How America created GDP and what goes in it : Planet Money What even is "the economy"? And how do you measure it? Our path out of the economic darkness and into the light has been guided in large part by one single statistic: GDP. This week: the origins, history, and problems with the economic indicator to rule them all. | At this Summer School, phones ARE allowed during class... Check out this week's PM TikTok! | Listen to past seasons of Summer School here.

Planet Money Summer School 2: GDP & What Counts

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SYLVIE DOUGLIS, BYLINE: This is PLANET MONEY from NPR.

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STACEY VANEK SMITH, HOST:

Welcome, everybody, to PLANET MONEY Summer School.

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SMITH: This is Season 3. And this season, we are getting back to basics - the big economic questions, aka macroeconomics. Every Wednesday through Labor Day, we call class into session and bring you one big idea per episode - how to fight inflation, how recessions happen, things like that. We take a classic PLANET MONEY episode and pair it with insights from our esteemed professor guides. And this semester, they are Kristen Broady, economist with the Federal Reserve Bank of Chicago. Hey, Kristen.

KRISTEN BROADY: Hi.

SMITH: And Luigi Zingales, professor of finance at the University of Chicago's Booth School of Business and host of the podcast "Capitalisn't." Hey, Luigi.

LUIGI ZINGALES: Hi.

SMITH: So last week on Summer School, we learned about the two major schools of thought about economic booms and busts - how they happen and what the government should do about it. Go back and listen to that whenever you get the chance. This week, we look at something else that connects us to the awakening of economic theory that was really sparked by the Great Depression. And that was this question that seems so basic and so obvious that it's actually really mind-blowing when you try to answer it. And that is this - what is the economy? How do you measure it? The answer has to do with the invention of this concept called GDP. That is gross domestic product. And it's basically like a report card for the country's economy. And honestly, it's not that old. And before this economic indicator was invented, I mean, is it fair to say, Kristen, that the economy as we think about it didn't really exist?

BROADY: No. I mean, it was an economy, right? Like, there's always been exchange of one sort or another - different things that were used for money over time, whether it was cowrie shells or something else. But the term economy is a new one.

ZINGALES: I think that Kristen is right - economic activity always existed, is that nobody was paying attention to measure the total aggregate.

SMITH: Measuring the total aggregate, the entire economy. Because if you can boil the economy down to a single number, a number that rises or falls every year, then you can measure your own progress, and you can also compare yourself to other countries, right? Like, whose economy is richer? Whose economy is growing faster? So after a quick break, we will hear the story of the invention of GDP. It's reported by Jacob Goldstein and David Kestenbaum back in 2014. And then right after that, Kristen, Luigi and I, we will dig into this number, GDP. We'll look at the good, the bad, the ugly, what's counted and what isn't.

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JACOB GOLDSTEIN: If you'd walked up to somebody on the street a hundred years ago and asked them, how's the economy doing? They would not have had any idea what you were talking about.

DAVID KESTENBAUM: Sure, people talked about how many ships came into New York Harbor or how the wheat harvest was that year. But this idea that we take for granted today that there is this thing out there called the economy, that idea did not exist a hundred years ago.

GOLDSTEIN: And today, not only do we talk about the economy, we talk about it with a single number. So without even really thinking about what it means, we can say last year the U.S. economy grew by 1.9%.

KESTENBAUM: And I was hoping for 2.5, at least. So, Jacob, we are not making this up. It really does seem like the economy, at least as we know it, that notion, really was born at a particular moment in history. You can use Google to go back hundreds of years and search through old books for the phrase the economy. And if you do that, what you find is 1700, basically nothing, 1800, nothing, 1900, nothing. And then a few decades after 1900, people suddenly felt this really compelling need to talk about the economy, this giant invisible thing that was all around them.

ZACHARY KARABELL: It was invented because of the Great Depression.

GOLDSTEIN: This is Zachary Karabell. He just wrote a book called "The Leading Indicators," and he actually does that Google trick in his book.

KARABELL: And it was invented because there was clearly a perception that there was something really, really bad going on, but they didn't really know what. I mean, you could see there were homeless people on the street. You could see there were farmers - you know, the Okies heading from their dust bowl farms off to California by the tens of thousands. But there was no way of really grasping it.

KESTENBAUM: You can imagine, say, FDR saying to his advisers, boil it down for me. How bad is it? What's the big picture? But to answer them, they needed a number, the number that today we call GDP, gross domestic product.

GOLDSTEIN: It's not like no one had thought about this kind of thing before. For hundreds of years, there would be moments when, say, the king of England would tell some adviser to go ride through the countryside and figure out how much stuff England had, add up all the wheat and all the horses and all the swords and figure out, basically, if England had enough stuff to go invade France.

KESTENBAUM: But during the Great Depression, the U.S. government decides to do this in a much more serious way. They're going to go way beyond sending out a guy and a horse. They're going to try to add up everything that gets made in the entire country in a given year - all the houses that get built, all the beers sold in bars, every fedora, every Studebaker, every visit to the doctor.

GOLDSTEIN: And to do this, they need a numbers guy, a guy who is willing to devote his life to wading through really boring reports and figuring out how to add up lots and lots of numbers. And they find just the right guy. His name is Simon Kuznets. Adding up all this stuff is harder than it may sound. First of all, you just have to figure out everything that you need to count. Once you've figured out what to count, you have to figure out how to count it. For one thing, you have to make sure you're only counting what the U.S. is producing. So if someone buys a Hershey bar in New York City but the cocoa to make that chocolate bar came from Brazil, you have to subtract out the cost of the cocoa because it didn't come from the United States. That cocoa is part of Brazil's GDP.

KESTENBAUM: So Kuznets and a bunch of other numbers guys go to work on this stuff. And in 1934, at the request of Congress, they publish this report - it actually makes me yawn to read the title. It is called National Income, 1929-1932. And this report becomes a bestseller. Thousands of copies are printed, and they sell out. Here's a sampling of what Americans were so eager to read - quote, "the economic changes that occurred in this country during recent years are sufficiently striking to be apparent to any observer without the assistance of statistical measurements. There is considerable value, however, in checking the unarmed observation of even a careful student by the light of a quantitative picture of our economy."

GOLDSTEIN: Well done, David. You can see why this very wonky statistic, which, at the time, was called national income, becomes sort of an overnight sensation. More than anything before it, national income is an answer to this really basic question - what the hell is going on? How bad are things? Are they getting worse? Are they getting better? And pretty soon, you can't turn on the radio without hearing these new numbers and what they're measuring, this new thing called the economy. Here's Zachary Karabell.

KARABELL: By 1937, Roosevelt starts talking about the economy, and he starts talking about national income going up.

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FRANKLIN D ROOSEVELT: National income had amounted in the year 1929 to $81 billion.

KARABELL: You'd never hear Abraham Lincoln or Teddy Roosevelt or George Washington talking in this way. One of the things that's remarkable to me is how quickly we went from a world where none of these terms and none of this conversation was part of our national consciousness to it being at the center of our national consciousness.

KESTENBAUM: This number that Kuznets is adding up becomes part of a kind of intellectual revolution. Over in England, the Brits are also adding up this number, and the British economist John Maynard Keynes starts talking about the economy as something that the government can control.

KARABELL: You get a lot of people who really start believing that there's this thing called the economy that's a mechanical system that obeys laws, just like physics and that if you can get the - if you can describe the system and the variables correctly, it's very mechanistic - like, input in, output out. And so part of the reason for measuring is the belief that all this fuzziness that had attended human history around waves of - you know, bursts of growth and then collapse and money going up and money going down, that we could capture it and control it, the same way scientists were capturing and controlling physical reality.

GOLDSTEIN: This new idea, this idea that economists and the government could really control this new thing called the economy, was about to be tested in a huge way. In 1941, the U.S. enters World War II, and the government basically takes over the U.S. economy to fight the war. Fighting an all-out war is not just risky for soldiers. It can mean massive food shortages at home. It can mean rampant inflation. It can bankrupt a country almost overnight. Fortunately, the U.S. has a secret weapon - Simon Kuznets. Kuznets becomes the chief economist on the Planning Committee of the War Production Board.

KESTENBAUM: But FDR has apparently not consulted with Kuznets. And in 1942, he gives his State of the Union speech, laying out incredibly specific plans for what he wants to do in terms of war production. He says this year, we are going to make 60,000 planes and 45,000 tanks. And he goes on and on with specific numbers for ships and anti-aircraft guns.

GOLDSTEIN: Kuznets looks at those numbers. He really crunches them. He uses those tools that he put together to make his early version of GDP. And he goes back to the Roosevelt administration. And he says, I've got some bad news for you. Your big plan - it isn't going to work. Kuznets looks at how much steel and aluminum and copper the U.S. is producing. He looks at how many factories there are. And he realizes the U.S. economy just is not big enough to make all the planes and tanks and everything else that Roosevelt is planning. And if the U.S. tries to do that, it could lead to shortages. It could lead to massive inflation. It could wreck the U.S. economy.

KESTENBAUM: It was the generals versus the economists, and the economists won. That's who Roosevelt listened to.

KARABELL: There are many people who have said, and I would agree with them, that the invention of GDP was one of the prime factors in winning the war. The ability to, with some confidence, be able to dedicate all these resources - because a lot of the reasons why America won the war wasn't because we fought particularly better than anyone else. It's because we had such a massive industrial machine that dwarfed the capacity of anybody else. And it was because we were able to use that with confidence that we weren't going to create huge domestic destruction.

GOLDSTEIN: The war ends, and after the war, GDP really sweeps the world. There are all these new international organizations - the United Nations, the International Monetary Fund, the World Bank. And the people running these new global groups - they love GDP.

KARABELL: First thing you do in the 1950s and '60s, if you're a new nation, is you open a national airline, you create a national army and you start measuring GDP. And you start measuring GDP because if you want to go to the World Bank or you want to go to the U.N. and you want some sort of economic aid, the sole criteria for those is if we give you money, you have to show that it helped your GDP.

KESTENBAUM: And, of course, once you have a single number summing up your country's economy, it's tempting to rank countries by GDP like it's some kind of Olympic competition, which people do, especially during the Cold War, which - you know, the Cold War, as much as anything, was this battle of economic systems. Who's winning, communism or capitalism? Let's ask GDP. Politicians around the world start to focus on this thing. How do we make our GDP bigger? How do we win this competition? How do we move up in the rankings?

GOLDSTEIN: And by the 1960s, GDP is such a big deal that it gets its own backlash. Robert Kennedy calls out its shortcomings in 1968.

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ROBERT F KENNEDY: 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...

KESTENBAUM: Kennedy wasn't the only one complaining about how GDP was being used. Simon Kuznets, the super serious, sober economist who had helped create it, he eventually won the Nobel Prize, in part for that work. But he was not entirely happy with how his creation was being used. Again, Zachary Karabell.

KARABELL: Kuznets, himself, said, look, this - the fetishization of numbers and the use of this number as a proxy for everything is what politicians do, it's what people do. I would never have recommended that. I would - and it's the easy way out, avoiding hard discussions, and it can be easily abused.

GOLDSTEIN: In just a few decades, GDP went from being a useful Depression-era tool to a World War II weapon to a piece of Cold War propaganda to facing its own backlash in the 1960s. And, of course, GDP is still with us today. So in the end, what should we make of it? What does GDP really do?

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SMITH: We will get to that question and many more right after a quick break.

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GOLDSTEIN: So in the end, what does GDP really do?

DIANE COYLE: It does what it says on the tin. It measures the economy. We shouldn't try to make it do something it's not intended to do.

GOLDSTEIN: Diane Coyle is an economist who just wrote a book called "GDP: A Brief But Affectionate History". And she says, look, GDP was never intended to measure overall well-being or a nation's standard of living. Certain things that are bad actually make GDP go up, like hurricane damage that costs a lot to fix.

KESTENBAUM: Sometimes it's not even clear what should count as GDP. For example, suppose, Jacob, you and I both stay home to take care of our kids. That labor, by the current rules, does not count as GDP, even though it's pretty clearly work. But, Jacob, if you come take care of my kids and I go take care of your kids and we pay each other, then it does count.

GOLDSTEIN: And then there's the black market, which means everything from off-the-books babysitters to mafia drug deals. In the U.S., the black market does not count toward GDP. But in some other countries, it does. Back in the '80s, Italy started counting its black market. And overnight, the Italian economy became bigger than the U.K. economy. The Italians celebrated. They called it il sorpasso. But, of course, nothing had really changed. Here's Diane Coyle again.

COYLE: We tend to think about GDP as if it's a natural object - it's, like, a mountain - and we have methods of measuring it that are better or worse, they're more or less accurate. But there is a thing there to be measured. And actually, that's just not true with the economy. There's no natural entity called GDP in the universe.

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GOLDSTEIN: In other words, maybe the most important thing to remember about GDP is it's not a thing. It's an idea, and that idea keeps changing. Just last year, the U.S. tweaked the way it calculates GDP and, in an instant, the economy was $500 billion bigger.

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SMITH: That was David Kestenbaum and Jacob Goldstein back in 2014. After a quick break, we will dive into the number. We'll take a look at what is and isn't counted and how that has helped to shape our society, our nation and even the planet.

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SMITH: Hello, Summer School students. We are back with our professors, Kristen Broady and Luigi Zingales. So, guys, we just learned all about the creation of gross domestic product and this idea of trying to measure an economy. But let's kind of dig in and talk about some of the bigger lessons here and a little bit what we can take away from all this. Kristen, why don't you begin?

BROADY: I guess I would say that changes in GDP are the most popular indicator of this nation and other nations' overall economic health. And while we shouldn't perseverate on it, it is a measure to help us compare our nation to other nations and to compare how our economy is doing right now versus times in the past or to be able to set goals in the future.

SMITH: Yeah, I mean, this number really has become this kind of shorthand for talking about where the economy is. I mean, I know that economists use this number a lot to sort of measure the health of the economy and to determine whether or not we're in a recession. Politicians will talk about this. You know, like, during my term in office, the economy grew 3% and that's really good. Also, to compare countries - like, well, during the same time, China's economy grew 6%. Are they beating us? So, Luigi, what do you think of the way that this number gets used?

ZINGALES: I think that one message that is pervasive in economics is every measure you start to use will create a distortion in behavior because people will focus excessively on that measure. And GDP is both a blessing and a curse. It is a blessing because how will we do without it is a very useful measure. But it is a curse because some stuff has been left out.

SMITH: Yeah. One of the most interesting points, I think, in this episode is sort of the things that are and aren't counted in GDP, one of the things being something economists call intermediate goods. And those are kind of products that businesses sell to each other to make other products, right? So if I'm making chocolate bars and I buy sugar from a sugar beet farmer, that is an intermediate good. And that purchase of sugar, that does not get counted in GDP. But when I use that intermediate good to make my finished product, my chocolate bar, and I sell that, that does get counted in GDP. But, Luigi, your point, I think, was that some of the things that get left out create these sort of unintentional incentives. Would you mind expanding on that a little bit?

ZINGALES: I think that the major flaw is it doesn't measure the destruction of value that you have in production. So the pollution and the damage to the environment are really - what is the opposite of value added?

SMITH: Like a liability? Like a...

ZINGALES: Yeah, it's a value subtracted to the economy. If I produce a bit of energy but, in exchange, I destroy the environment, I'm really not adding any value. And the fact that this is not counted, I think, creates enormous amount of distortions because it pushes, especially developing economies, to destroy the environment in order to become more developed countries. If you think about China has succeeded enormously from industrial production, but has made many of these cities not livable because of pollution. And I think that that should be counted.

SMITH: But that gets back to this issue of incentives, right? Because if you are a country and you want to start counting pollution in your GDP, that's going to push your GDP down, and it's going to look lower compared to the countries that aren't counting it. That's going to make your country's economy look smaller than other countries' economies. And nobody wants to do that, right?

BROADY: Well, I don't know about that. I think every trend has to start somewhere. I think about when Alicia Keys stopped wearing makeup, right? Like - and I'm not saying she was the first person to do that. But, I mean, it was talked about on social media. It started a trend. I'm not really sure where it went. But I think with anything, it's got to start somewhere. And, you know, sometimes it's just the right decision, right? Like, if we're talking about conservation or climate change or whatever it is, like, whether you factor it in or not, that could be a trend that starts, you know, other nations doing that.

SMITH: I mean, that's true. You could sort of establish yourself as a trendsetter. Like, this is the right thing. This is a more accurate economic number. I mean, that could be a very powerful statement. Other than pollution, though, Kristen, is there anything that you think should be added or subtracted from GDP?

BROADY: I guess I would add another thing - household production. Like, when you think about - we talked about people taking care of their own children or things that are produced, whether it's a garden that you have at home or a different task that people perform that really do add value, I think that we should account for those things somehow.

SMITH: Yeah, the idea in that story that if David and Jacob watch their own kids, it doesn't add to the economy, but if they were to watch each other's kids and pay each other for it, that would count. And that - you know, that has all kinds of implications even beyond just economically. I mean, it actually made me think of something that happened when I was just a kid. When I was back in second grade, my mom was a homemaker.

And I remember growing up, still - I was taking, like, a survey or something, and my second grade class was like, what does your dad do? What does your mom do? And when I put what does my mom do, I wrote nothing. And I remember the teacher coming over to me and being like, well, like, does - you know, she, like, listed off all these things. Does she do this? Does she - and my mom does an enormous amount of work. But it was interesting that, you know, my little 8-year-old brain - I loved my mom, but it was just interesting to me that, like, in my head, well, she didn't have an official job in, like, the formal economy.

BROADY: Exactly, yeah. That should be valued somehow, just recognizing the work that people do outside of whatever they do to earn a wage.

SMITH: You guys have been so generous with your time. Thank you guys so much.

BROADY: Good talking to you.

ZINGALES: Bye-bye.

SMITH: OK, it is time for homework and vocabulary. And remember, there is an incentive to do your homework. At the end of Summer School, there is a test. And if you pass the test, you will get a diploma, a diploma that you can print out and put on your wall if you want.

So let's go to our vocabulary words. There is gross domestic product. That is the sum total of all goods and services an economy produces, aka everything consumers buy, plus government spending, plus all of the investments people make, plus all of the stuff we sell other countries. That is what we count as GDP, at least right now. There are intermediate goods, those are products sold between businesses to make other products. They do not get counted as part of GDP, but finished products do. Those are products that are sold to consumers. For this week's homework, spend a day paying attention to everything you buy. Is it a good? Is it a service? Did any intermediate goods go into the goods you're buying, like flour going into your Egg McMuffin? If you want some extra credit, post one of your discoveries to social media - TikTok, Twitter, Instagram, we are everywhere @planetmoney. Just be sure to use the #PMSummerSchool so we can find you.

So that was just a lot of economics that we hit you with. And here at PLANET MONEY Summer School, we want to leave you dancing always. To that end, we have developed a Spotify playlist - Econ Songs of the Summer, and people have been writing in with the most wonderful suggestions. We've added some of them to the playlist. You should check it out. But the one that really struck us, especially for this week for GDP, was the Daft Punk song, "Harder, Better, Faster, Stronger". It just seemed like the perfect metaphor for GDP that, you know, more growth, faster growth, bigger economic growth, without necessarily factoring in some of the costs or consequences of that growth and what that can mean for our country and our planet. So we wanted to play you out with a little bit of Daft Punk.

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DAFT PUNK: (Singing) Harder, better, faster, stronger.

SMITH: Please join us next week. We will be talking about the business cycle - the booms, the busts and how they can make inequality worse.

This is Season 3 of PLANET MONEY Summer School. If you want to catch up on Seasons 1 and 2, How To Think Like An Economist and A Guide To Investing, just find the Summer School feed on your podcast app or you can go online to PLANET MONEY Summer School. We've got a page there with all the previous seasons and exams all together in one place. We also have our Summer School TikToks and, I have to say, they are pretty fantastic. Follow along there for a parallel universe of economic learning @planetmoney. We'll post links to those videos in the show notes.

PLANET MONEY Summer School is produced by Audrey Dilling with help on this episode from Emma Peaslee. Special thanks to Jeff Guo, Greg Rosalsky and Greg Morton. PLANET MONEY Summer School is edited by Alex Goldmark, engineering on this episode from Gilly Moon. Our project manager is Devin Mellor. I'm Stacey Vanek Smith. PLANET MONEY is a production of NPR, and we will see you here next week, same macro time, same macro place. Thanks for listening.

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