity is evenly shared.  When GDP was developed in the 1960s, this was largely true.  Now, it surely isn’t. 

As we have noted in prior blog posts, averages distort the real experience of the majority of American households.  For example, it might seem that most Americans can repay their debt, the perception that leads Fed officials to conclude that overall household debt is sustainable even though it continues to reach record levels.  However, disaggregate the data by economic inequality, and one quickly sees that the richest Americans have the least amount of debt and those with the most debt have the least assets with which to ensure repayment. 

Economists are gradually moving from these aggregate assumptions to what have come to be called heterogeneous-agent or neo-Keynesian approaches, but majority, establishment opinion still rests on aggregates.  With Congress pushing for change on GDP, a more heterogeneous, equality-focused effort will advance – and a good thing too.