When you get down to it, Gross Domestic Product (GDP) is really a pretty lousy measure given how we try to use it.  But it’s about all we have so far.  Timothy B. Lee offers a fantastic example using Google and GPS.  A GPS is one of those “Global Positioning Systems” – those systems that tell drivers in a robotic voice where to turn to get to where they’re going so they never have to really look at maps again.  (I’m personally not a fan of GPS, but that’s a different tale).

But before we get to the example, let’s review some basics about GDP.  GDP is used by economists as the most common measure of the overall welfare or economic well-being of an economy.  Technically, GDP is a count of the “market value of all goods and services produce for final consumption (usage) by an economy within some time period, usually a year.”  We generally consider increases in GDP a good thing and decreases a bad thing.  Why?  Because more goods are supposed to mean more value and more well-being for people.  To figure out how to add up all the different goods, we add up the money value of the goods when they’re sold.  Otherwise, if we tried to add up actual physical quantities, we would have a horrendous mother-of-all-adding-apples-to-oranges problem.  How do you determine how many bottles of Coke are the equivalent of an open-heart surgery? You can’t.  So, we add up the money values.  But that depends on prices that the goods are sold at.

So what happens when innovation takes the price of good or service down to zero?  We still get the goods/services and utility they bring, but we they show up as zero in GDP calculation.  What happens when we invent a magic wand? Here’s Timothy B. Lee’s example:

Today these magic wands exist. For example, a couple of years ago, Google waved a magic wand that transformed millions of Android phones into sophisticated navigation devices with turn-by-turn directions. This was functionality that people had previously paid hundreds of dollars for in stand-alone devices. Now it’s just another feature that comes with every Android phone, and the cost of Android phones hasn’t gone up. I haven’t checked, but I bet that this wealth creation was not reflected in GDP statistics. And it’s actually worse than that: as people stop buying stand-alone GPS devices, Google’s innovation will actually show up in the statistics as a reduction in GDP.

So what’s the point? Should we scrap using GDP?  No.  We need GDP measures.  It’s useful. But we always need to be mindful that there’s more behind the cold statistics.  There’s always a human story and an economic reality behind the numbers. Making policy through pure reliance on the reported numbers without understanding the economic reality behind them is a mistake.  It’s like a doctor that treats only the blood test results and not the patient.

There’s lots of ways GDP can mislead.  This type of innovation-leading-to-zero-cost is only one.  GDP also misses valuable services that aren’t sold in a market, like the meal your spouse or roommate cooked yesterday, or the way your mama & papa took care of you as a little kid, or even the tomato you grew in your backyard and ate on your sandwich.  GDP also just measures goods and services.  It doesn’t tell us whether the additional toys made us any happier.

Still, despite it’s defects GDP is the best we have.  At least for now.  Maybe some brilliant reader or student will figure out a better way to measure national welfare some day.  It’s happened before like when Colin Clark, Simon Kuznets, and Richard Stone developed our current methods of calculating GDP.  But for now, we have to make do.