Measuring progress in terms of GDP is an innocent fraud

John Kenneth Galbraith, arguably the most famous American economist of his times, died in 2006. On his death, some obituaries referred to him as the most read economist of all time (of course overshadowed by Karl Marx before him and Paul Krugman after him).

This wasn’t really surprising given the easy and lucid style of Galbraith’s writing.
A lot of what Galbraith learnt over 70 years of his work life has been summarised in his last book The Economics of Innocent Fraud — Truth For Our Time. “For some 70 years, my working life has been concerned with economics…During that time I have learned that to be right and useful, one must accept a continuing divergence between approved belief — what I have elsewhere called conventional wisdom — and the reality. And in the end, not surprisingly, it is the reality that counts,” he writes.

Galbraith refers this gulf between belief and reality as innocent fraud where “most progenitors … are not deliberately in its service.” 

One such innocent fraud is the measurement of economic and social advancement through the gross domestic product or the value of goods and services produced in an economy.

“Economic and larger advance is measured by the increase in total production of all goods and services…what is called the gross domestic product (GDP),” writes Galbraith.

“There are undoubtedly rewards from an increasing GDP, for from such increase comes the income, employment and services that sustain life and enhance its accepted enjoyments. But from the size, composition and eminence of GDP comes also one of our socially most widespread forms of fraud.”

And why does Galbraith call the way GDP is currently measured in, a fraud? “Good performance is measured by the production of material objects and services. Not education or literature or the arts but the production of automobiles, including SUVs…
The best human past is the artistic, literary, religious and scientific accomplishments that emerged from societies where they were the measure of success. The art of Florence, the wonderful civic creation that is Venice, William Shakespeare, Richard Wagner and Charles Darwin, all came from communities with a very low gross domestic product. It was their good fortune that they were free from the constraints of salesmanship.”

The second major form of innocent fraud that Galbraith points out is the business of projecting the economic future. Essentially “this is the world of finance — of banking, corporate finance, the securities market, the mutual funds, organised financial guidance and advice.”

And what is the innocent fraud here? Galbraith says, “The fraud begins with a controlling fact, inescapably evident but universally ignored. It is that the future economic performance of the economy, the passage from good times to recession or depression and back, cannot be foretold. There are more than ample predictions but no firm knowledge…Also with unforeseeable technological and other innovation and consumer and investment response. There is the variable effect of exports, imports, capital movements and corporate, public and government reaction thereto. Thus the all-too-evident-fact: The combined result of the unknown cannot be known.”

How does this cycle work? “The men and women so engaged believe and are believed by others to have knowledge of the unknown; research is thought to create such knowledge. Because what is predicted is what the others wish to hear and what they wish to profit or have some return from, hope or need covers reality.” And thus we think economic forecasters make sense.  

Another form of such innocent fraud is the belief that in corporation, the ultimate power lies with shareholders. As Galbraith explains “The fraud has accepted ceremonial aspects: One is a board of directors selected by management… It includes men and the necessary presence of one or two women who need only a passing knowledge of the enterprise….Given a fee and some food, the directors are routinely informed by management on what has been decided or is already known. Approval is assumed, including management compensation — compensation set by management for itself.”

As has time and again been shown, management compensation has no direct link with the performance of the corporation, making Galbraith’s point even stronger. “Reference to corporate management compensation as something set by stockholders or their directors is a bogus article of faith. To affirm this fiction, stockholders are invited each year to the annual meeting, which, indeed, resembles a religious rite. There is ceremonial expression and, with rare exceptions, no negative response. Infidels who urge action are set aside; management position is routinely approved.” And that’s how the world works and not in a way we think it does.