Robert Barro says GDP overstates national income because it counts investment twice.
Here is Scott Sumner explaining Barro’s point with an example:
Thus suppose Tesla builds a battery factory that costs $1 billion, which lasts for 20 years. They hire workers and pay another $2 billion in wages over 20 years. The batteries sell for a total of $3.3 billion, a profit margin of 10%. In this example, $4.3 billion is added to GDP over the life of the factory—$1 investment and another $3.3 billion in consumer goods (batteries). But there is actually only $3.3 billion worth of actual “goods” being produced; the $1 billion factory investment is an input.
As Scott Sumner points out, GDP isn’t meant to be a measure of national welfare, but of national output. This should always be kept in mind and should be pointed out whenever someone is using GDP per capita as a measure of welfare. But it’s clear that GDP, understood as national output, is really useful for many policy discussions.
That said, I was thinking about how to correct GDP to better measure that part of national output which is directly relevant to people’s wellbeing. And here’s what I would do: I would count all spending on consumption goods (private and public) as well as residential construction spending which is presently counted as „investment“. Following Barro’s critique I would not count spending on capital goods such as factories, machines, tools, and intellectual property which are only indirectly useful to consumers in so far as they help produce consumer goods in the future.
As for government consumption, I would suggest to apply a “waste correction” to take into account the fact that some of that consumption just isn’t useful to consumers. Spending billions of euros on a tunnel or an airport or a bridge which nobody has used yet or on a weapons system which (hopefully) will never be used, is to a large degree wasted money, although views will differ exactly how much of it is really wasted. At any rate, I think GDP should try to account for government waste.
So to sum up, I’d propose the following measure:
= Private consumption
+ Government consumption x (1 – waste ratio)
+ Investment in residential construction
Here’s what this would look like for Austria in 2018:
|million euros, 2018|
|of which waste||14.859|
|Ratio: welfare-relevant |
In other words, conventional GDP overstates the supply of goods that are directly relevant for the welfare of households by almost 30%. I would like the welfare-relevant GDP measure to be used when comparing living-standard across countries or within countries across time. And I would like growth theory to focus on the growth of this measure.
(PS: What about exports and imports? Exports aren’t welfare-relevant for the home country, because those are goods consumed by foreigners. Imports are, of course, already included in measures of private and public spending measures. So there’s no need to add exports and subtract imports as done in conventional GDP.)