The Financialization of GDP and its Implications for Macroeconomic Debates

The large and growing literature on financialization has focused on identifying the expansion of the financial sector into various realms of economies and societies, as well as analysing its effects on economic growth, employment, inequality and democracy, among other variables. Most works in this literature, however, still use standard indicators such as Gross Domestic Product (GDP) for empirically defining and examining the scope of financialization or the extent of its impacts. This paper builds on recent research focusing on the financialization of GDP itself. While the original measure in the 1930s and 1940s was designed to capture the production of measurable output, subsequent updates to the national accounting framework shifted the production boundary (which determines what gets counted in GDP) to cover more services, including those for which there is no direct measure of output. In particular, the ‘value-added’ of financial services is imputed based on banks’ revenues and costs, and the inclusion of such income in GDP has caused a deterioration in its correlation with measures of employment and median income, as well as in its performance as a leading indicator. Using new data and treating financial revenues as a cost to the overall economy, a new measure – Final GDP – performs better than GDP on all three fronts. It also sheds light on several unresolved empirical debates in macroeconomics. First, the phenomenon of the Great Moderation of fluctuations in output appears to be a statistical artefact, as the inclusion of finance in GDP smooths over volatility as well as trends of secular stagnation. Second, the spurious breakdown of Okun’s Law also turns out to be a figment of the data, since GDP by construction has been diverging from employment and aggregate demand. Jobless growth recoveries thus turn out to be merely periods of stagnation when employment growth is naturally subdued. Finally, using in-sample forecasting, FGDP outperforms GDP as a leading indicator, foretelling the Great Recession earlier and more clearly than the standard measure. The paper concludes by assessing some broader implications of the finalization of GDP for economics and politics.