GDP and Other Complex Numbers

When investment advisors want to justify their expensive and ineffective advice they look for red herrings to batter their clients with. One such example surfaced in, of all places, Pieria last week. It was an article sourced from Schroders about how misleading GDP is  as a measure of economic wellbeing. The article is one of three dedicated to telling investors that they ought to ignore GDP as an indicator worthy of informing their investing. Instead, presumably, they ought to pay Schroders lots of money for its ‘value-investing’ based advice.

Well, I happen to agree that GDP is a bit of a farce. It ignores all sorts of useful stuff and includes all sorts of silly stuff. It totally ignores domestic work as if it didn’t exist, and puts the consequences of socially negative events – the reconstruction after an earthquake – on an equal footing with activity generated by socially positive events.

The problem, at heart, with GDP is that it includes only things that are easy to measure. Easy, that is, being described as having a market price or a convenient cost that the economists and accountants compiling the numbers can identify.

Since the economy is vast and complicated getting hold of even this kind of information can take months. This means that GDP figures are pretty much always revised. The so-called first release is never where the final numbers end up, so no one ought get too excited over it.

But people do.

We live in a short term society, where numbers of various kinds flood our attention, and where we are inured to using them as the basis for conversation, argument, and even policy action.

But they are invariably inaccurate.

This is what the Pieria article bases its argument on. The economy is too complex to be banged into one number. The number always shifts about providing no bedrock on which to stand, and, besides, who can trust numbers that consume and army of technicians to compile?

And tinker with: clearly the author gets upset over technical ideas like ‘chain weighted’ indices and ‘hedonic pricing’. I get that. They are a tad complicated and are easily attacked. But they are also useful. They help add to the numbers. They make things a little more consistent. And consistency is the great goal of all number crunchers.

Being written by someone steeped in the private sector, in finance and investing no less, the article – actually all three in the series – smells a bit of anti-government sentiment. Those GDP numbers cannot be trusted because the economy’s complexity eludes the government simpletons, all thousands of them, trying to distill it into GDP releases.

This is very Hayekian. The essence of Hayek’s extreme position was that the economy is essentially inscrutable. It is unknowable. It is so vast and difficult that it lays beyond our ability to comprehend, calculate, and thus manage. Central planning, under such circumstances, is thus a fool’s errand. At best it has no effect, at worst it makes things a lot worse. It is, therefore, better to leave the economy to itself and the so-called self-adjusting capabilities of the marketplace. If you believe in such magic of course.

To anyone who has striven away in the bowels of big business this exact same notion will sound familiar. The accounts of a large bank are only loosely related to the actual economic position that the bank occupies. Likewise any business. The accounts are simply an indication of what’s going on, their relevance is useful only in the context of skillful interpretation. They are no more or less ‘real’ than any of the numbers we see for the national economy. All such accounting, even with the best intentions, is a vague representation of reality. And, as such reality will always elude us. It isn’t measurable. Besides we can’t even agree on what to count.

So if a Schroders customer cannot trust GDP, and ought not invest on the basis of the numbers, then they ought not trust any other number compiled by armies of technicians. Such as corporate balance sheets and income statements. That means we would be left with nothing but the guesswork of ‘experts’.

And chicken entrails perhaps? That’s an interesting twist on ‘value investing’.