At one point during my book session at the Urban Institute today, I made the comment that, just as the SEC sometimes makes companies restate past years’ income which turns out to have been partly sham, so maybe the U.S. should have to restate GDP for the last few years. Think about it – the financial sector was nominally producing 8% of the total, and much of this appears in retrospect to have been wealth transfers unaccompanied by the actual performance of services or creation of value.
E.g., suppose a firm made tons of money by purporting to insure 100% of New Orleans’ hurricane risk. The premiums go into GDP on the view that they are not just transfer payments but reflect the value of the insurance. Then Katrina hits and the firm goes bust since it’s totally unable to cover the undiversified risk. Was there ever really national income from the insurance premiums, or was this (take your pick) theft or the equivalent of a transfer payment?
That, of course, is basically the story of AIG. “We didn’t know a hurricane would actually hit New Orleans – our climate model, based on the previous 5 years’ results, showed no severe hurricanes in New Orleans whatsoever.”
OK, I’m engaging in a bit of snark here, not to mention argument by anecdote. But the underlying point is a serious one. Think of all the CDOs that were being swapped around for billions of nominal dollars. There was perhaps some genuine value creation mixed in there – diversifying within mortgages and creating risk tranches wasn’t entirely worthless – but due to the bubble economy the market prices grossly outweighed the actual value creation.
If there’s one thing we try to avoid in measuring GDP, it is making subjective evaluations of value rather than simply looking at prices and transactions. But what ultimately matters is the subjective underlying stuff – the actual creation of things people value. If there’s one thing we’ve learned in the bubble economy of the last few years – other than the facts that transparency is far lower and managerial incentive problems far graver than we realized – it is that prices really can go far, far away from the underlying subjective fundamentals that we care about.
I don’t, of course, seriously propose that we restate past years’ GDP. But it’s important to keep in mind that, even before the crash hit, we were not as rich as we thought we were, and in judging this conventional economic measures can lead us far astray.