government debt (bonds etc) from banks and other institutions with newly created money, as undertaken after the crisis.
One effect, as I’ve already tried to show, was to boost economic activity by as much as $20 trillion annually in the years leading up to the 2008 crash. In Figure 13 I’ve taken the information on real wealth creation – based on raw-material extraction, as shown in Figure 11 – and used it to plot a line representing my estimation of GDP without the credit bubble. This is simply the line that GDP would have followed if it had continued to grow at its long-term trend rate, which, allowing for efficiency improvements and a gradual reduction in the waste of resources, happens to correlate very closely with raw-material extraction. This is, of course, what one might expect, and follows the trend that my first chart showed for most of the previous century, until money lost its link to gold in 1971, after which time the financial sector of the economy began to expand quite rapidly.
The chart shows the build-up of this artificially created wealth: the loans that led to the inflation of asset prices, especially housing, which in turn contributed to the inflation of the credit bubble. By adding up the difference between the two lines for each year, I arrive at a figure that represents the bubble. This figure is in the region of $200 trillion, and at the time of writing (early 2014) the bubble still appears to be expanding.
$200 trillion seems a lot of money to have been created out of nothing, and I am inclined myself not to believe it. Although the method I used to reach this figure seems sound enough, the whole thing obviously requires careful investigation.
Figure 13
First, I think we should look more closely at GDP, which, as I mentioned earlier, is not an accurate reflection of real wealth creation. [When I talk about total world Gross Domestic Product, as I do here, I really mean the gross output of the global economy. The word ‘domestic’ no longer applies in the global sense, but I shall continue to refer to it as total world GDP, because it is arrived at by combining national GDP figures.]
GDP is theoretically a measure of annual industrial output, but it includes all economic activity, whether productive or not. As well as including spending based on debt, which has been my main point so far, it also includes a great deal of unproductive output based on general activity within the service sector, including government spending on health, education and defense, only a small percentage of which involves real wealth creation (mostly the spending that goes into construction of public buildings, plus some manufacturing related to equipment and the defense industry). Because of this, the figure for real wealth creation – what we might call productive GDP – has always been much lower than the official GDP data would suggest. We can see this in Figure 14, which gives a breakdown of economic activity in the US, UK and Eurozone, according to official GDP figures.
Figure 14
The data suggest that agriculture represents just 1.2% of the US economy, by value added. For Britain the figure is a mere 0.7%, while the financial sector apparently adds over 30%, when grouped with related activities such as insurance, accounting and legal services (banking by itself is around 10%).
Even taking the lower value, one might conclude from this information that banking is more than 10 times as important to the UK economy than is agriculture, and business services generally more than 30 times as important. In GDP terms, this is obviously the case. But out there in the real world, on the ground as it were, away from the City of London’s square mile, it seems an absurd statistic. Who would you prefer to be without, bankers and lawyers, or farmers?
Even in Britain there is still a lot of farming going on, with 69% of the land either cultivated or grazed, though this isn’t enough to feed everyone (40% of the food eaten in Britain is imported). But the US is the biggest agricultural producer in the world, or third biggest after China and India, depending on how you measure it. US agriculture feeds over 300 million people and still has enough left over to export a quarter of its produce to the rest of the world. You only have to pass through the vast American heartlands to see the obvious importance of this huge industry. Yet according to the figures, it represents only 1.2% of the economy. So what’s wrong with these statistics?
The problem lies in the way GDP is calculated. Gross Domestic Product is a measure of the final output of a nation’s economy, and represents the market value of all goods and services produced in one year. In 2010, for example, the net contribution of US agriculture to the economy was around $170 billion. But this figure then feeds into the food-processing industry, where value is added by turning the raw produce into food that people can eat. The value added to agricultural produce is now reflected in the manufacturing figures, the food-processing sector of which shows an output figure of $800 billion. This food is then distributed by the retail sector, where it adds another $500 billion to GDP figures. So a more accurate reflection of the importance of agriculture, when measured by value to the US economy, would be $1,470 billion. This would represent around 10% of the economy rather than 1.2%, with 15% of US jobs dependent on agriculture.
But this is to be expected; we already know that the primary sector is vital to industry, and industry to services. That’s how the economy works, as I explained in Chapter 2. The distortion of GDP figures really occurs because of the inclusion of economic activity brought about by the spending of accumulated wealth and newly created money (credit, or debt), whether by the private sector or by governments. According to the same set of figures that gave us agriculture as 1.2% of the US economy, we have a total government contribution of 22%, and financial and other business services, including insurance, law and real estate, giving a total of 32%. How is it possible that the government has created more wealth than farming and industry? It isn’t, of course. No real wealth can be created by finance, insurance or government – nor by any other service. All they can do is reallocate wealth that’s already been created by the primary and secondary sectors of the economy at an earlier period than the GDP figures imply.
In other words, although GDP figures are calculated so as not to count the same new wealth twice in one year (in the way I showed above, with the wealth of agriculture feeding into processing and then retail) they do count the industrial wealth of the past, over and over again. The apparent wealth-creating activities of the service sector, which make up such a large percentage of developed economies these days, are really just a recycling of the wealth of past industry.
In addition to this, although most investment income is excluded from GDP figures (in recognition of the fact that such ‘rent’ is not genuine output), there is a different measure of the so-called wealth added to the economy by the financial sector. A strange concept devised by the United Nations in 1993 attempts to account for the ‘intangible’ wealth created by banks using a system that translates the financial risk from loans into output.2 So the more debt a bank takes on, the more it apparently contributes to GDP.
Services add value by assisting the real wealth creators to produce their goods, certainly, but that value is already reflected in the figures for real industrial output. We see therefore that GDP figures are seriously flawed as a measure of real wealth creation, and this distortion must surely be reflected in policy decisions based on these figures.
Another example of how GDP figures seriously understate the importance of primary industry is in mineral extraction. A 2009 study by PricewaterhouseCoopers (PwC) of the US oil and natural-gas industry arrived at the results shown in the following
