(Mis)measuring Economic Wealth

In 2012, as Greece faced its economic crisis, German Chancellor Angela Merkel vocally supported proposed austerity measures. Approximately one year later, the International Monetary Fund (IMF) released a paper documenting that it had massively underestimated the multiplier effect, by almost double. The same report also attributes the slow Greek economy to the failure of the private sector, attributing this stagnation to a lack of confidence created by political turbulence. As Greece faces its third round of bailouts, the rest of the world is left to wonder where it went wrong. In a new paper, Joseph Stiglitz offers potential ideas about what may have contributed to the mismeasurement of wealth.

Economic wealth has commonly been measured using productive capital and labor; however, as economies and production methods have changed, these variables have become dated and less accurate measurement tools. Economists most commonly use land to measure capital, and land is actually a constant variable. Although the value of the land may increase, and thus increase wealth, the amount of land is constant. Stiglitz specifies that an increase in the value of land does not reflect an increase in economic productivity.

The second variable failure Stiglitz outlines is labor. Historically, it has been common practice to associate a higher number of laborers with a more productive economy. However, Stiglitz posits that this assumption is no longer accurate, as labor’s share of income is decreasing. What we’re seeing is not an increase in wealth; rather, it’s a redistribution, in Stiglitz’s words, “from workers to capitalists.”

However, this redistribution can occur at a higher level as well. Stiglitz contends that governments create a risk transfer when they allow the creation of monopolistic, “too big to fail” banks. The government is now liable for this risk, but our calculations don’t include this contingency on the balance sheet, and, therefore, the wealth is overestimated. Failure to recognize these redistributions can underestimate changes in society’s overall wealth, and could even lead analysts to conclude that economic growth is trending in an entirely different direction than it is in reality.

There are other limitations to the traditional wealth measurement approach as well. For instance, idiosyncrasies of human, social, and natural capital cannot be concretely measured. Stiglitz is particularly concerned about the failure to measure human capital regarding education. Acknowledging that some effects of education on economies are dubious, as it is difficult to determine if students stay in school longer to “wait out” a dwindling job market or if the cost of school becomes prohibitive in a downturn, there are more concrete interpretations available. Governments may lower education grants, funding for head start programs, or healthcare access, all of which have lifelong effects.

Stiglitz reports that, due to the recession, the US gross domestic product (GDP) is 15 percent lower than what it would have been without a downturn, and the European GDP is approximately 17 percent lower. After including a three percent interest rate, minus the discount, the loss is over $200 trillion. However, these calculations do not include the limitations he identifies to the measurement of capital and labor. Stiglitz argues that, if these were included in the economic calculations, the overall impact of the recession would be greater. While Stiglitz doesn’t offer specific alternative GDP percentages, the current post-recession reports support his theory that our miscalculations of wealth are underestimating the long-term cost of a recession.

A recent report indicates that this recession’s impact on millennials will be long lasting, as they may make less money over their entire lifetimes. Many millennials took underpaying jobs that they are now afraid to leave, hampering their personal job growth and lifetime wealth. Furthermore, the fear the recession ingrained in millennials is now affecting the stock market. While older generations held 46 percent of their wealth in stocks, millennials average only 28 percent. This highlights Stiglitz’s argument that, by failing to recognize these different types of capital, we fail to fully understand why recessions or downturns persist.

Furthermore, Stiglitz points out that, when we ignore the hidden costs of capital, we fail to craft meaningful and effective policies that could mitigate their effects. Stiglitz argues that these breakdowns in measurement have led to short sighted austerity programs that recognize only government liability, and inhibit viable long-term solutions. The Center for Economic and Policy Research seems to support this theory with modern data, demonstrating the failure of austerity programs to positively affect employment.

That being said, economists are beginning to think about and measure economic wealth differently. Following the self-admitted shortcomings of the IMF’s estimations in 2013, the IMF has altered its opinion and recently rejected a new austerity plan, calling for explicit debt relief for Greece. Separate from the IMF, Stiglitz and other economists publicly rejected austerity measures within Greece, while others pointed to the negative effects austerity had within Great Britain. As economists change their measurement techniques, and the IMF changes its perspective, there is an opportunity to learn and craft more meaningful and effective policy in the municipal default of Puerto Rico.

Article Source: The Measurement of Wealth: Recessions, Sustainability and Inequality. Stiglitz, Joseph E. The National Bureau of Economic Research, July 2015

Featured Photo: cc/(Ken Teegardin)