This is a complete economic fallacy. Unfortunately, virtually every economic commentator in the country, irrespective of politics, subscribes to it, including nearly all of our academic economists and even our so-called “economic rationalists.” So please believe me when I say I am not picking on poor old Terry.

The problem ought to be self-evident but clearly is not. These commentators rely on GDP (gross domestic product), not realizing that it is anything but gross. They have yet to figure out that national accounting leaves out an enormous amount of business spending on the fallacious grounds that it involves double-counting.

The GDP-approach is a value-added one that contains two very deep flaws. First, what it calls double-counting is not even counted at all. When an intermediary input priced at $1,000 is booked at $2,000, double counting has clearly occurred. When company accountants discover such errors they immediately correct them. Economists, on the other hand, refuse to count the input at all. This is because they take a value-added approach while still claiming that it is based on gross spending.

It is surely ridiculous for economists to ignore as unimportant business expenditure that is an essential component of total business spending. Any company that ignored these costs would quickly go bankrupt. So why should economists do what no sane businessman would ever dream of doing? It ought to be immediately apparent to these economists that if spending on intermediary goods were to cease the economy would collapse. Yet orthodox economics completely discounts it, regardless of sound accounting rules.

Friedrich von Hayek explained in some detail not only how this spending took place through various stages of production, but also how changes in monetary policy could affect it in such away as to offset the benefits of increased savings and investment. (The Paradox of Savings in Profits, Interest and Investment, Augustus M. Kelley Publishers, 1975). Unfortunately his valuable insights have been ignored by the vast majority of orthodox economists.

For GDP to therefore accurately measure economic activity in terms of spending it must, by definition, include all areas of spending. When this is done a radically different picture of the economy emerges. Let us take a look at the US Bureau of Economic Analysis’ Survey of Current Business for 2003. (Figures are in billions of US dollars and have been rounded off). GDP is $10,083, consumption spending is $7,385, which is 73 per cent of GDP, and spending on intermediary inputs is $8,297. Therefore, gross spending equals $18,380.

As we can see, omitting intermediary inputs literally eliminates the flow of goods from one stage of production to the next stage, leaving out massive business spending. The second flaw now becomes patently obvious: leaving out spending on intermediary inputs exaggerates consumption spending to the extent where economists now believe it drives the economy. We can also conclude from this line of reasoning that Mr McCrann’s claim that “investment adds to about 15 per cent of the economy” greatly inflates the true figure.

Classical economists, however, were fully aware of the fact that consumption spending is derived from production and not the other way round. John Stuart Mill nailed this point when he wrote: “What a country wants to make it richer, is never consumption, but production”. (Of the Influence of Consumption on Production, 1829). In other words, it is production we have to worry about, not consumption.

This article is not suggesting there are no problems in the current level of business spending –– there are. Unfortunately our economic commentariat has yet to spot them. And if Terry is anything to go by, it never will.

Gerard Jackson is Brookes’ economics editor

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