Chocolate and Gold Coins

Tuesday, October 25, 2005

GNP and Contra-Bads

Dilip D’Souza has written an interesting piece about electric stabilizers: a device to prevent electric gadgets from India’s unstable electric grid. This is an example of a particular category of good which I will call a “contra-bad” to coin a term. A contra-bad is a good that simply exists to counter a public "bad". He argues that such goods should not be counted in GNP because they would have no value if other parts of the economy were not so inefficient.

Many of the goods and services we buy and much of the government sector is devoted to producing contra-bads. Security systems, guns, police, most lawyer services, and national defense all fall into the category of contra-bads. These are things that we would simply not need in a perfect world. It is reasonable to worry if too much of the economy is devoted to contra-bads instead of producing genuine goods like automobiles and homes and MP-3 players.

However, I would not agree that the existence of contra-bads means that the metric of GNP is flawed. GNP is not a measure of happiness. This essay by Atanu Dey might be relevant here. Or read this follow-up essay here. GNP measures what an economy is capable of producing. GNP is national income, (more or less). It measures what an economy is capable of buying. It is pretty clear that if you have a small GNP you probably would want to have some more of it. But a large per-capita GNP does not mean that you are actually buying things that make you happy, it just means that you have the income necessary to buy nice things. But you might end up wasting it on other junk. The Egyptian pyramids come to mind or this bridge.

It is a good question to ask whether too much of the economy is devoted to producing contra-bads instead of genuine goods. In the long run, your economy won’t grow if it is producing contra-bads or other intrinsically useless goods, (I am guessing that this was Ravikiran’s point).

However, it is wrong to say that contra-bads are bogus GNP. What a nation is capable of producing is largely independent of the types of goods that it produces. The Indian economy could easily switch from producing stablizers to MP-3 players or many other goods. If it isn’t producing a lot of goods, it isn’t the mixture of goods that it produces that is the problem; it is the regulatory environment and it is the types of skills that the workers lack that is the problem.

Contra-bads would seem to be wasted national income. Ironically, the U.S. probably spends more on contra-bads than anyone. But if Dilip is arguing that India really cannot afford to spend its limited income on contra-bads, I couldn't agree more.

15 Comments:

  • I think you brought out the salient aspects of GNP quite clearly. I also think Dilip was arguing that India cannot afford to spend its income on contra-bands........clearly, the GNP alone doesn't tell the full story.

    Good post.

    By Blogger Sunil, at 11:42 AM  

  • Hi Sunil
    Thanks.
    GNP tends to be misunderstood and misused. But it still shows roughly what a country is capable of producing.

    I should point out that National Income has a formal definition and it deducts sales taxes and depreciation, plus some other stuff, but it is closely related to GNP.

    By Blogger Michael Higgins, at 12:24 PM  

  • Here's a kicker. Suppose there are no facilities to build stabilizers, and the power is still fluctuating, you have burnt TVs, computers, etc. which brings further loss to the economy, just having to re-build or repair them. So in essence this is a measure of defense and is contributing to the economy. I understand both stabilizers and TV repair shops do not have a place in the perfect world and the world is not perfect. Thinking that these things shouldn't be accounted for in the GDP calculations is a mistake.

    By Blogger Ravi, at 1:34 PM  

  • But if you take his argument to the very end, automobils as an industry would be a contra-bad. We would not need automobiles if we can work from home (telework). In fact, the whole hosts of other industries would be listed as contra-bad - to includes healthcare.

    By Blogger Minh-Duc, at 2:55 PM  

  • Yes, in fact it is my point

    minh-duc, I don't think that it makes any sense to take the argument to the very end. Obviously, we should compare it with the next best alternative, not the the alternative we would have if things were perfect. Compared to a futuristic scenario where genetic engineering has eliminated disease, spending on healthcare is just a contra-bad. But we should look at what alternatives we have right now. If lack of public sanitation is a public bad, then spending on curing infectious diseases is a contra-bad.

    By Anonymous Ravikiran, at 12:21 AM  

  • Extending the debate here

    http://free-blog-site.com/navin/archive/2005/10/25/84954.aspx

    Ravikiran is slightly off the mark while explianing GDP growth

    By Anonymous Navin, at 3:58 AM  

  • Hi Ravi, Minh-Duc, Ravikiran, and Navin
    Ravi: No one denies that a contra-bad is a good that contributes to the economy. But its goodness is depended on an avoidable "bad" which presumable could be eliminated at a much lower cost than the value added of the "contra-bad".

    Mihn Duc: Ravikiran explained most of this before but I will say that -yes- the idea of a contra-bad is a little squishy but not as squishy as you are implying. I would only consider a good to be a contra-bad if its existence is solely to counteract a preventable human negative externality. So medical care is not a contra-bad.

    But I agree that there is an issue about whether a good is really contra bad or not. For example, if the electric plants in India were so very inexpensive compared to other plants that it was more efficient to keep them as they are and have people buy stabilizers, then stablilizers would be an ordinary good.

    Ravikiran: Thanks for the link above and answering Mihn-Duc's question.


    Navin: I apologize for Ravikiran's somewhat sarcastic tone on his blog but he is correct, you need investment to grow GNP. Investment can come from many sources, and one of them could be savings, but it could be borrowed from oversea or it could be reinvested profits.

    By Blogger Michael Higgins, at 7:02 AM  

  • A micro-economic perspective -

    Assuming two economies with equal gdp, populations and assuming equal real per-capita GDP, the economy whose citizens are spending more on contra-bads in their consumption basket automatically enjoy a lower level of standard of living by virtue of the extra spending on contra-bads just to enjoy the same level of amenities as the citizens of other nation. However the spending on contra-bads would still be GDP. However the unfortunate citizens would be putting more hours per-capita in work just to enjoy the same living standard of living. My point being I fail to see the benefit of excluding contra-bads from GDP measurement.

    By Anonymous Yadu, at 7:57 AM  

  • Michael, it is nice of you to apologise for my sarcasm, but I was irritated by Navin's use of that equation.

    Navin, if you think that the GDP equation says anything at all about my point, I'm afraid you do not understand my point.

    Yadu, just try these two scenarios:
    1) Someone breaks my glass window once every year. I spend part of my income replacing it. I am unhappy about it, of course.

    2) No one breaks my glass window. I use the same part of my income on drink. Drinking makes me happy.

    This is the scenario you were constructing - where the GDP is the same in two cases. In one case, I am happy; in another I am sad. But the GDP does not capture the difference between the two. If that were all to it, then Dilip's point is valid and there is something wrong with the GDP. Even if we do not exclude contra-bads, we might have had to discount them in some way to capture the differences in well-being. The reason why we don't have to, is that there is a third scenario, which is more likely (because of something called marginal propensity to save.), viz

    3) No one breaks my glass window. I use part of my income saved on drink. Drinking makes me happy. I also use the balance to beautify my house. Doing so increases the value of my house next year.

    In the third scenario, the GDP grows. Looking at the growth rate helps us understand which economy is doing well.

    By Anonymous Ravikiran, at 2:32 PM  

  • Ravi,

    I wrote abt the equation to make it clearer for all readers. I dont know you and your qualifications so you can't expect me to write in any fashion. If you are miffed at it , so be it.

    If your point is, investments only can boost GDP growth then i will say its INCORRECT.

    If your point is, breaking glasses will reduce GDP growth, then my questions is reduce compared to what ?

    Micheal thanks for your explanation but i feel, INVESTMENTS help in GDP but its not NECESSARY. I have explained the same in my post here


    http://free-blog-site.com/navin/archive/2005/10/26/84981.aspx

    By Anonymous NAvin, at 3:55 PM  

  • Yeah that was what I was trying to say, that trying to calculate GDP while excluding contra-bads would be too cumbersome. The reason we don't have to resort to that avenue is because a) There are alternative measures which can be used in conjunction with GDP to evaluate contra-bads. b) no measure is ever going to be perfect and complete.

    Michael, congrats on your invention of the term, it seems to be becoming popular.

    By Anonymous Yadu, at 1:17 AM  

  • Navin,
    My only point is that the equation proves nothing at all. Nada. Zilch. You couldn't have written it to "make it clearer" to all readers. Making it seem like it is a question of maths when it is a question of how we model the economy does not add to the reader's understanding. It only misleads him.

    By Anonymous Ravikiran, at 1:35 AM  

  • Hi Yadu Navin and Ravikiran
    The comments here are getting a little out-of-control in part because the comments section of Ravikiran's and Navin's blogs aren't working.

    Navin: How can you have growth without investment? Stop, don't answer the question, you simply cannot. Productivity increase can only occur if firms invest in new technology. They need to buy new hardware, new software, new training, hire better trained workers, whatever. If firms could get more productivity out of the same old technology, what were they doing wrong in the past?

    Savings and investment are different things. Savings in Japan could be investment in the U.S. This is why the current account deficit is always negative for the U.S. and positive for Japan. But one reason the return on investment is lower in Japan is partly because diminishing returns on investment.

    Yadu: The point I was making in my post was that it is important to keep separate the ideas of income and standard of living. Where I live, everyone has a high income but the money doesn't go far. But income is still a useful metric. I just have to understand that I need more information before I can translate income into "what do I get with that income." National Income accounting doesn't answer this second question.

    Ravikiran: I agree with most of what you write but it is important not to try to make an equation between GDP and standard of living. These are two very different things. Sure, they are correlated, and if thats all you mean then the contra-bads might show up as a form of error term in the regression. But there are a lot of factors that influence standard of living and its often times very hard to compare.

    For example, what price do you put on something abstract like 'freedom of religion'? That's why it is dangerous to go down the road of reading too much into the GDP measure. It measures what it measures: the value of the goods and services provided at their market prices. It doesn't measure national welfare.

    By Blogger Michael Higgins, at 5:47 AM  

  • It measures what it measures: the value of the goods and services provided at their market prices. It doesn't measure national welfare.

    Thank you, Mike.

    By Blogger Dilip D'Souza, at 12:35 AM  

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