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Wednesday, January 15, 2014

What Is the Real Gross Domestic Product?

I have been wondering what it really means when one states, as is often done, that Greece’s GDP collapsed by about 30% since the crisis erupted. For sure, it means that today’s GDP is about 30% less than it was back in 2009. But was 2009 a true reflection of the gross domestic product of the Greek economy?

Think of a village. Not a poor village but neither a particularly well-to-do village. One of the villagers hits the jackpot and gets 10 MEUR tax-free. Now he has to decide what to do with the money. Since he is 50 years old, he decides to spend all of it on consumption and enjoy the rest of his life. In fact, he spends about 1 MEUR annually and that, of course, allows him to lead a fantastic life. Life in the rest of the village improves a lot, too, because much of that money is spent in the village. Put differently, the village’s GDP explodes. Ten years later, the jackpot winner is 60 years old and he has run out of money. Unless he finds another source of income, he has to return to the living standard of 10 years earlier. And the rest of the village? That depends on what they did with the money recycled by the jackpot winner. If they spent it, too, they, too, will have to return to the living standard of 10 years earlier.

Where am I wrong?

7 comments:

  1. Imho your description is correct but incomplete. During the 10 years period prices have considerably risen. Local producers disappeared because even bred, butter and olives were imported because everybody felt that this was more fashionable...

    People got used to that life in paradise and when the dream abruptly stopped got angry without too much reflecting the causes.

    H. Trickler

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  2. You are not wrong herr Klaus. Only to suggest that althought GDP reduced around 30% the prices do not follow the same pattern in relation to income devaluation. The reason for that was the inability of greek state to regulate properly internal markets so as to become ευφικιεντ by promoting quality. The other reason -for my point- is related with the direction and our inability to show more interest in creating small but promising industries. To innovate. We see cafes and yiros.
    In 90' Sweden was in dire situation but in negotiations with foreigners the only they do not accept was to reduce funds for R&D. The boom in IT was one of the results.
    In Greece there is not a direction.

    Finally, about devaluation to add that the inflation althought in Greece is the lowest in EU 28 (-1.7) in oil prices is by far positive, in an economy poor of innovative companies.

    http://www.bankofgreece.gr/BogEkdoseis/sdos201309-10.pdf

    pages 95,96/196

    I believe that even if prices reduced and some quality reforms were reality, today the 30% less GDP will be much more bearable to the extent that also the economy could also take advantage from reforms.

    MS

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  3. "They will have to return to the living standard of 10 years earlier. Where am I wrong?"

    You are wrong in that 10 years earlier there was no 30% unemployment.

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    Replies
    1. I didn't say that there was 30% unemployment 10 years later and there wouldn't have been if everybody had kept doing what they were doing before they were showered with money.

      If, however, they had stopped doing what they were doing before, then, yes, there would have been unemployment. It is impossible to get a scrambled egg back into the shape it was in before it was scrambled.

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    2. There is no real and not real GDP. Open capital flows have been a way of life for sometime now, and how they influence GDP is very much real. If you consider the effects that capital flows have on GDP not real, then you must revert to the era of capital controls (i.e. implementing a domestic-based monetary policy and a controlled currency-rate, thus choosing two of the three options of the "impossible trinity").

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    3. Jim, you are getting a bit shallow now by explaining that capital flows have been a way of life for some time now. I've got news for you: capital flows have been a way of life (nearly) forever!

      The critical factor is what capital is used for. That's why I pointed out that the man, after receiving the 10 MEUR, 'had to take a decision'. If long-term capital is used for short-term consumption, you have the situation of the fellow who takes out a 3 month advance to pay for his vacation. He will enjoy his vacation but when he returns, the debt is still there. The man used capital which had no term; it was a gift. So when he had all spent it, he could easily return to the living standard he had before. The rest of the village could do the same if they had not used the money unwisely.

      Debt is not bad. It all depends what debt is used for!!!

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    4. You are not (wrong).
      The first mistake was made decades ago when Gross Domestic Product was coined and defined, according to definition it is in fact gross domestic consumption. Do not worry too much about the village; they have squirreled away enough money to survive until the next jackpot, some more some less. Later this year they will start gambling again on the market. Waiting for the jackpot is what the villagers mean when they talk about "back to growth" or "until the crisis we had the highest growth rate in Europe".
      Starve the beast.
      Lennard

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