Towards a measure of welfare-relevant national output

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:

Welfare-relevant GDP
= 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
Private consumption199.459
Government consumption 74.295
      of which waste 14.859
Residential investment 17.232
Welfare-relevant GDP276.126
Conventional GDP386.063
Ratio: welfare-relevant 
/ conventionalGDP
71,5 %

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.)

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A quick game theoretic thought about the Brexit negotiations

In the last few days, I watched the British news a bit about Boris Johnson forming the new UK government. There was of course a lot of talk about the Brexit negotiations. I was a bit puzzled at one point about some of Boris Johnson’s statements. On the one hand there is a lot of talk about being prepared for a hard Brexit and on the other I also heard him say something like that “the chance of a hard Brexit is one in a million” a little while back. So why prepare for some contingency that you do not expect to happen under essentially any circumstances? Also you get the feeling that Boris Johnson, despite having said that, would not so much mind a hard Brexit. In this short post, I explore why all this might actually all make good game theoretic sense (and why perhaps, at least for this matter, his UK opponents should get on board with his strategy if they care about the UK unless, of course, they think they can still stop Brexit).

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Confirmed: Raising tariffs is shooting yourself in the foot

As everybody knows from Econ 101, protective tariffs are harmful for the country that imposes them. A protective tariff is a tax on imports that is so high as to make all imports fall to zero.

But there is an argument why a low tariff may be better than no tariff at all. The reason is that a large country (large compared to its trading partners) faces an upward-sloping supply curve for its imports such that a fall in import demand lowers the world-market price of imported goods. Hence, part of the cost of the increased tariff would fall on the rest of the world due to lower export prices (a fall in the terms of trade) while the country that imposed the tariff might win overall.

Whatever the theoretical merits and demerits of this argument, recent experience with tariff increases in the US (aka Trump’s Trade War) provides powerful evidence against it.

In a newly released paper, Amiti, Redding and Weinstein show that the tariffs imposed last year by the Trump administration had two main effects:

1) US prices of imported goods rose one-for-one with increases in tariff rates.

2) Import demand decreased substantially with an estimated price elasticity of 6 (i.e. 6 percent lower imports for every 1 percent of higher tariffs).

As a consequence of these two results the paper estimates the welfare costs of the Trade War to be about 6.9 billion dollars. While that is not a huge number compared to the total size of the US economy, keep in mind that we’re only talking about a marginal change of the average tariffs from 1.5 to about 3.25 percent. And remember that the welfare costs rise with the square of the applied tariff rate. So should tariffs go up more in the future, the welfare costs will be much bigger.

I regard this as decisive evidence that the optimum tariff is indeed zero. Note that finding No. 1 implies that American consumers are paying the full cost of the tariff increase, with no terms-of-trade effect on the rest of the world. If even the largest economy in the world cannot improve their terms of trade by increasing tariffs, then smaller economies have no hope of doing so either. Raising tariffs is indeed shooting yourself in the foot.

Moreover, this paper is also a triumph for simple textbook economics. The results of Trump’s tariffs are exactly what one would expect from the kind of supply-and-demand model taught in Econ 101. As Tyler Cowen points out, the complete pass-through of tariffs to consumer prices also implies that monopoly power is not a big issue in these markets. It’s good to know that the much-maligned perfect competition partial equilibrium models still gets some important things right.

Good and bad monopolies: the case of Coca-Cola (or Red Bull)

In this series of short posts I give you my personal opinion (as it is at the moment) and my reasons for this opinion about how good or bad I believe different monopolies to be. I am planning six mini-case studies of monopolies. When I talk about a monopoly in this post I simply mean a firm that has some power over its price: it can choose a lower price and sell a bit more (but not super much more) or a higher price and sell a bit less (but not super much less). A firm with such a power will typically – see a previous post – choose a higher price and sell less than would be Pareto-efficient. And this way such a firm will typically make “abnormally” high profits. While all this is probably true in all six cases, I am, for various reasons, in fact not equally worried about every one of these. I want to discuss the following six “monopoly” cases: Coca-Cola (or Red Bull), Google, Facebook, Scientific Publishers such as Elsevier (possibly also publishers of €100 textbooks such as Pearson), the OPEC cartel of a set of oil producers, and pharmaceutical companies (such as Novartis). This one is about Coca-Cola, and applies equally to Red Bull.

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Intro to Econ: Seventh Lecture – Competition

Economists tend to think that competition between firms is a good thing. In fact most countries (all?) have some anti-trust regulation in some form or another. Anti-trust means against “trusts”, where trusts are here meant to be cartels (groups of firms) that collude especially by determining prices together and thus avoid competitive pricing. But how would competition improve matters in the first place?

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Intro to Econ: Seventh Lecture – Pricing in the presence of a flat demand function

What if you, as a producer or at least seller of some good, face a “flat” demand function? With “flat” demand function I mean any demand function that has a non-infinite slope, that is any demand function where you can vary the price a bit and this does not immediately lead to a demand of more than you can provide (at a slightly lower price) or a demand of zero (at a slightly higher price). This means that in such a case you could choose a price, and different prices will have different consequences for you but also for your consumers.

To fix ideas consider the following situation. You are in charge of a student organization and you are trying to do a bit of fundraising. You are thinking of showing a movie in a university lecture hall at reasonable ticket prices to students. You have convinced the university that they let you have a largish lecture hall with 500 seats for free. You only have to pay for the cleaning cost, which say amounts to €200. You also have to pay for the right to show a movie, which say amounts to €500. You have otherwise convinced some of the other members of the student organization to help with ticket sales, advertising, and other matters, for free. The key question for you is now, what to charge the students for the tickets?

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