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In this article, Professor Michael Pettis talks about how GDP can be overstated if non-productive assets are not written down.

However, I've seen in a few places (in the comment section of the link above, here in the comments, and elsewhere (I cannot recall the link)) that GDP accounting does not work this way and that he is incorrect. Specifically, the general commentary is that investments are not written down in GDP accounting like it is in corporate accounting.

I'm surprised there's any disagreement because this seems like a rudimentary calculation, and not something that's opinion.

Can someone clarify what the issue here is to someone who only has a few undergraduate courses in economics?

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I think you are misunderstanding the discussion there.

There is no ambiguity or disagreement on what steps are taken to calculate GDP or what items are included/excluded etc. National/international agencies have handbooks with set rules, for example, US Bureau of Economic Analysis has its NIPA handbook. So you can always just go there an check the methodology. Under most standard methodologies there is no adjustment or even difference made between productive or non-productive investment. However, there are disagreements on whether GDP actually appropriately captures economic activity and if it is comparable between countries.

Pettis in that article does not say that China literally miscalculates GDP by not excluding non-productive investment. Rather disagreement here is what the GDP actually measures.

GDP’s intended purpose is to measure the value of output produced by a nation. but it is imperfect measure. For example, economists generally agree that house production is important part of economic activity, but it is hard to measure so it is excluded in GDP (this holds for many other economic activities such as those taking place in grey or black markets). In fact in his report to U.S. Congress Kuznets (who is the person who developed the modern concept of GDP) mentions in a preface that national product (GDP) in his view should encompass all production at its hypothetical market value. But he later concludes that it is difficult to properly measure non-market activity so it is excluded from the calculation. This is not an issue as long as all countries have approximately the same level of these hard to measure activities but it would create a problem in international comparisons if different countries have different levels of home production and other non included activities.

For example, in some agrarian society almost all if not all production might be done at home. So statisticians trying to record GDP for such society using the standard methodology could report 0 GDP (in hypothetical case all production is done at home & gray markets), but that obviously does not mean that there is no economic activity going on or that country has no valuable output. This is just a limitation of the GDP, GDP is not economic activity, it is proxy for it (for example, in world without thermometer you might measure temperature just by touching things and feeling if they are more hot or cold, but that would obviously create problems in interpersonal comparisons).

In cases where you know that countries in your sample have widely different levels of home production, if you want to do some more nuanced international comparison of GDP, you would do some extra research to try to find out what the value of home production is (nowadays there are some ways how this can be more or less precisely estimated) and you could try to adjust countries GDP for this problem.

Similarly, in that article Pettis does not say that GDP is miscalculated, in a sense that Chinese statisticians did not follow standard procedures. Rather there Pettis argues that because (in his opinion) a lot of Chinese investment is unproductive, compared to other countries, and according to Pettis this means that total factor productivity (TFP) for China (which is calculated using GDP), cannot be easily compared to TFP in other countries.

So, it is not that Pettis says GDP is literally miscalculated, rather he states that GDP and TFP in China cannot be readily compared to other countries. Then he goes on to propose some ways how GDP could be adjusted to compensate for that. Such adjustments are often controversial because there is large number of different ways of how one can adjust GDP and there is no clear agreement on which one is the best. In fact, going back to the previous example, the reason why GDP still excludes home production even though virtually all economists would agree its important part of the economy is that there we too do not have any agreed upon way to measure home production (at least not to such an objective degree as we can market production). So such proposals are often criticized because people do not agree on how the correct adjustment should be and thus many people even in research prefer to just default to using GDP as recorded as it is at least objective.

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  • $\begingroup$ nahb.org/News-and-Economics/Housing-Economics/… Housing’s contribution to GDP averages 15-18% and occurs in two ways: Residential investment (averaging roughly 3-5% of GDP) which includes construction of new single-family and multifamily structures, residential remodeling, production of manufactured homes, and brokers’ fees. Consumption spending on housing services (averaging roughly 12-13% of GDP) which includes gross rents and utilities paid by renters, as well as owners' imputed rents and utility payments. $\endgroup$ Jun 29, 2021 at 17:09
  • $\begingroup$ @1muflon1♦ I think Pettis is literally arguing that there should be a write down in the actual calculation (not just merely how you interpret the number and adjust for it). This is a comment in his article that you can CTRL F: $\endgroup$
    – Snowball
    Jun 29, 2021 at 17:15
  • $\begingroup$ "You are only partly right, and because your confusion occurs so often among those who inly partly understand GDP accounting, I always make sure to explain (not always to much effect, apparently) that it is the "writing down" of the asset that matters, not its creation (and it is indeed like corporate accounting, which also does not include the exchanging of cash for an asset as revenue)." $\endgroup$
    – Snowball
    Jun 29, 2021 at 17:15
  • $\begingroup$ "To explain again: when a business invests in a project that turns out to have no value, when it writes down the asset, this reduces its profitability, which in turn reduces its contribution to the value-added component of GDP. That is how it should (but doesn't, if it isn't written down) affect the GDP calculation. If entities in two countries each invest \$100 in projects that create no value, and in one country that project is written down, but not in the other, the former will record $100 less GDP than the latter during the period in which the write-down occurred." $\endgroup$
    – Snowball
    Jun 29, 2021 at 17:15
  • $\begingroup$ In other words, he is arguing that actual calculated GDP should be lower (not an interpretation of calculated GDP), since he states that it affects the value added component of GDP. $\endgroup$
    – Snowball
    Jun 29, 2021 at 17:17

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