How GDP Came to Be, Part 1
People with a historical bent know that behind things that are often quickly dismissed as boring, tedious or mundane, there’s usually a good story. Consider gross domestic product.
Gross domestic product, which often goes by its initials, GDP, is the big kahuna of economic measures. Defined by the U.S. Department of Commerce’s Bureau of Economic Analysis (BEA) as “the total market value of the final goods and services produced within a country in a year,” GDP is the most comprehensive measure of a country’s economic activity.
Ask an economist how big the U.S. economy is and you’ll be provided with the most recent estimate of U.S. GDP. Ask how the U.S. economy is doing and you’ll be provided with the most recent one-year percentage change in U.S. GDP.
GDP is not a topic for everyone. But before moving on or dozing off, readers in touch with their inner historian ask, “Who thought of GDP, and why?”
The story of GDP begins in Britain with William Petty (1623-1687): physician, philosopher, economist. Historians of economics credit Petty with the first systematic effort to measure not GDP but national income, GDP’s first cousin. What prompted Petty’s effort? His country was at war.
Discord over trade policies unresolved by the First Anglo-Dutch War (1652-1654) had Britain and Holland at each other’s throats again in the Second Anglo-Dutch War (1664-1667). Petty felt confident that Britain had the economic capacity to finance the war from tax revenue and produce sufficient armaments to defeat the Dutch. But he wanted reliable evidence on the size of Britain’s economy to prove it – to himself and his countrymen.
Petty devised a system for estimating national income and wealth using double-entry bookkeeping, then described his system in a work published in 1665. Petty’s use of double-entry bookkeeping established a precedent: the BEA’s National Income and Product Accounts, from which we get estimates of U.S. GDP, is a system of double-entry accounts.
High government officials found Petty’s system impressive but his underlying data, thin. The idea of measuring the size of an economy soon receded from political consideration. Charles Davenant (1656-1714) brought it back with greater effect in a pamphlet published in 1694. The inspiration for Davenant’s pamphlet is clear from its title: “An Essay upon the Ways and Means of Supplying the War,” in this case, the Nine Year’s War with France. Davenant’s purpose for estimating national income was the same as Petty’s: to empirically assess Britain’s capacity to wage and finance a war.
Small subsets of successive generations of economists spent the next 196 years arguing about what should and what shouldn’t be included in national income. Adam Smith (1723-1790) instigated much of the arguing by insisting, in his “Wealth of Nations” (1776), that a nation’s wealth is enhanced only by the production of physical commodities.
Alfred Marshall (1842-1924) ended much of the arguing in 1890 by showing, in his “Principles of Economics,” why Smith was silly to think that services contribute nothing to a nation’s wealth. Economists have found it silly to think about services the way Smith did ever since.
The German government entered 1914 with $70 million in gold stored away for the sole purpose of financing a future war, should one arise. World War I did that summer. By 1916, a major German offensive would ring up $70 million in expenses in a day and a half. After World War I came the precarious 1920s, the Great Depression and World War II, one right after the other. The quest for GDP grew more urgent with each event. We’ll explore that in my next column.