(Editor’s Note: This will be the first in a series on economic topics, focusing on governments, fiscal policies, taxes, trade, and “economic growth.” BudgetBakers, as always, takes no political position and does not advocate for any specific economic policies. These posts are for educational purposes only.)
A popular story in American politics is that during the 1992 campaign for the American presidential election, then Arkansas Governor and soon to be President Bill Clinton had a sign posted at his campaign headquarters. It was written by the legendary political operative and later actor and tv personality James “Ragin’ Cajun” Carville, and it read:
1. Change vs. more of the same.
2. The economy, stupid.
3. Don’t forget health care.*
In the history of Presidential politics in the United States, economic issues have often dominated the landscape. This is no surprise, considering that the US economy has historically been one of the most dynamic in the world, producing nearly $30 trillion in GDP (Gross Domestic Product), out of a worldwide total of about $100 trillion every year. That means that the US, despite being home to just over 4% of the world population, generates nearly 30% of the world’s economic activity. At least, as we’ll see, that is what the theory says.
The degree to which the American economy drives the world’s system of trade cannot be overstated. No other country or group of countries, like the EU ($16.7 trillion), or China ($18 trillion) even come close to it. In addition, the United States’ outsize role in the global financial system and global trade makes almost everything it does relevant to the world economy.
Whether you live in the US or not, care about what happens in US elections or not, the American economy matters to your wallet. What happens with a third of the whole world economy inevitably matters to everyone else.
In this series, we’ll come to understand why that is.
*They did forget healthcare
What We’ll Cover In This Series
In this series of posts, we’re going to talk about why the health and direction of the American economy matters to the rest of the world, and more specifically, to you.
Yes, even to you.
We will also talk later about how a new administration in government may mean large scale effects on the US economy, and therefore on global trade and currencies as well. Those effects, like it or not, are likely to ripple out and become a real topic of concern for anyone with a bank account and a job.
To do this, we will also have to talk about why American elections matter. Not just because of how it makes people feel, but because of the role the American economy plays, both as the military and financial center of world trade, and as the biggest economy there is or ever has been.
We’ll also discuss the realistic probable effects of a change in the Presidency, with Donald Trump set to take over for his second, final term as President.
We will do our best not to speculate on the actions of a Trump administration. What will happen remains to be seen. This is not about politics, but about policy. What will the effects be of the most likely policies of the new President, and how will they affect you?
Defining Economic Growth
To even get that far, our first stop, and the bulk of today’s article, is going to be about the way that this effect is measured in America, and in the global economy, and why. You probably will find out things you didn’t know, and you may find out things you didn’t really want to know, but probably should.
Remember: this series is about a political issue, but it is not political. We will focus on the money: specifically how it’s quantified, how it’s raised, how it’s divided, how it’s spent, how it’s taxed, and what that all means for you. That means exploring the systems that manage the money, and that in turn, means talking about the history of those systems. But we are not here to make political or ideological arguments.
On the contrary, you may be surprised to find that many of the political battles over economic issues that drive national politics seem less sensible or relevant than they are made to appear. You may also find that actual disagreements on economic policy between mainstream political factions are not that big; far smaller today than at most points in history.
What’s Gross Domestic Product?
We mentioned how big of a GDP (Gross Domestic Product) the United States commands. The media references GDP constantly, but very rarely goes into detail explaining what it actually means. Today we’re going to address that.
We’ll see today that GDP is both “simple,” and also very complicated. One of the reasons GDP is so ubiquitous in politics is that it’s a single number, which either goes up or down. However, why it goes up or down, and what effects government actions have on it are much less straightforward.
In our next post, we’ll do a deep dive into how GDP is calculated, and why it’s done that way. That post will be much more technical than this one.
The super simple version for today, is that GDP is supposed to measure the total amount of “economic output” that a country produces, measured by how much stuff and how many services are bought and sold.
GDP = Spending + Investment + (exports – imports).
The above is a simplification of a much more complicated equation, and the figures for spending and investment can be found in different ways, but all methods are looking for the same single number. For example, that number for the U.S. in 2023 was $27.36 trillion, or $27.36 million million. The U.S. economy saw a 2.5% increase in GDP over the year before (adjusted for inflation).
The apparent simplicity and hidden complexity of the GDP indicator, as we’ll see, is a big reason for its popularity among policymakers and the media. It leaves everyone with plenty of room to spin their own narratives about the state of the economy, and about the success or failure of another leader’s policies.
Want to make it seem like the other guys are bad? The GDP isn’t growing enough. Want to look good? The GDP is growing. Want to criticize the other side? Their policies made our GDP worse. What does it mean? Pretty much only economists, and now you, will… sort of understand. But we say “sort of,” because actually, nobody really knows exactly how the economy works, or even if it’s really growing or not.
It’s pretty complicated.
Does GDP Really Matter?
It’s worth asking before we dive into a series of posts on economic topics: does this question really matter to you? One of the main challenges of using GDP to measure reality is actually its simplicity. Can one number ever really tell us how the economy works?
More importantly, in what way is knowing how it works going to help you make decisions? The answer to that, honestly, is that we aren’t completely sure. It might help you, or it might just convince you that what you’re being told by the media and the government isn’t as simple as they make it seem.
Knowledge is power, and knowing more about what political leaders are promising, and why, empowers you to make more informed choices, and to prepare for policies that will affect you. Because, understand GDP or not, it is definitely among your government’s top three priorities at any given time. Every political decision and policy debate relates somehow to the economy, and those decisions end up having impacts on your life.
The United States, for example, has just elected a President who promises to engage in a trade war with many of its largest trading partners, raising tariffs on imports, largely in a bid to boost his country’s GDP. Whether that happens or not, and whether it actually works or not, the effects of such promises are already being felt in global currency exchange rates, which end up affecting the cost of basic goods and services everywhere in the world.
As we hope you’ll find today and in the future, these explainers are here because regardless of any political ideology or beliefs one has, the fact is that the political systems of the developed world are obsessed with the performance of the economy, and have been most especially since near the end of the Second World War.
That obsession is heavily concentrated on GDP growth, determining how countries trade with each other, how money moves, and where investments are made.
This obsession causes most of the political divisions in the developed world to focus on the government’s role in the economy. In large part, that is the main thing that voters in developed countries are now asked to vote on.
How did it get this way?
A short history of GDP’s rise to fame.
GDP was originally adopted in 1944 at the U.S. led Bretton Woods Conference, as a key metric to track the effects of monetary policy on the economies of the developed world. The idea of the conference was for representatives of the Allied Nations to develop a system of international monetary policy; a way to manage world trade and financial markets after the Second World War ended.
The fear as delegates met in New Hampshire in 1944 was that when the Allies were victorious and occupying the Axis countries, they might repeat many of the same mistakes that were made following the First World War. The chaotic transition away from wartime economic conditions in 1918 had led to financial crises in both victor and defeated countries, as currency exchange rates fluctuated wildly.
The collapse of the German economy and the “Weimar Hyperinflation” following the first war had hindered recovery, and set the conditions for another conflict. The Allies now needed a way to facilitate recovery, and stimulate growth in postwar Europe and Japan. This required a common security framework for international trade, and a currency exchange system so that recovering nations could accept investment capital to rebuild.
The Bretton Woods System set the conditions for the integration of the European economy into the European Union. It also elevated the United States Dollar as a global standard for currency exchange, and established the United States as a virtual guarantor of international trade security, a role it continues to play today.
In order to create a stable international financial system, the International Monetary Fund (IMF), and the International Bank for Reconstruction and Development (IBRD, or the World Bank) were established. The currency exchange rate of all participating countries was “pegged” or fixed to the US Dollar – a practice that continued until 1971. This gave participating countries confidence in their own financial systems, greatly aiding the recovery.
The system is widely seen as a major success. The rapid recovery of West Germany following the war was sometimes called the Wirtschaftswunder, or The Miracle on the Rhine, a period of unprecedented growth and enhanced cooperation in Western Europe.
To accomplish all of this, the IMF and World Bank needed a common method of tracking the relative economic progress of participating countries, so that redevelopment funds and investments could flow where they were needed. Even though the currency fixing system has largely ended, participants in the system continue to enjoy historically low volatility in their exchange rates, which makes international trade and investment safer and easier.
Enter GDP
In order to successfully regulate trade and exchange rates, the IMF and World Bank needed a common method of determining the relative economic health and rate of development of many economies following the war, all in various states of health at that point.
Gross Domestic Product (GDP) was identified as a simple, clear indicator for economic health. It told central bankers one important thing: is there more or less overall economic activity this year, than last year? This quarter, over last quarter? Was there too much or not enough money in the financial system at any one time? The system also helped countries to clearly understand the role of international trade in their economies, telling them which sectors needed more development.
As the post-war world continued to develop, GDP became a well known indicator of economic health, not just by international banking officials, but also in the national politics and mainstream media of many nations. It came to indicate a country’s relative esteem and even economic power and importance, with the fortunes of political leadership rising and falling with the GDP growth rate.
Today GDP is deeply engrained in the political system, and that popularity may be a weakness. What happens when the political system of developed countries is almost exclusively focused on the question of whether GDP is rising or falling?
As we’ll see, GDP is a limited indicator of the overall vibrancy of a country’s economy and life. There are many things GDP cannot indicate. Yet over the years, it has consumed the attention of governments and citizens around the world. Growth rates now often drive entire countries to do things that are, perhaps, not in their overall best interest. It has also led them to find ways to cause GDP to appear to be rising, sometimes even when the actual economic health of a country isn’t necessarily improving.
As we saw in the opening quote from Carville: if politics becomes obsessed with one number, then the politicians will find a way to make that number go up, or even to make sure that the other side can’t. Either way, they will draw our attention to that number, even if it has little meaning to us as individuals. If we will vote for someone who promises to make that number go up, then that’s what they will promise to do.
GDP has become so interwoven in the political system, that many economists now argue it no longer really measures the economy at all. Instead, they say it only measures the political system’s control over the financial system; the ability of politicians to make the number go up.
But for all that, GDP still matters.
What GDP Can’t Measure
We’ll see in this post that GDP matters, if for no other reason, because we have decided that it matters, and built many of our political and governmental structures around that idea, making it very hard to change.
Though it is supposed to be a measure of economic activity, any athlete who has had to lose weight for a competition, or student who has stayed up late into the night before an exam will understand that anything we try to objectively measure can be influenced, or even cheated.
GDP has many other weaknesses too. One that we will touch on again is the difficulty of accurately measuring it, even if there is no cheating. There are many ways to measure the same economic activity, and not all economic activity can be measured. As long as black markets and tax evasion and theft exist, there will be large effects in an economy that GDP figures cannot capture.
Even if GDP can be measured accurately, there is serious debate about whether GDP growth should even be seen as an absolute good. By the lights of GDP, “economic activity” includes many many things, both good and bad for society, the environment, and the economy.
There are also things that human beings do for each other that do not involve money, and so are rarely recorded in the GDP tally. Work that makes our communities safer, or happier, or culturally richer can go unnoticed, while ever less productive paid work and other activities that harm communities and the environment are recorded in GDP, and promoted by leaders and media as progress.
As Robert F. Kennedy said in presidential campaign speech in 1968, months before he was assassinated:
“Gross National Product counts air pollution and cigarette advertising, and ambulances to clear our highways of carnage. It counts special locks for our doors and the jails for the people who break them. It counts the destruction of the redwood and the loss of our natural wonder in chaotic sprawl. It counts napalm and counts nuclear warheads and armored cars for the police to fight the riots in our cities. It counts Whitman’s rifle and Speck’s knife, and the television programs which glorify violence in order to sell toys to our children. Yet the gross national product does not allow for the health of our children, the quality of their education or the joy of their play. It does not include the beauty of our poetry or the strength of our marriages, the intelligence of our public debate or the integrity of our public officials. It measures neither our wit nor our courage, neither our wisdom nor our learning, neither our compassion nor our devotion to our country, it measures everything in short, except that which makes life worthwhile. And it can tell us everything about America except why we are proud that we are Americans.”
Kennedy’s arguments seem prescient in today’s digital world, where huge amounts of thought provoking art and multimedia expression in the form of podcasts, educational videos, blogs, social media content, and research papers are created and published free of charge. Both making and consuming such media deliver enormous benefits (or harms) to society, but cannot be measured in GDP growth.
If this blog post makes your life better in some way, know that this improvement is not included when you are told that the economy has grown in the past year.
GDP Alternatives
“One Cannot Eat The Economy”
Today, economists propose many competing measures of the same basic data: the “Human Development Index,” for example, or the “Genuine Progress Indicator.” One proposal is for a “capability approach,” that focuses on capabilities and functions that people are able to achieve to lead better lives, including many things GDP does not measure at all. Famously, Bhutan publishes a Gross National Happiness (GNH) Index, seeking to measure the physical, mental, and spiritual health of its population.
These tools have their devotees and in some cases are better for actually understanding the world.
You’ve probably noticed yourself, that regardless of what you’re told about the economy, your salary doesn’t go up when the GDP rises, or go down when it falls. In many measurable ways, your life can be better or worse, and politicians can argue the exact opposite is happening. One cannot eat the economy.
And yet, the political system’s focus on the GDP, filtered through the popular media, strongly affects how people vote, and so ultimately the success of one political party over another. And so, through that process, GDP ends up having a real impact on our lives through government policy. It determines what trade policies they pursue, what tax cuts or rises they seek, how much governments spend, and what labor rights they defend.
GDP is a metric that these types of policies can affect measurably. That should explain GDP’s popularity with politicians. The focus on that one number works. Even if it doesn’t tell people how their lives are going, they do care about it. Presidents use it as a measure of their own success or failure. Governments are formed with economics at the top of their minds.
GDP is invoked everywhere in the public and private sectors, to justify tax policy, government spending, deregulation, hiring, private industry layoffs, lost bonuses, and lower profits. As limited as it may be, GDP is a way of life. It’s a management style. It’s a whole thing.
GDP was $10.1 trillion in 2022? Let’s try to get 10.2 trillion in 2023. Not too fast, as we don’t want prices to rise too much, but not too slow, because we definitely don’t want inflation to stop completely. This primacy of GDP as a guiding principle makes it essential to the political systems of the modern world.
And it’s not going away.
Later we will discuss how and why this system might change in the future. But for now, GDP matters because we say it does.