Sixty years may see a long time to you, but not to me. And not when you

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Sixty years may see a long time to you, but not to me. And not when you remember that the study of economics, in its recognisable form, started with the publication of Adam Smith’s Wealth of Nations in 1776.

GDP is the most closely watched bottom line of the "national accounts" for the Australian economy.

So what do GDP and the national accounts measure, where did they come from and are they as all-important as our economists, business people and politicians seem to think, or is GDP the source of our problems, as many environmentalists and sociologists seem to think?

What GDP measures can be described in several ways. I usually say it measures the value of all the goods and services produced in Australia during a period.

But because workers and businesses join together to produce goods and services in order to earn income, it’s equally true to say that GDP is a measure of the nation’s income during a period.

And since income is used to buy things, it’s also true that GDP measures the nation’s expenditure (but only after you subtract our spending on imports and add foreigners’ spending on our exports).

Now some qualifications.

GDP measures the value of goods and services bought and sold in the market place, plus the goods and services supplied by governments but paid for by our taxes. This means GDP doesn’t include the (considerable) value of all the goods and services – meals and so forth – produced in the home without money changing hands.

Economists (and economic journalists) make so much fuss about the quarterly ups and downs of GDP – is the economy growing or contracting, is it growing faster or slower? – it’s easy to assume that economic growth is something they’ve always obsessed about.

In truth, it’s a relatively recent preoccupation – suggesting it’s a habit we may one day grow out of. You see this more clearly when you consider the origins of GDP and the national accounts it springs from.

The 60-year anniversary is of the move to quarterly estimates of the growth in GDP in September quarter, 1959. It’s hard to be obsessive about something when you don’t get regular reports on how it’s going.

Fact is, until the Great Depression of the 1930s, economists were preoccupied with studying how markets worked ("micro-economics") and gave little thought to how the economy as a whole worked ("macro-economics"), let alone how fast it was growing.

In his recent history of the federal Treasury, Paul Tilley noted that it was just a department full of bookkeepers until the upheavals of the Depression caused its political masters to ask questions about what they should be doing that it couldn’t answer. That’s when Treasury became macro-economists.

It was the failure of "neo-classical" economics to provide an effective response to the Depression that led to the ascendancy of an Englishman who did have answers, John Maynard Keynes. At the heart of the ensuing the "Keynesian revolution" in economics was the notion that there was such a thing as the macro economy and that it was the responsibility of governments to "manage" that economy, ending its slump and getting workers back to work.

Once you started thinking like that, it became obvious that, to manage the economy effectively, you needed to measure it and track the changes in it over time.

The first economists to start developing a systematic and internally consistent way of measuring the economy, in the early 1930s, were Simon Kuznets in the United States and Colin Clark in Britain. Clark, a disciple of Keynes, moved to Australia in 1938 and spent the rest of his life as an adviser to the Queensland government.

For some years after World War II, our Treasury issued annual, out-of-date estimates of the size of GDP and its components.

The Keynesian economists’ preoccupation then was not with growth as such, but with keeping the economy at "full employment" – in those days defined an unemployment rate of less than 2 per cent – which, admittedly, did require it to be growing pretty quickly. In those days, however, GDP was used more as an aid to the short-run stabilisation of the business cycle – "demand management".

Paul Samuelson’s legendary introductory textbook, first published in 1947, which "brought Keynesian economics into the classroom", didn’t have an entry for "growth" until its sixth edition in 1964.

It was only about then that people became preoccupied with economic growth, as indicated by the growth in GDP.

The critics are right to point out the many respects in which GDP falls short as a measure of human wellbeing. But, though it’s true many people treat GDP as though it is such a measure, it was never designed to be used as such.

I agree with the critics that there’s more to life than economic growth and that politicians and economists should give less attention to growth and more to the many less tangible, less well-measured social factors that also affect our wellbeing.

It’s true, too, that GDP was developed before we became conscious of the need for economic activity to be ecologically sustainable – which the present hellish summer reminds us it certainly isn’t at present. In this sense, GDP is no longer "fit for purpose".

It’s wrong, however, to conclude that continuing growth in GDP is incompatible with ecological sustainability. People say that because they don’t understand what drives the "growth" that GDP measures (hint: improved productivity).

We can have unending growth in GDP and sustainable use of natural resources (which is what the environmentalists care about) by changing the way economic activity is organised – including by getting all our energy from renewable sources.

Discuss

Define GDPand distinguish between real GDP, nominal GDP and potential GDP as used in both the static and dynamic AD/AS models of the economy. Use your own examples to illustrate and explain your definitions.

2. Discuss whether, in your opinion, Gross Domestic Product (GDP) is no longer "fit for purpose".