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Are Accounting Scandals Good for the Economy?

No doubt the accounting and financial mischief thought to have taken place at Arthur Anderson, Enron, Halliburton, WorldCom, Xerox, and other large American corporations has not been good for America's economy. Or has it? Aside from marginally increased scrutiny by the Securities and Exchange Commission, much of the economic activity surrounding Enron and other corporate fraud is considered positive in a leading measure of economic progress, the Gross Domestic Product (GDP). The Enron scandal alone may well contribute up to $1 billion to the U.S. economy.

Nobel Prize winning economist Simon Kuznets, one of the developers of the GDP, warned in 1934 and again in 1962 that it should not be used as an indicator of America's economic welfare. The intent of fraudulent accounting may have been more direct at Enron, but in the final tally, all the court cases, lawyers' fees, housing criminals, media frenzy, and payouts continue to be counted as positive gains by the accounting standards of GDP. And politicians are eager to take credit for the growth.

"We've got a consistent and effective strategy, and we're making progress… Our third-quarter economic growth was vibrant, and that's good," said President Bush in November. When the President proudly takes responsibility for economic growth and affirms a continued dedication to the "all growth is good agenda" and the media reports it, the public can become over-confident. However, before we become too hopeful based on one-sided accounting, it is important to consider what is really going on in the economy. Are non-productive contributions such as "creative accounting" or destructive spending like war fueling our economy? Plans and presidential sound bites premised on empty economic growth may well lead America further off-course and contribute to future economic instability the world over.

If all new economic activity moves from the middle and lower income classes to the richest 1 percent in America, the GDP reports the same number as it would if the money went to all Americans. GDP, of course, is not meant to account for where the money goes, but if most of it goes to a select elite is it really worth the same as if it went to Americans who needed it most? Since 1968, income inequality in America has been steadily worsening. Meanwhile, volunteer work and raising children are not counted at all, though few would argue that they do not contribute to the well-being of society. Higher health care and education costs, longer commute times to work, increasing pollution, clear cutting forests and paving over open spaces, and increased use of fossil fuels can and do all add growth to the "positive-only" ledger accounting of the GDP.

In the 1960s Robert F. Kennedy said of the Gross National Product, the forerunner of today's GDP, “…[It] does not allow for the health of our children, the quality of their education, or the joy of their play. It does not include the beauty of our poetry or the strength of our marriages; the intelligence of our public debate or the integrity of our public officials. It measures neither our wit nor our courage; neither our wisdom nor our learning; neither our compassion nor our devotion to our country; it measures everything in short except that which makes life worthwhile."

The GDP shows that in the period from January 2000 to January 2003 the economy grew approximately 2.7 percent – about $266 billion (in $2,000 inflation adjusted dollars). On a person basis this resulted in a real increase of $130 per American. Without reference to the quality and distribution, this economic growth may look good on the surface. Using an alternative measure, called the Genuine Progress Indicator (GPI), however, shows that the value of economic activity grew by less than one percent during the same period. On a per capita basis, from 2000 to January 2003 there was actually a $228 decline in GPI, with the biggest reductions coming from the degradation on natural resources and national debt, respectively. On the other – positive – side of the ledger, GPI shows a $600 billion increase in the value of housework and volunteer work from 2000 to 2003, which is not counted in the GDP.

There is an argument that measures of economic progress must be scientific and value free. Some believe that attempts to measure the quality of what is going on in the economy and how it affects people makes too many assumptions or too many value judgments. The GDP, however, is not value free. To leave social and environmental costs and contributions to the economy off the books does not avoid value judgments. On the contrary, it makes the obvious value judgment that things such as the destruction of farmland and natural resources, underemployment, longer-commute times, and the loss of free time, count for nothing in assessing how the economy is faring. GDP does put a value on such factors: Zero. Keep in mind, this is on top of adding in the value of crime, deficits, and war related expenditures and other less desirable expenditures.

Redefining Progress has developed an economic indicator that attempts to get much closer to the economic reality that people experience. The Genuine Progress Indicator includes more that twenty positive and negative aspects of our economic lives. The GPI uses the same personal consumption data as the GDP, but takes into account a number of other factors. Adjustments include factors such as income distribution. Additions take into consideration things like the value of volunteer and housework. Deductions are made for crime, degradation and destruction of natural resources, and other factors. The result is a substantively different picture than that presented by the GDP. Admittedly, the GPI cannot accurately reflect everything of value in an economy – or life, for that matter. Still, the GPI highlights an important message: the quality of economic development is at least as important as the quantity of economic growth as measured by GDP.

The ambiguous accounting practices of Anderson, Enron, WorldCom, Xerox and other large American corporations combined pale in comparison to the over counting of the GDP. Using the GDP as a measure of economic progress amounted to a $7 trillion overstatement of economic gains in 2002 – that is about $25,000 per American. Enron et al. eat your heart out!

  • Gross Domestic Product (GDP) vs. Genuine Progress Indicator (GPI) (in 2000 dollars)
    From 2000 to 2002 the GDP per capita increased by $180, while the GPI decline by $212 over the same period. The difference is caused by the adjustments in the GPI, which, for instance, subtract environmental degradation and crime from the GDP.
    Sources: Bureau of Economic Analysis, National Income and Product Accounts; Jason Venetoulis and Cliff Cobb, Genuine Progress Indicator: Measuring the State of the Real Economy, 1950 to 2002 (2004 Update).
  • Gross Domestic Product versus Genuine Progress Indicator, 1950-2002, Per Capita ($2000)
    While DGP has continuously grown, the real GPI has remained flat or even declined a little since the early 1970s.
    Sources: Bureau of Economic Analysis, National Income and Product Accounts; Jason Venetoulis and Cliff Cobb, Genuine Progress Indicator: Measuring the State of the Real Economy, 1950 to 2002 (2004 Update).

Dr. Jason Venetoulis is senior research associate at Redefining Progress in Oakland, Calif.

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