The paradox of choice

2012-APR-21

Here is a puzzle for Keynesian and other neo-classical economists.

When a consumer buys something, he must choose; and if he increases his purchase of one product, he must reduce his purchases of other products by the same amount. In other words he cannot buy both. This must be true for whole communities as well. How then can you have economic growth?

It is of course impossible without monetary inflation. This is because any statistical average, in this context GDP, can only grow if people are not forced to choose between alternatives, a condition that can only occur if they are given extra money. Not even a draw-down on savings to spend on consumption creates extra spending, because it is merely reallocates spending on capital goods to consumption goods. This simple point has been ignored by all neo-classical economists. The result is that in their pursuit of so-called economic growth, they have committed themselves to monetary inflation. Their concept of growth is to make that extra money available to consumers, so that they are not limited to what they earn and forced to choose. It has also become the basis for economic modelling, which takes known demand for products and services and from it extrapolates growth for an average of all of them.

The means by which GDP is adjusted for inflation is inadequate, because if it was adequate, this law of choice proves that real GDP statistic remain the same. Reported real growth in GDP is therefore no more than a statistical gap. Anyway, it is irrelevant: not only is it impossible to have wholly accurate statistics, but it is also impossible to predict the future consumer preferences that should be the basis of economic forecasting.

So the gap cannot ever be closed, and it does not help that the neo-classical establishment yearns for results that confirm their misplaced concept of economic growth. Government has money on the result as well, with a variety of bonds and welfare benefits indexed to prices. There are therefore compelling reasons to under-report the effects of monetary inflation and so to ensure that real growth is always recorded.

Understanding these dynamics is central to a proper understanding of our economic condition. It is not just a question of modern statistics measuring quantity and not quality as some critics assert. The whole basis of macro-econometric measurement is flawed and as long as we think in terms of GDP, CPI and other aggregated data we will continue to mismanage our affairs. Any reported GDP growth is statistical rather than real, a point that should be borne in mind every time the subject of economic growth crops up.

The establishment has been deluding itself in this matter ever since the Second World War, when price indices and GDP began to be widely used. The answer to the conundrum we have posed is that growth in GDP cannot be a measure of economic activity, because of the paradox posed by choice. Instead an economy progresses, as entrepreneurs come up with products consumers will want tomorrow. Even though we pay lip-service to their role in society, none of their future input is reflected in the static economic models of the neo-classicists, which is why they resort to base subterfuge.