f This is the Modern World
Friday, January 13, 2012 7:30 am
The distortions of GDP: Hedonic pricing and financial productivity growth

#in If you take away much of the growth in financial services productivity and strip away the method of calculating the GDP deflator using hedonic pricing, the exceptional growth of the US economy looks pretty unexceptional. That’s the argument of Yves Smith.

I am directly plagiarizing the words below from Smith because I want to slim the article into two key points that show a massive distortion of American prosperity. With apologies to Smith, I recommend reading the full post.

1. The chimera of financial services productivity.

The conventional view that European productivity gains lagged those of the US starting in 1995 is increasingly questioned. From Paul Krugman in 2009:

I went back to something that was a hot topic not long ago, and will be again if and when the crisis ends: the apparent lag of European productivity since 1995…I noticed something that gave me pause.

In their paper, van Ark etc. identify the service sector as the main source of America’s pullaway — which is the standard argument. Within services, roughly half they attribute to distribution — roughly speaking, the Wal-Mart effect. OK.

But the other half is a surge in US productivity in financial and business services, not matched in Europe. And all I can say is, whoa!

First of all, how do we even measure output of financial services? If I read this BEA paper correctly, we more or less use “checks cashed” — or, more broadly, the number of transactions undertaken. This may be the best we can do, but it’s a pretty weak measure of actual work done by the financial system.

And given recent events, are we even sure that the expansion of the financial system was doing anything productive at all?

In short, how much of the apparent US productivity miracle, a miracle not shared by Europe, was a statistical illusion created by our bloated finance industry?

Dean Baker has argued for some time that, properly measured, the productivity gap between America and Europe never happened. I’m becoming more sympathetic to his point of view.

2. The fallacy of the “hedonic price index”

Let’s look at GDP. That’s a fundamental figure, surely beyond question or compromise. Really? Our GDP stats include something called a “hedonic price index” basically to allow for the fact that computers are becoming more powerful at lower costs. In essence, the US grosses up the price of computers in its GDP reports to adjust for the fact that computer prices are dropping.

These adjustments are significant. The US is the only country that uses hedonic indexing. The Bundesbank complained that if they calculated GDP the way we did, their GDP growth would be 0.5% higher. And the cumulative distortion is massive. In 2005, Michael Shedlock contacted the Bureau of Economic Advisers and they supplied some dated information on hedonics (including a spreadsheet). Even so, he found that hedonic adjustment to GDP was 2.257 TRILLION dollars, or 22% of then-current GDP.

Monday, December 19, 2011 7:10 am
Help us Iceland. You’re our only hope.

#in The economies of the developed world need help. We need a hero. We need Iceland. Yes, this Arctic country of about 320,000 people has been held up as model of how to handle the fiscal and banking crises that have shaped our economic debates since 2008.

Iceland was booming during the last decade. People flocked to the renowned Reykjavik club scene and enjoyed the steamy waters from the volcanic springs. It’s the land of Bjork. You’ve probably heard of Bjork, right? She’s the pint-sized singer who has been churning out innovative and distinct music since the early 1990’s. But Iceland’s banks offered the best stage show: at the 2007 peak, Iceland had a banking system that had grown to 10 times the size of its national economy thanks to aggressive loans made all across Europe. Then the party stopped.

Iceland’s economy has been something sort of like Bjork’s career in reverse.

Bjork is now established as one of the most innovative performers of our time. But her first band, The Sugarcubes, were just a hit with college radio stations. They were a Nordic version of the B-52s. With Einar Orn Benediktsson playing the Fred Schneider role. 

The B-52’s had some great tunes and they played some funked out party rock. Kate Pierson and Cindy Wilson wore big beehive hair styles and had gorgeous voices. Unfortunately, they decided to add some comedic relief to their band by interspersing the vocals of Fred Schneider. It was like putting Paul Lynde from Hollywood Squares on with the Supremes. I don’t need to hear “Rock Lobster” or “Love Shack” ever again. Please, for the love of all that’s decent, I beg all wedding Djs to leave “Love Shack” off the playlist.

Unlike the women in the B-52’s, Bjork figured out she was the real star and went solo after a couple Einar-laden albums. The Iceland banks did the same thing. They figured out that they could hang with the big boys and started making loans like crazy.

When the party ended, Iceland did something that other countries did not: Rather than bail out their banks with sovereign funds, they allowed them to fail. People lost a lot of money. Iceland’s economy shrank, big time. But they have emerged from the wreckage with a low-ish national debt, they have once again returned to the international bond markets, and their devalued krona is allowing exports to boom. They also implemented capital controls (a controversial move).

Iceland’s been such a hit with so many economists, that the IMF, Jospeh Stiglitz, Paul Krugman and others decided to hold a big summit on the lessons that were learned.

It stands in sharp contrast to Ireland, who effectively decided to nationalize the banking system (with one exception, thank you Wilbur Ross). Now Ireland faces a national debt that it will struggle under a generation of austerity to pay off. They are tethered to the Euro, so they can’t allow their currency to depreciate.

I’m not going to get into all the great ideas that came out of Iceland. I just find it interesting that a nation of 300,000 can be a model for how to deal with an economic crisis. I live in Omaha. We have 880,000 people in our MSA. We’ve got some pretty damn smart people living here, but I couldn’t imagine us having our own currency, central bank, and national anthem. 

Could you imagine the IMF looking to a nation called Omaha for lessons on macroeconomic and fiscal remedies? Successful case studies are great and all, but Iceland? Holy crap! I mean, Vladimir Putin has chunks of guys called Iceland in his stool. There are more people born in in six days in India than live in all of Iceland.

All right, all right, enough with the Iceland put downs. Its a fine country and we are lucky to have it as an economic lesson. And if Fred Schneider wants to move there and start a band with Einar, that would be fine.