Why Things Are Going to Get Worse - And Why We Should Be Glad. Michael Roscoe
and legal services (banking by itself is around 10%).
Even taking the lower value, one might conclude from this information that banking is more than 10 times as important to the UK economy than is agriculture, and business services generally more than 30 times as important. In GDP terms, this is obviously the case. But out there in the real world, on the ground as it were, away from the City of London’s square mile, it seems an absurd statistic. Who would you prefer to be without, bankers and lawyers, or farmers?
Even in Britain there is still a lot of farming going on, with 69% of the land either cultivated or grazed, though this isn’t enough to feed everyone (40% of the food eaten in Britain is imported). But the US is the biggest agricultural producer in the world, or third biggest after China and India, depending on how you measure it. US agriculture feeds over 300 million people and still has enough left over to export a quarter of its produce to the rest of the world. You only have to pass through the vast American heartlands to see the obvious importance of this huge industry. Yet according to the figures, it represents only 1.2% of the economy. So what’s wrong with these statistics?
The problem lies in the way GDP is calculated. Gross Domestic Product is a measure of the final output of a nation’s economy, and represents the market value of all goods and services produced in one year. In 2010, for example, the net contribution of US agriculture to the economy was around $170 billion. But this figure then feeds into the food-processing industry, where value is added by turning the raw produce into food that people can eat. The value added to agricultural produce is now reflected in the manufacturing figures, the food-processing sector of which shows an output figure of $800 billion. This food is then distributed by the retail sector, where it adds another $500 billion to GDP figures. So a more accurate reflection of the importance of agriculture, when measured by value to the US economy, would be $1,470 billion. This would represent around 10% of the economy rather than 1.2%, with 15% of US jobs dependent on agriculture.
But this is to be expected; we already know that the primary sector is vital to industry, and industry to services. That’s how the economy works, as I explained in Chapter 2. The distortion of GDP figures really occurs because of the inclusion of economic activity brought about by the spending of accumulated wealth and newly created money (credit, or debt), whether by the private sector or by governments. According to the same set of figures that gave us agriculture as 1.2% of the US economy, we have a total government contribution of 22%, and financial and other business services, including insurance, law and real estate, giving a total of 32%. How is it possible that the government has created more wealth than farming and industry? It isn’t, of course. No real wealth can be created by finance, insurance or government – nor by any other service. All they can do is reallocate wealth that’s already been created by the primary and secondary sectors of the economy at an earlier period than the GDP figures imply.
In other words, although GDP figures are calculated so as not to count the same new wealth twice in one year (in the way I showed above, with the wealth of agriculture feeding into processing and then retail) they do count the industrial wealth of the past, over and over again. The apparent wealth-creating activities of the service sector, which make up such a large percentage of developed economies these days, are really just a recycling of the wealth of past industry.
In addition to this, although most investment income is excluded from GDP figures (in recognition of the fact that such ‘rent’ is not genuine output), there is a different measure of the so-called wealth added to the economy by the financial sector. A strange concept devised by the United Nations in 1993 attempts to account for the ‘intangible’ wealth created by banks using a system that translates the financial risk from loans into output.2 So the more debt a bank takes on, the more it apparently contributes to GDP.
Services add value by assisting the real wealth creators to produce their goods, certainly, but that value is already reflected in the figures for real industrial output. We see therefore that GDP figures are seriously flawed as a measure of real wealth creation, and this distortion must surely be reflected in policy decisions based on these figures.
Another example of how GDP figures seriously understate the importance of primary industry is in mineral extraction. A 2009 study by PricewaterhouseCoopers (PwC) of the US oil and natural-gas industry arrived at the results shown in the following table.
Contribution of Oil and Natural Gas Industry to US economy (2007)
Source: PwC report for American Petroleum Institute, Sept 2009
PwC concluded that the sector accounted for 7.5% of total US GDP, compared to the 1.5% shown in official GDP statistics. But even the PwC estimate still uses the same flawed data for overall GDP measurement. In other words, the total GDP figure from which they calculate the sector’s 7.5% contribution still includes the supposed 54% for the financial and government sectors, plus another 25% or so for all other services that, as I’ve already pointed out, are merely recycling past industrial wealth. If we remove these from the picture, we find that the US oil and gas industry makes up 37% of the real economy.
This failure by economists and politicians to appreciate the inadequacy of GDP figures seems quite pervasive. For example, the data for mineral extraction that form the basis of my first chart, and which set me off on this investigation, come from a 2011 United Nations report called Decoupling Natural Resource Use from Economic Growth. In this report, the authors state:
‘These data indicate that globally, natural resource use during the 20th century rose at about twice the rate of population, but at a lower pace than the world economy. Thus resource decoupling has taken place “spontaneously” rather than as a result of policy intention. This occurred while resource prices were declining, or at least stagnating. Further research is needed on this relationship between “spontaneous” relative decoupling and declining resource prices.’
In other words, the authors fail to understand why the economy apparently grew faster than the rate of natural resource use would suggest it should have done. They obviously didn’t make the connection to the growth in debt, yet I would suggest that the connection is quite clear. Because spending on credit requires no industrial activity, it uses no natural resources; the debt is created by leveraging the accumulated wealth of past industry. Or, to put it another way, new money is created from past activity. This is not to say that it doesn’t result in any use of natural resources – some of this new money is bound to be spent on industrial goods, and therefore will boost industrial production, and consequently the use of raw materials. But my point is simply that the credit is created from nothing, as distinct from money that has been earned by real work.
Although some of this artificial wealth will be spent on real goods, a lot more of it goes into services and inflated asset prices, particularly housing. Although construction uses resources, the inflation of house prices does not; a house of a certain size requires the same resources, however much it sells for. Yet inflated selling prices result in a general feeling of rising wealth and raise GDP figures by boosting economic activity, especially in the financial and real-estate sectors.
If we look again at that chart of GDP and mineral extraction, this time adjusting the baseline slightly so that both graphs start at the same point (Figure 15), we see even more clearly the link between natural resources and economic growth. The link begins to break some time around 1971, when the dollar, and subsequently all money, broke away from the gold standard.3 Adjusting the baseline might seem like cheating, but all we are doing here is comparing growth rates. The scales are not the same, but that doesn’t matter: there is a strong correlation between the growth of resource use and the growth of the economy, as one might expect. The only surprising thing, as the UN researchers found, is that GDP apparently starts to grow without resources, and I have explained this as being the debt bubble. [I also show here the relatively small gains from increased material recycling, reduction in waste and fuel-efficiency improvements.]
At the start