William Petty, hoping to avoid taxes, tallied national income for the first time in 1664. Source: National Portrait Gallery, London

Earliest Calculations of GDP Had Some Unexpected Results

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March 28 (Bloomberg) -- Early this morning, Commerce Department officials released the latest figures for U.S. gross domestic product, which showed that fourth-quarter growth was somewhat faster than previously estimated.

Such announcements tend to be eagerly awaited. GDP aims to compress an entire economy into a single number, putting a price on the total amount of goods and services a nation produces. Governments, markets, pundits and investors all count on this singular, miraculous figure to offer some indication of whether things are getting better or worse.

The extent of GDP’s power can be gauged by the elaborate ritual that has evolved in Washington around its official announcement. Twelve times a year, Steve Landefeld, the director of the Bureau of Economic Analysis, and his team lock themselves up without access to phones or the Internet, draw the curtains, and carry out a task that has been refined over 50 years. They have one goal in mind: to arrive at a single number through the convergence of about 10,000 data streams from recent economic activity, including harvests, construction and retail sales.

Once determined, the number is noted in a press release, which is locked away. A single copy is delivered to the president’s Council of Economic Advisers. So powerful is this figure that no one may utter it before the official revelation; its premature release could rock global markets. Only at 8:30 a.m. the next day is it officially released.

Calculating Income

GDP, as we know it, is younger than Alan Greenspan, but the idea of measuring national income was first conceived 350 years ago by English polymath William Petty. During a career in medicine, music and politics, Petty made the first quantitative analysis of the national income and wealth of England.

With England at war with the Dutch Republic, Petty, a wealthy landowner, feared that taxes on land would be increased. In his “Verbum Sapienti” (“A Word to the Wise”) in 1664, Petty demonstrated that, contrary to common belief, land produced only a small portion of England’s national income -- and landowners, therefore, made up only a small part of the potential tax base. By estimating the wealth and national expenditure of England and Wales, Petty found there was a much larger, and as yet untapped, source of income to be taxed: labor. His analysis showed that labor produced three times more income than land.

This was the first quantitative analysis in economics, a discipline that wouldn’t officially emerge for 100 years. Petty wrote of his approach: “The method I take to do this, is not yet very usual; for instead of using only comparative and superlative words, and intellectual arguments, I have taken the course (as a specimen of the Political Arithmetic I have long aimed at) to express myself in terms of number, weight and measure.”

It took more than 250 years, the Wall Street Crash of 1929, and a worldwide depression for economists to fully appreciate Petty’s quantitative approach to national income. The first to investigate the concept comprehensively was John Maynard Keynes, in “The General Theory of Employment, Interest and Money,” in 1936. Meanwhile, Presidents Herbert Hoover and Franklin D. Roosevelt had commissioned the economist Simon Kuznets to develop estimates of U.S. income to guide their policy responses to the Great Depression.

Kuznets’s “National Income, 1929-1932,” was the first comprehensive measure of national income and output. His accounts, a set of industry-by-industry estimates, allowed Roosevelt to describe the performance of the U.S. economy in his budget request to Congress.

War Economics

World War II gave further impetus to the development of national accounts. The government needed to assess the effects of moving from peacetime consumer spending to federal spending on war. This early measure evolved into the gross national product (or GNP), a term Kuznets invented, which later became GDP.

Across the Atlantic, the war gave Keynes the chance to persuade the British government to implement his theory, arguing that it could be applied to managing the risk of inflation incurred by war. To apply it required national-income statistics. By early 1941, the U.K., too, had a set of national accounts.

Despite Keynes’s belief that these were emergency measures only, for use in war or depression, the postwar rise of organizations such as the World Bank and the International Monetary Fund made these measures essential for most countries. The success of Kuznets and others in developing national-income accounting was described by the economists Paul A. Samuelson and William D. Nordhaus as “truly among the great inventions of the 20th century.”

In the 21st century, however, GDP accounts are in some ways wanting. Driven by concern for the environment, some economists are reconsidering the productive power of land -- or nature. Echoing Petty’s discovery about the value of labor, a 1997 study by professor Robert Costanza estimated that nature provides goods and services worth trillions of dollars annually to the world economy.

Current GDP measures only account for legal transactions in the money economy, not stocks of wealth or unpaid work. Rainforests felled for timber boost GDP, but an intact rainforest counts for nothing, despite the work it does absorbing carbon dioxide and sustaining the water cycle. We are beginning to feel the costs of such omissions.

In 2012, the United Nations adopted a new international standard to give “natural capital” equal status to GDP. Just as GDP emerged during the 1930s in response to great crises, so alternate measures are now being developed in response to the environmental crisis. Deciding what to include in national accounts by definition requires some judgment calls. So take the latest GDP figure for what it is: a human construct, not a comprehensive -- or fully objective -- measurement.

(Jane Gleeson-White is the author of “Double Entry: How the Merchants of Venice Created Modern Finance.” The opinions expressed are her own.)

To contact the writer of this post: Jane Gleeson-White at janegleesonwhite@iprimus.com.au

To contact the editor responsible for this post: Timothy Lavin at tlavin1@bloomberg.net