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We Measure The Economy Wrong

We measure the economy wrong.

Well, maybe not wrong, but way we measure the economy is increasingly irrelevant to the day-to-day lives of citizens when attempting to measure positive effects.

If it’s reported that “the economy” is getting worse, you’ll probably notice the effects in your personal life. If it’s reported that “the economy” is getting better, you may not be as directly affected.

Let’s look at how we measure the economy today. Keep in mind, the economy isn’t a thing in and of itself. It’s a model of many different things, the modern version having been created by Adam Smith in his book The Wealth of Nations in 1776.

There are a variety of ways to measure this model, or at least some parts of it. Some of the more common ones include:

  • Gross domestic product (GDP)
  • Interest rate (Prime Rate)
  • Stock Market Indexes
  • Unemployment rate
  • Consumer spending
  • Exchange rate
  • GDP per capita
  • GNP
  • Government debt
  • Rate of Inflation
  • Balance of Trade

I want to look a bit closer at some of the most trusted and most cited measurements: GDP, interest rates, stock market indexes, and the unemployment rate.

Many of these measures are often proxy statistics in that they don’t directly measure what we want to know. Instead, they measure something that’s easier to define that we think will indicate the information we’re actually trying to find. While this is an extremely useful method in general, a proxy statistic can be misleading if the data is too far removed from the root issue. It’s especially important to remember this when looking to make changes or assess changes that have been made. If a proxy statistic improves, that’s great, but it doesn’t necessarily mean that the area in question improved.

With that in mind, let’s talk about some common economic measurements, examine if they affect citizens directly, and how substantially they do so.

GDP

What it measures

There are a few types of GDP measurement, but all attempt to answer the same question: “what is the total dollar value of all final goods and services produced in the country this year”. Final goods and services being ones delivered to the final consumer. (So lumber sold to a construction company to build houses that will be sold isn’t included in the GDP, but lumber sold to a homeowner for them to use in their own house is.)

There are three general methods of measuring GDP - production, income, and expenditure. Production attempts to answer this by calculating what is produced, income attempts to answer the question by calculating what sellers received in income, and the expenditure method attempts to answer by calculating what consumers spent.

Why it’s ineffective

The GDP rarely affects the average citizen directly. This is intentional as the GDP is intended to measure the state of a country’s economy as a whole. This is useful information, but its direct effect on any individual citizen can vary greatly. Generally the GDP decreasing is seen as bad, as it’s generally indicative of job loss or wages decreasing, and increasing is seen as good as it can be indicative of wage increases and lower unemployment.

However, while these things are related, it’s not necessarily a good measure of how the average person is doing. An example is when an industry is disrupted by a new one, for instance when the coal industry was (and is) disrupted by natural gas, and renewables. New jobs were created, new companies formed and grew, and the economy of America grew as a new industry was born. The GDP has increased in the last decade, in part because of this industry boom. It is reflective of new jobs being created and unemployment decreasing.

However, the new jobs being created aren’t in the same places as the coal industry. Unemployment for coal miners is rising. Wages decrease for the remaining miners. Towns based around the coal industry are dying. New jobs aren’t available in the area, and there are few and decreasing amounts of jobs for that particular skill set in the country. New job training is difficult to come by, expensive, or both. Almost all coal miners are going through difficulties ranging from wages not rising to losing a job in a dying town with no way to pay rent, and no way to gain skills needed to get a new job.

I am not making any commentary about the particulars of these situations, other than to draw your attention to the fact that these results aren’t really indicated by the GDP. The GDP can indicate how the average citizen is doing but doesn’t necessarily do so.

Interest Rate (Prime Rate)

What it measures

The prime rate is the rate that banks offer to borrowers with the best credit. This, at a high level, measures how expensive money is. If you can get a 15 year mortgage at 3% on a house that’s $100,000, that loan “costs” $24,304.70, as that’s what you’d pay in interest over the life of the loan.

That’s a relatively low cost for money, compared to a 7% rate where your interest costs would be $61,789.09.

Why it’s ineffective

Interests rates can affect the average citizen directly but not as often, or with as much impact, as might be imagined. One of the single biggest impacts this metric has is on new borrowers, particularly those purchasing a home. While this definitely impacts new home buyers, the current interest rate primarily affects those buying at that point in time.

An interest rate change immediately affects those on ARMs (adjustable rate mortgages). However the amount of mortgage holders using ARMs was is less than 7% this March, and that was the highest rate since 2014.

Not only that, but currently more Americans are renting than at any point in the last 50 years. With most Americans not taking on mortgage debt, the interest rate isn’t directly affecting them. While the interest rate affects real estate investors that need to pass on the costs to their renters, that rate only affects the investors that are purchasing at that point in time, or the small minority using AMRs. Renters are paying the passed-on interest rate from the time the owner took a loan to purchase the property, not the present one.

While this rate is relevant to some average citizens, it’s not many. In fact, the National Association of Realtors reports that in 2017 approximately 6.12 million homes were sold, and the US Census Bureau reports over 117 million households were in the US in 2016. So the interest rate affected slightly more than 5% of households in the US.

This statistic is relevant to those wanting to borrow money, but it is a proxy statistic of dubious quality for the average citizen.

Stock Market Indexes

What they measure

The most typical method to measure the stock market is indexes. The most common ones are the Dow Jones, a traditionally used index that measures 30 large US companies, and the S&P 500, a somewhat more diversified index of 500 companies.

Why it’s ineffective

Unlike some of the other metrics I’m diving into, the stock market does affect most Americans directly but not as substantially as you might expect. In 2017 the Federal Reserve found that 51.9 of Americans were invested in the stock market. It is worth noting that a change in the stock market would have no direct effect on almost half of Americans, but I want to examine that 51.9%. If you’re invested in the market, a change obviously has a direct effect on them, but how much?

Edward N. Wolff’s research shows 84% of the stocks are owned by the country’s richest 10%, meaning that the remaining 16% of stock ownership is spread far more thinly among American stockholders. So while market measures are relevant, they are mostly impactful to 10% of Americans and vary from less impactful to non-impactful for the vast majority of citizens.

So while this is probably the most directly impactful measure in the list of ones I’m covering, its impact is small relative to the weight it’s often given in discussions around economic policy.

Unemployment

What it measures

What this measures is pretty clear, but how the data is gathered is somewhat unintuitive. The data is not gathered from any type of welfare or unemployment payment data, but by a survey sent monthly to approximately 60,000 households. The percentage of respondents that claim they have no job and are actively looking is what determines the unemployment percentage. Respondents who have no job and report not to be actively looking are not included in this percentage.

Why it’s ineffective

Unemployment is interesting. In theory, low unemployment means that competition for labor is fierce, and should therefore be relatively easy to get a job if unemployment is low. This all seems to hold true; however, this measure does not cover some crucial pieces of information, namely: hours per week worked, wages, and benefits.

While unemployment directly affects citizens, the usefulness of the bare percentage is debatable. Let’s go back to our coal mining example. Let’s say a coal miner was making the average for a starting coal miner (~$60,000). When the miner loses their job, a few things can happen. Let’s say they get a new job with a minimum wage at $7.20 per hour and work full time - their annual income is now just over $15,000.

Let’s look at a less “minimum” example. Let’s say they get a job that pays double minimum wage and work 60 hour weeks - their income would come in at approximately $45,240 per year, only about three quarters of what they were previously making.

Another example would be this miner being unable to find full time work, so they take multiple part time jobs. Now they are likely working more that 40 hours a week, perhaps with income comparable to my previous example, but likely have no benefits.

In these examples, there is a serious deterioration in quality of life for the miner (or whichever person lost their job), and is not reflected at all in the unemployment statistics.

Going Forward

The economy as a comprehensive model is a relatively recent conception. As such we’re still learning how to measure the best possible way. The ones here: GDP, Interest Rate, Stock Market, and Unemployment are extremely important to the general study of economics and to large-scale political questions. However, their relevance to the average citizen is either deteriorating or was never extremely significant in the first place.

While I’m no economist, below are some metrics that will better serve most citizens in how they view the economy, its effects on themselves, and the general population. The economy is such a complex beast that there will probably be no measure that is worthwhile in all discussions. Hopefully these below can be added to the measures already provided so as to convey information about the economy that indicates how it affects the majority of citizens.

Real Wage Growth

Real wage growth would measure wage growth after inflation is taken into account. So if a person gets a 3% raise but inflation is 5%, they have actually had a real wage _decrease _of 2%.

This will show if the actual buying power of the average citizen is increasing or decreasing.

Cost of Living to Wage Ratio

This ratio is similar to the last one but is connected more directly to living expenses. So this is more useful for showing day to day expenses but less able to indicate social mobility. This is particularly significant in areas with a high cost of living.

A raise of 10% can sound substantial, and it generally is, but if rent also went up an average of 10% the person effectively didn’t receive a raise.

Multiple Employments

This metric could be paired with the current unemployment statistic.

This metric will indicate how many employees find it necessary to work multiple jobs, provided in conjunction with the unemployment rate we’re familiar with for context. So if the unemployment rate stays at a low percentage, but the multiple employment rate rises significantly, it would indicate a decrease in higher-paying jobs.

Fully Employed People On Government Benefits

A benefits metric will indicate how poor the employment market is or isn’t by demonstrating how many full time employees still require government assistance to make ends meet.

A low percentage here would indicate a presence of higher-paying jobs, while a higher percentage would indicate the need to investigate why fully employed people need government assistance.

Compensation vs. Wages

Companies include benefits in their calculations of compensation (as they should). However this is less relevant to the average citizen as it doesn’t directly affect them as long as they are receiving them. The costs to a company of retaining an employee and the wages that the employee are receiving are both relevant measures and should be exposed.

This data is significant as it will highlight where costs are going. Often company compensation costs increase, but due to rising healthcare costs, wages aren’t rising correspondingly.

Summary

Current economic metrics are good for measuring the economy from an academic standpoint, but are less indicative about what’s happening to the average citizen. Any single measure of something as large as the economy is incomplete, but adding the metrics I’ve suggested here will help bring greater visibility to how changes in economic policy are affecting citizens of a given country.

Even if new metrics become more common as we progress, newer and better measures should always be considered. Economic policies must be made with the democratic majority in mind, and while perfect data is hard to come by, recognizing incomplete data is the first step to improvement.

Photo Credit: https://www.flickr.com/photos/kjgarbutt/6407312465

Author

Eldridge Alexander

Manager of Duo Labs at Duo Security. Formerly employed at Cloudflare and at Google. Technologist, magician, designer, musician, videographer, blogger, and avid sweet tea drinker.