The Misjudgment That “Russia’s Economy Has Grown”

The Illusion of “GDP Growth” from Higher Wartime Defense Spending

Relying on Statistics Alone Easily Leads to Misreading the Economy

Growth Without Wealth… We Must See Through the Errors of Keynesianism

In the recent World Economic Outlook released by the International Monetary Fund (IMF), one questionable set of data stands out. It says that Russia’s gross domestic product (GDP) grew by 3.0% last year and is projected to grow by 2.6% this year. As everyone knows, Russia is now in its third year of war. War consumes wealth that has been accumulated; it does not create new wealth. So the claim that Russia’s wartime economy has grown cannot help but seem strange.

The key to this oddity lies in how GDP is measured. GDP is the market value of all final goods and services produced during a given period. GDP measured this way is called production GDP. At the same time, all goods and services produced are purchased by someone in society. Therefore, the total amount spent by members of society to purchase them is equal to the amount measured from the production side. GDP measured this way is called expenditure GDP, and specifically it is calculated as the sum of household consumption, business investment, government spending, and net exports (exports minus imports). Based on this expenditure GDP, if government spending rises, GDP rises. The reason Russia’s wartime economy appears to have grown is that it more than doubled its defense spending.

That production GDP and expenditure GDP are equal is an accounting identity. Yet governments and many economic experts have turned this identity into a theory of causation and used it to justify growing the economy by increasing government spending. But simply because GDP statistics rise does not mean people’s lives improve. People’s lives improve when the production of goods and services increases and their quality improves. That is true economic growth. The agents that produce goods and services and create wealth are the private sector, not the government.

If one looks only at GDP figures, it is easy to misjudge economic conditions. A representative example is the claim that World War II ended the Great Depression. The Great Depression was the worst economic crisis in U.S. history: the unemployment rate, which was 3.2% in 1929, rose to 25% in 1933 and remained in double digits through 1940. Then, after the outbreak of war, unemployment fell to 1.2% in 1944, while GDP reportedly increased by 84% during 1940–1943. Looking only at the statistics, it seems as though World War II ended the Great Depression. But the sharp decline in unemployment during the war was the result of military conscription, and the surge in GDP was due to increased government spending for the war effort. Because of higher government spending, GDP rose, but in reality private consumption and investment fell. In 1943, real private GDP excluding government spending was 14% lower than in 1941, and due to shortages of consumer goods and soaring prices, the lives of ordinary Americans were extremely difficult.

Another example of misreading economic conditions by looking only at GDP statistics is Nobel laureate Paul Samuelson. In the 1961 edition of his famous introductory economics textbook, he noted that the Soviet Union’s GNP was about half that of the United States, but predicted that because the Soviet economy was growing faster, Soviet GNP would surpass that of the United States by 1984, or by 1997 at the latest. As his predictions kept missing the mark, he later postponed the crossover point to 2002–2012.

Larry Summers, who served as President Obama’s chief economic adviser, also said after the 2011 Kobe earthquake in Japan that “when a disaster occurs, the reconstruction process can paradoxically cause GDP to rise temporarily.” Another Nobel laureate, Paul Krugman, wrote in a New York Times Op-Ed after the September 11, 2001 terrorist attacks that “as terrible as it may sound, a terrorist attack like Pearl Harbor, which ended the Great Depression, could be economically helpful to some extent.”

These are all absurd claims based on the statistical figure called GDP. But there is a source behind them: Keynesian economics. In The General Theory, Keynes argued that “pyramid-building, earthquakes, even wars may serve to increase wealth.”

Government spending to recover from war, terrorism, and natural disasters such as earthquakes uses resources that could otherwise have been used for other productive activities. Such spending does not create anything new. War, terrorism, and earthquakes never produce prosperity. That is common sense. If Keynesian economics were really true, then to grow the economy we should start wars, welcome terrorism, and eagerly hope for natural disasters such as earthquakes. How foolish and dangerous that would be.

Jaewook Ahn

Professor Emeritus, Department of Economics, Kyung Hee University

Chairman, Center for Free Enterprise (CFE)

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Original title: ‘러시아경제가 성장했다’는 오판

Author: Jae-uk Ahn

Date: 2024-02-14

Source: https://www.cfe.org/bbs/bbsDetail.php?cid=press&idx=26451