The Gross Domestic Product (GDP) and the Gross National Product (GNP) are aggregate numbers. There is a slight difference in the methodology used, but generically they are the measure of macro economic output in dollars. These numbers are considered to be important because they reflect how busy we are producing goods and services for each other's consumption. They are regularly used to imply a rising or falling standard of living and/or quality of life by politicians, economists and pundits. It is believed that they are a key indicator of economic health and policy success or failure.
There are a number of problems with relying on these figures. Anything that is not a financial transaction is not counted. For example, if someone volunteers their time, paints their own house, or does a car repair for a friend, it is not recorded in the official output of the nation. Self-sufficiency is a measuring liability. The purchase of the paint or auto parts would be counted, but not the value of the labor to use the materials. Other off-market transactions include under-the-counter, illegal activities (gambling, drugs, prostitution), and cash second-hand sales.
It is guesstimated that these off-market transactions could be between 5% and 30% of the GDP/GNP total. If true, then small changes in the GDP/GNP could be easily offset by larger changes in the off-market aggregate. One aggregate could move up while the other aggregate moves down. They could both be moving in the same direction simultaneously, too.
Another problem with these calculations are they cannot make any qualitative reading. There is no way to account for planned obsolescence, losses due to catastrophe, or the generic quality of the dollar output. Pawning your possessions has the same value as buying them, as a measure economic activity. An entire town or a way of life could be destroyed and the numbers would reflect nothing of it.
What are these economists doing, and how does it effect policy?
GDP/GNP measures "government aware' transactions. These are the transactions that the government attempts to influence through taxes and legislation. The off-market transactions are usually illegal specifically because they are untaxed and unregulated. Many states have legalized formerly illicit activities in the hopes of closing a budget shortage. Gambling is legal when the State runs the lottery and taxes the winnings and the labor involved. When organized crime manages gambling, and fails to pay taxes, the exact same behavior is illegal. Legal gambling is measured as economic output, even though nothing is produced.
Governments act on the false assumption that the budget approach is working. By making the local (counted) economy larger, they expect to be able to balance revenue and expenses more easily. Everyone acts similarly. Businesses try to grow sales. Non-profits attempt to raise more funds. Wage earners seek richer compensation. It is commonly believed that growth can solve the problem of shortage. Unfortunately, the problems scale up in size as well. The ratio does not change favorably automatically. It is possible that waste will increase, thereby making the ratio worse. The false belief that growth can solve problems is why the GDP/GNP gets so much attention.
A corollary to the idea that growth can solve problems, is the idea that having centralized control makes things easier to manage. Somehow, having one person doing ten things simultaneously is better than having ten people each doing one thing well. This was the argument in favor of The Constitution, which took thirteen small problems and centralized them into one big problem. Had they been able to solve the money problem on a small scale, then they would have been able to solve it at a large scale. In fact, all they did was make the money problem larger. They did not have a grasp of the situation.
Both the growth and the centralization approaches ignore the importance of the R/E ratio. Centralization requires more regulation. The more the state regulates, the more its expenses will rise. Not only do problems scale, but they can compound at a different rate than the useful economic activity. This is the failure of the last 230 years of American government. We have created an economic prison. All of the solutions, combined with the expansion of the nation, have made the original problems worse. We now have multiple layers of false solutions.
The most troubling aspect of the GDP/GNP is that all it measures is the fiction of inflation. Inflation is a micro-economics transaction, caused by the application of percentages, in a buy-low sell-high sequence. The GDP/GNP is just the aggregate of these reported transactions. The growth in the GDP/GNP is not a growth in productive output, it is a growth in the value applied. It is painfully common to hear it claimed that a growth in the GDP/GNP will help relieve poverty. One Prime Minister recently reported that both the GDP/GNP and inflation were expected to increase at 7.5%. He did not recognize that the totality of the alleged growth in the GDP/GNP was just the increase in inflation. The twin increases were not going to relieve anything. He viewed the increase in GDP/GNP as good news, and the increase in inflation as bad news. He did not recognize the connection. His economic advisors were expressing cognitive dissonance. The GDP/GNP, like inflation, is commonly discussed and poorly understood.
The best way to understand the link between inflation and the GDP/GNP is to see it in action. Let's again use the example of an apple moving from tree to table, and being touched by five different businesses on its way. In the previous model, the farmer picked the apple and sold it to the cooperative, who sold it to the wholesaler, who sold it to the cold storage company, who sold it to the distributor, who sold it to the supermarket, who sold it to the consumer. Using a 50% profit margin, the apple cost 7.6 cents. Using a 100% profit margin, the same apple would cost 32 cents.
The difference between an economist an an entrepreneur is that an economist adds up all the totals, whereas the entrepreneur inflates their purchase price into a selling price. If we multiply our single apple by 100 million apples, the gross revenue for each business is one million dollars times the selling price. For example, in an economy with a one cent apple and a 50% mark-up the GDP/GNP is $20.78 Million (1+1.5+2.25+3.38+5.06+7.59=20.78). Using a 100% mark-up, the GDP/GNP is $63 Million (1+2+4+8+16+32=63).
The GDP/GNP is a reflection of the mark-up used and the original cost of the apple. An economist adds up the gross sales for each business to arrive at the GDP/GNP. There is no practical difference between a $63 million GDP/GNP and a $20.78 Million GDP/GNP. The only difference are the numbers that people write down. The same exact number of apples are moving from tree to table. Whether it is one apple or 100 million, the math is exactly the same. The only thing that grew were the numbers, not the physical output.
GDP Explanation by Steve Consilvio
There is another odd flaw in the economist's GDP/GNP methodology. The total is based on revenues, but not every business is profitable. A business that is losing money must borrow. That borrowing is counted as a sale for the bank. Banks have a unique revenue/expense ratio. They purchase the depositors money with interest, and sell the depositors money as a loan. This is unlike other forms of barter. Money is being exchanged for money. This double-counting inflates the GDP/GNP because losses are never recorded, the same as planned obsolescence, destructive losses, and unregulated transactions. Gambling and financial services move money from one hand to another, yet it is counted as a sale. For example, when a non-profit foundation gives money to a non-profit organization. The movement is counted as expense and revenue. Every transaction of money that is "government aware' gets counted, even when no product is being produced or consumed. The government has centralized the measuring of data, but like budgets, it is measuring its own false assumptions.
Banking and the creation of paper money have allowed both debt and inflation to become infinite. Measuring and misunderstanding the GDP/GNP is a common. The national debt and annual budget can be a very high percentage of the alleged GDP/GNP output. In some countries, the budget deficit is greater than the measured GDP/GNP, which is proof that the measure is meaningless.