Measure what is measurable, and make measurable what is not so.
-Galileo Galilei
Every scientific endeavor grapples with a fundamental dilemma: we yearn to grasp concepts that resist straightforward measurement. Any instrument of quantification is inherently shackled by the technological constraints of its era and the subjective choices of those wielding it. Often, we find ourselves unable to measure directly what we wish to understand, relying instead on proxies or scant information to illuminate our interests. Thus, the measurement utilized is not the essence itself, but merely a representation of it.
Regrettably, those lacking a grounding in scientific reasoning frequently conflate measurement with the actual phenomenon—a common pitfall in economics. Consider the Consumer Price Index (CPI), a barometer for inflation derived from a curated selection of consumer goods. The underlying premise is that if prices behave independently, the Index should exhibit little fluctuation. Conversely, if the Index consistently trends upward or downward, we might infer inflation (a rising Index) or deflation (a falling Index). However, it’s crucial to recognize that the Index can fluctuate for reasons unrelated to inflation. A single price change, all else being equal, can alter the Index due to its structure as a weighted average. Thus, one shift can ripple through the entire Index.
To illustrate, let’s imagine a significant spike in gasoline prices while all other prices remain static. The CPI would ascend, since gasoline is factored into the Index. Yet, no informed economist would claim that this signifies inflation; after all, inflation is defined as a broad rise in prices, and here we have merely one price experiencing an increase. Those who mistakenly equate CPI with inflation risk misinterpreting and misdiagnosing the economic landscape.
A similar narrative unfolds with Gross Domestic Product (GDP). While GDP serves as a metric of economic activity, its growth rate does not equate to economic growth itself (nor does it encapsulate a theory of economic growth). GDP measurement, akin to CPI, is an accounting construct that aspires to act as a proxy for genuine economic growth. Yet, those who conflate GDP measurement with economic growth often err in concluding that an uptick in GDP necessarily indicates real growth. The GDP is calculated from New Consumption + New Investment + New Government Spending + New Net Exports. Any alteration in these components will inevitably lead to a rise in GDP. This is an undeniable fact, yet it does not imply that this increase reflects actual economic growth. Historical contexts, such as America during World War II and the USSR, underscore this misalignment. The U.S. saw a significant GDP increase during the war, primarily driven by soaring government expenditure. Yet, many indicators suggested a decline in living standards compared to the Great Depression: consumer goods were scarce, and self-sufficiency became a necessity as people cultivated their own food. In the USSR, GDP growth appeared promising, leading to predictions of it surpassing U.S. GDP. However, post-collapse revelations revealed that the standard of living for Soviet citizens had scarcely evolved since the Tsarist era, with GDP artificially inflated by state spending, rendering it a dubious measure of actual economic vitality.
This persistent confusion between measurement and the underlying reality presents an enduring challenge for central planning and industrial policy. Central planners must establish objectives, necessitating measurements to gauge progress. Unfortunately, this often results in a fixation on achieving the metrics, eclipsing the broader goals. Consequently, plans may succeed in hitting numerical targets while failing to achieve their intended outcomes.
Update: I appreciate David Henderson for pointing out that my earlier description of GDP was not entirely accurate. The measurement of GDP is indeed an identity, while the concept of GDP transcends that definition. Additionally, John Hall rightly noted that GDP reflects economic activity rather than growth. I’ve amended the previous paragraph to more accurately convey my intent.
