I recently discovered a dirty little secret. It had been hiding from me in plain sight. While searching for a podcast, I was intrigued by the episode title ‘How buying Cocaine helps the government’ in the new BBC series ‘Economics with Subtitles’. It cleverly explains how silly GDP can be as a measure of sustainable economic activity. The reason – as the name suggests – is because it’s GROSS. All that matters is volume and price, regardless of what the volume is or whether the price is worth paying.

As an example, the episode started with the story of the biggest drugs bust in UK history and explained why it would have a negative impact on GDP. Maybe I would have known this if I’d paid more attention in economics class, but I was staggered to learn that civil servants at the Office for National Statistics actually spend time estimating the value of the illegal drugs trade, primarily so that its value can be added to GDP.

As it happens, the Nobel Prize winning economist Simon Kuznets who first developed the modern concept of GDP never intended it to be used this way. In fact he was very angry about it for exactly the reason highlighted above. His novel view back in the 1930’s was that for economic activity to be valuable, it should have a positive impact. He felt that negative economic activity should be deducted from the gross number to provide value to policy makers. But in a quirk of history, politicians and central bankers wanted a number, this one was easier to calculate and suddenly ‘gross’ became the global standard. The genie was out of the bottle, never thus far to return.

Source: UK Office for National Statistics.  Millions GBP.

So, illegal drugs are a good thing according to GDP but what other unintended consequences are there and what impact does this have on society or the environment? Firstly, fossil fuel or tobacco production are considered unashamedly positive with no consideration of the negative environmental or healthcare costs incurred. Secondly, the quality of products are ignored. So an underperforming fund manager charging a high fee is valued more highly than an outperforming manager charging a low fee. Finally, high value free services such as volunteering and charity work are considered economically worthless. It seems obvious to me that if there was some attempt to measure the positive and negative impacts of economic activities, it would almost certainly lead to better policy making. Some societies have learned to tax consumption of damaging goods but this has usually been too little too late – mostly due to aggressive, self-interested lobby groups.

On a positive note, a recent Nobel Prize was awarded in the area of the economics of climate change which attempts to account such negative externalities proactively. Hopefully such approaches will become standard. In the meantime, remember that the ‘GDP growth’ so loved by politicians is not all it’s cracked up to be. For our part, we will keep focusing on analysing the net positive impact of each company we invest in from the bottom up. For loyal readers it should be obvious why. We believe measuring impact from the bottom up adds a dimension to our investment process that creates positive impact and the potential for better long-term returns.

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