To:

  • Myself

On:

August 22

They say our production is growing. But what actually counts as "product"?

In my last letter, I found myself discussing the GDP. And it left me feeling a little uncomfortable, because honestly, I wasn’t really sure what “the GDP” means. I thought I knew, but when I tried to really explain it to myself, I had more questions than answers.

In particular, what does it mean for the GDP to grow?

The first place I googled myself to was this explanation from the OECD:

Gross domestic product (GDP) is the standard measure of the value added created through the production of goods and services in a country during a certain period.

The higher the GDP, the more goods and services we’re producing, the better off we all are. It sounds great in theory, but the GDP has been rising and rising for decades, and to be blunt, the theory of “we get better off” doesn’t match my experience.

Now it is true that we’re materially better off in some ways - we have more computers, cell phones, online services and university degrees. But it’s also true that we’re less likely to own our homes, we make less of what we consume domestically, we’re lonelier, and we’re paid less – at least at the inflation-adjusted median.

So what does it really mean for the GDP to grow?

The answer is complicated, because it turns out, there are a lot of rules on what counts towards the GDP and what doesn’t. The idea is reasonably simple: “end-consumption” counts, while intermediate consumption doesn’t; a car sold to a consumer counts, while a tire sold to the company producing that car doesn’t. But let’s take a look at a few more examples:

  • Research on new construction techniques counts towards the GDP.
  • Mining the minerals that are used in construction doesn’t.
  • The construction of a new house using those materials and techniques counts towards the GDP.
  • Selling that house on to you, Dear Reader, doesn’t.
  • Renting that house out to some poor college student counts towards the GDP.
  • While living in that house yourself… also counts towards GDP.

Huh. That’s weird. Ownership of houses is judged as creating “value added”, so long as the property is owner-occupied. From what I can tell, ownership of a vacation home also counts towards the GDP, but let’s focus on the living-full-time-in-the-house-you-own scenario, as that’s more common.

The idea here is that owners are like small businesses providing a service (shelter) to themselves; the owner is getting value from their home’s existence by living in it. That value is then estimated by looking at what it would cost to rent a similar house nearby, and interpolating an “imputed rent”.

If you’re struggling to make any sense of this, then maybe an example with some real numbers would help.

Say that Tyler spends a year of his time and 100,000 of his dollars to build a cozy new house on a $400,000 block in an up-and-coming neighborhood. Upon completion, Tyler sells this house and land to Quentin, who’s parents want to buy him a graduation present.

Quentin decides to live in the house. Given that similar houses would rent for about $2,000 per month, this decision adds $24,000 to the GDP in the first year. What’s more, as the house and land appreciates, the contribution to the GDP increases too. Say that over time, the rent rises on average about 5% a year. After 30 years, and adjusting for 3% inflation, Quentin’s decision to continue living in the house will add $41,920 to that year’s GDP.

If you sum this up, Quentin’s decision to live in his house will add around $1,000,000 dollars to the 30-year GDP. Meanwhile, the production of the house, including Tyler’s labor, and all of the house’s materials, contributed just 1/10th of that.

Curiously, ownership of non-houses doesn’t count towards the GDP in the same way; housing is special. The roof over your head adds to the GDP by its very existence, while the chair you’re sitting on and the clothes on your back don’t.

Concretely, in 2019, in Australia, “Housing services” (including rentals and owner-occupied homes) accounted for 12% of the “value added” to Australia’s economy. Finance (i.e. interest payments) also accounted for about 6%.

Meanwhile, the 8% of Australia’s workers employed to actually construct things – including but not limited to housing – get credited with just 2% of the “value added” each year.

All in all, around 20% of Australia’s GDP is attributed to housing in some way. And that portion has been growing; according to a 2016 paper by the RBA, “gross housing output has gradually increased as a share of total net domestic income from 7.8 per cent in 1950 to 12.3 per cent in 2014”.

And speaking of growth, I’m reminded of my original question.

What does it mean for the GDP to grow?

At this point, I think the better question to ask may be: does a growing GDP mean anything at all?