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VIDEOThe Truth Behind GDP
Don't be fooled by Friday's number.
The talking heads will greet this number with great enthusiasm. They will interview members of the administration, which will greet the number with even greater enthusiasm proclaiming that a long period of steady economic growth is right ahead of us, all of which is due to its economic policies and actions.
Yeah, right.
In advance of this stellar achievement, I thought it might be useful to look at how the two most important economic indicators, GDP and the unemployment rate, are calculated. I have to admit I forgot the definition of Gross Domestic Product (GDP) from my undergraduate economics class, so if you also forgot, or skipped class that day, here it is:
GDP = C + I + G + (X-M)
C = Private consumer consumption, basically all the goods and services you buy
I = Investment, which includes business investment of plant, equipment, inventory, structures, etc. It doesn’t include investment in financial assets (your day trade that you accidentally held overnight does not contribute to GDP).
G = Government spending, all salaries, military, and investment, but no transfer payments, such as social security or unemployment benefits.
X = Exports
M = Imports
You might have noticed that there’s no consideration of debt, either personal or government, in the calculation of GDP. So, if the government spends like crazy (which it is), that spending will boost GDP.
China’s fourth quarter GDP came in at 10.7% -- to pull that off you need to do stimulus right. There’s no better example than this video. Every brick in that empty city is pure GDP. That stimulus makes our Cash for Clunkers and road repaving look pretty trivial.
With stimulus in mind, let’s look at our third-quarter 2009 GDP numbers.
GDP increased 2.2%, but most of that increase, 1.45%, was due to increased automotive purchases, obviously due to the Cash for Clunkers program. So a “G” program drove an increase in “C” without a subtraction of the increased national debt that was created by Cash for Clunkers. For actual numbers, click here.
Table 3 shows the actual numbers in billions of dollars. The quarterly numbers are seasonally at annual rates and the headline reported numbers are from the chained 2005 dollar column, which adjusts them for inflation. Look at two lines (shown here) in the Personal Goods section, motor vehicles and recreational goods and vehicles (SUVs fall into this category).
Click to enlarge
In the second quarter, total sales in these two categories fell $9.7 billion from the first quarter. In the third quarter, they increased by $45.4 billion from the second quarter. Because that's an annualized rate, the clunker program generated an additional $11 billion in sales at a cost of $3 billion. Whether or not you believe it was a good program, it did work and produced a pretty good multiple on the cost.
Total GDP increased $71.5 billion in the third quarter, but Personal Consumption only increased $63.6. Subtracting Clunkers leaves only $18.2 billion. Scanning all the other goods and services categories shows, on average, small gains and losses, the biggest of which was food at $6.6 billion -- not exactly an area where consumers enjoy spending more money. Overall, I'd hardly call it the start of the end of the recession for consumers.
The problem with GDP is that it doesn’t represent what the average American family is feeling. Much closer to consumer sentiment is the unemployment rate. You might think that the GDP calculation -- trying to get all spending and investment from all sectors -- would be difficult, but in reality, GDP has three months to get the final revision in, while the unemployment rate has little more than two weeks to be guessed at.
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