The idea of GDP is simple: the summation of what is produced within the UK avoiding any double counting. It is used to assess how well the economy is doing overall. For the government of the day, growth is good because it suggests we will all be better off. Though GDP is a very imprecise measure, it is one that most people broadly accept.
The economy used to be measured by gross national product (GNP). That measured what UK-owned assets produced, irrespective of where they were in the world. But GNP fell out of favour as UK owned assets were sold to foreign investors with the result that the economy, by that measure, appeared to be in decline. Successive Chancellors tried to make out the sale of UK owned assets was good, because it showed UK was ‘open for business’. But it didn’t really wash. So, since the 1980s, GDP has been the standard measure.
GDP is calculated by simply adding the product of various sectors together as if they were all of equal worth. But in truth some sectors benefit the common good and others are predatory on the common good. But if GDP is growing the government of the day takes credit for successful economic management, irrespective of the fact that it is the predatory components that have grown at the expense of the good sectors.
GDP is a deceptively complex measure of economic performance. To illustrate the problem, consider just two of the components: manufacturing and finance. It is important to understand the characteristics of these two sectors and in particular their relationship to each other.
Though there have been banks since ancient times, the wider financial sector was brought into existence primarily to finance the industrialisation process. Unprecedented amounts of money were required to build the transportation infrastructure, mills and factories and their world-changing technological innovations. The financial sector with its early stock markets and dispersed shareholdings was brought into existence to raise the necessary funding. Industrial development was the foundation of our ever increasing standard of living (and still could be). Calculating GDP by adding all components including manufacturing and finance in those early days made sense.
But the world has changed. The 1986 computerisation of stock markets combined with the neo-classically driven deregulation of markets had unforeseen consequences. New IT and deregulation encouraged a vast number of new financial intermediaries, private equity, hedge funds etc, widely referred to as ‘shadow banking’, to set up shop in the City of London. At the same time it enabled the creation of whole new ranges of financial ‘products’, securitised packages of mortgages, swaps and derivatives. The detail is written up elsewhere, but the effect is what matters. The new fund managers and traders, who post-1986 control the financial sector, were driven to achieve the big, fast returns available from the new financial ‘products’, rather than from traditional infrastructure, manufacturing and non-financial services.
This has resulted in a change of direction in the flow of finance. Money is no longer being raised for the real economy (manufacturing, start-ups, SMEs etc) to pay for new facilities, develop new products and create new jobs. Instead it has been redirected into the virtual economy where it is used to speculate on the future value of financial securities. This creates investment bubbles with the inevitable result. Because of the quicker and higher returns available from finance than from manufacturing, funding has been taken out of the real economy and redirected into finance. This redirection has been made even more attractive by the fact that when the bubbles burst, the resulting damage is paid for by the general taxpayer rather than by the financial sector that made fast returns by inflating the bubble.
This reversal of the flow of finance was reported in America almost three years ago to have been a ‘multi-trillion dollar transfer of cash from US corporations to their shareholders over the past 10 years’ [Fox J and Lorsch J W (2012), ‘What good are shareholders?’, Harvard Business Review, July] with a parallel disinvestment in London. Money was taken out of the real economy and passed via shareholders to the professional traders and fund managers for its control. The effect was massive. The global market for swaps and derivatives was estimated, at the time of the 2008 crash, to be worth $54 trillion, close to the value of global GDP and many times the value of the world’s stocks and shares [Lanchester, J, (2010), Whoops! Why Everyone Owes Everyone and No One Can Pay, London: Allen Lane, p64].
From enabling and supporting the real economy, the financial sector has become predatory on it, repeatedly stripping its assets and investing the proceeds for quick maximised returns. The result has been a hugely expanded financial sector and an explosion of inequality. Governments are aware of the problem and talk about ‘rebalancing’ the economy, meaning increasing the share of GDP derived from the real components. But the simplistic GDP measure, which looks good because of the growth of predatory finance is too convenient for them to actually do anything to ‘rebalance’.
The picture remains opaque while ever GDP components are simply added together to achieve the main measure of economic progress. Adding manufacturing and finance together as though they were of equal value, pound for pound, ignores the fact that one provides jobs and products and is for the general good, while the other is predatory benefiting only a narrow subset of the population.
So long as the gains in finance are greater than the losses in the real economy then GDP growth will be positive. Which is why GDP, despite its incoherence, remains the key measure for politicians. A positive GDP is what will be made to count at the next election. Though some politicians may believe GDP is a suitable measure, it seems rather more likely that, as part of the super-rich establishment, they are ‘intensely relaxed’ about the rise of finance and the inequality it has caused. So long as GDP grows.