Goodhart’s Law in action: Henry, Rudd and the financial crisis

One of the valuable insights that I learned about in my training in economics is Goodhart’s Law. This law, named after its originator, the first-class English economist Charles Goodhart, can be stated, very simply, as:

When a measure becomes a target, it ceases to become a good measure.

The idea is that statistical measures attempt to relate conditions in the world around us. When governments or other institutions sets targets for those measures, there is a temptation to use policy instruments to manipulate outcomes in order that the measures meet those targets. Thus, we no longer get a clear reading of the conditions that the measures are measuring. The real action has moved elsewhere, and what we are presented with is not an indication of what is happening in the world, but the effect on the world of the policy manipulations. 

I was reminded of Goodhart’s Law when reading Terry McCrann’s column on page 31 of today’s Weekend Oz: 

This “growth dynamic” faced its most serious challenge after the global financial crisis, when the developed world plunged into its worst recession since the Great Depression of the 1930s.

Just how much the “uninterruption” was an article of faith was demonstrated after the GFC, when in November 2008 then-treasury secretary Ken Henry said at the National Press Club: “We’re trying our hardest to make sure that [that happens. That] we do avoid a negative quarter of growth”.

Note that the government’s priority was not focussed on the economy itself – proper allocation of capital, preventing an increase in government budget deficit and debt as a result of wasteful spending, ensuring that those placed out of work by the crisis would be helped into new work through reforms to the labour market – but on the measure of the economy.

And so, seven years later, it turns out that the measures of economic growth did indeed register a decrease in GDP in the December quarter of 2008. Nothing Henry nor his boss Rudd did could prevent that. However, with Rudd and Henry now out of the policy-making process and enjoying lucrative pensions and private-sector salaries, the rest of us live with the consequences of their near-sighted decisions: a budget in structural deficit, a debt-load wasted on projects which generate zero revenue, and ongoing sluggish economic growth.

The GDP figures since the crisis show us that we avoided recession – largely as a result of policy manipulations which masked actual conditions in the economy. But the country is struggling. The targeted indicator, GDP, is no longer a good measure of actual conditions. The GDP measure became a target, and as a result it has ceased to be a good measure.


About Stebbing Heuer

A person interested in exploring human perception, reasoning, judgement and deciding, and in promoting clear, effective thinking and the making of good decisions.
This entry was posted in Flotsam and Jetsam, Good Thinking, Moral Hazard. Bookmark the permalink.

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