Finding the Real Economy 26 comments
an article to
-
Font Size:
-
Print
- TweetThis
Gross Domestic Product (GDP) is an attempt to quantify the market value of all final goods and services made within the borders of a nation in a year.
This definition of GDP is so hard to understand, and the methodology to quantify GDP is so convoluted, that it should come as no surprise that the media and the politicians believe GDP is the gauge of the economy.
It does comes as a surprise that many economists also believe GDP is the economy.
GDP Explained
The concept of GDP was an attempt by economists to quantify the important core economic elements so that America’s economic activity could be gauged.
GDP does not include many economic activities,
If you buy a new car this is in GDP; if you buy a used one it is not. If you buy a new house it is included in GDP; a used house is not. And interest income is also ignored in GDP as it is an intangible. The point is that the item or service must be produced – it cannot be pre-existing. In fact, one half of all of our economic transactions are excluded from GDP. And even this statement ignores the black markets of illegal drugs, flea markets, barter transactions, Federal Reserve transactions, etc.
Wikipedia definition:
GDP can be defined in three ways, all of which are conceptually identical. First, it is equal to the total expenditures for all final goods and services produced within the country in a stipulated period of time (usually a 365-day year). Second, it is equal to the sum of the value added at every stage of production (the intermediate stages) by all the industries within a country, plus taxes less subsidies on products, in the period. Third, it is equal to the sum of the income generated by production in the country in the period—that is, compensation of employees, taxes on production and imports less subsidies, and gross operating surplus (or profits).
The most common approach to measuring and quantifying GDP is the expenditure method:
GDP = private consumption + gross investment + government spending + (exports − imports), or, GDP = C + I + G + (X − M).
Using NIPA Data Directly without GDP Filters
GDP is derived from America’s financial transaction income statement – the National Income and Product Accounts Table (NIPA). GDP filters the elements of these NIPA tables which meet the criteria for GDP.
In essence, the NIPA tables together are similar to a detailed corporate income statement with supporting ledgers (tables). Income = expenditure. GDP is derived by using the expenditure side of the NIPA tables.
In the Wikipedia definition of GDP, the third method of determining GDP is to tally the income produced in a country (highlighted above). Of course only specific income producing activities would be included in GDP. As the income side of the NIPA is not detailed, it cannot be used to derive GDP.
To get a broad picture of the economy, the entire income side of the NIPA could be used - the total income of individuals, corporations and government. A single dollar may flow many times between individuals, corporations and government in each period. Nothing is excluded - interest used to finance the economy, profits from stock transactions, flipping houses, etc.
As the total NIPA income is $24 trillion (individual + corporations + government), it provides a broader view of the economy. It could be argued that this total NIPA income is the economy.
As GDP is a subset of the NIPA tables, it is expected that the movements of both should be similar. The graph below illustrates the QoQ changes to both real GDP and the NIPA total income. As the economy is being more broadly viewed with a larger sampling, there is much less volatility (noise).
A total income approach to viewing the economy creates a less volatile data set, it is easier to trend. For instance, it is easy to see that since 2006 we have been in a cyclical down trend. This is much closer to alignment with the start of the recession in December 2007 than is the peak in GDP, which occurred in the middle of 2003. GDP has been in a cyclical down trend (with considerable volatility noise) since then.
There are two tables used to create this NIPA total income – Table 6.1D which tallies the income of business and government, and Table 2.1 which tallies personal income. In both cases, the gross income was used without adjustment.
Unfortunately, Table 6.1D. National Income without Capital Consumption Adjustment by Industry has not been updated for 2Q 2009. This table provides the corporate and government figures. We will have to wait until 27 August 2009 to see 2Q results.
Table 2.1 provides personal income and was updated for 2Q 2009. Personal income is ½ of the total NIPA income. There was not much difference in personal income between 1Q and 2Q. Personal income grew by only 0.07% from the first quarter to the second, while wages and salaries in the private sector declined by 1.48%. Government paid wages and salaries grew by 1.02%. Personal current taxes declined and disposable income increased.
Although this income data could be fine tuned (such as removing taxes), there was no noticeable effect on the interpretation of the data. When data is not manipulated or adjusted, the results are easier to accept. If the data is detailed, an analyst can always remove an element which is determined is not appropriate for a particular analysis.
Using Total NIPA Income to Plot Economic Cycles
As NIPA total income is now trapping more of the economy than GDP, velocity of money calculations are more precise. Velocity of money analysis can be used to understand economic expansion and contraction cycles.
It is significant that using NIPA total income to determine velocity of money, we had a growth (expansion) cycle peak in 4Q 2007 – an exact marker for the beginning of our Great Recession.
It may be that velocity of money stopped declining at the end of 2008. However, 2Q 2009 results will not be published until later this month. I will revisit this velocity of money analysis when data becomes available.
If the 2Q 2009 data confirms a cycle bottom, it does not conversely imply an expansion cycle has begun. It confirms that the economy is no longer contracting. There are two important points:
- We have become Pavlov’s dogs. We are conditioned to thinking about jobs and manufacturing being the economy – like it or not, this is less than one half of the real economy. The NBER marked the beginning of this recession using jobs and manufacturing. Half of the economy is ignored.
- As we are travelers on this economic river, what happens today was set in motion many months ago. Economic change manifests slowly. It is almost certain that the events which will lead to the end of this recession sometime this year have already occurred.
Using Total NIPA Income to Calculate Real Economic Growth
Using NIPA total income data can be used to calculate real economic growth. Real GDP is an attempt to make GDP comparable across many years by removing the effects of inflation and other phenomenon to facilitate comparison. No one fully believes the BEA's real GDP number is correct.
The objective is to calculate real economic growth. Somehow the effects of inflation and population growth must be removed.
Most analysis ignores population growth. Consider that if your population grows by 1%, the economy needs to grow by 1% just to be operating at the same economic level per capita.
Inflation is a contentious subject as very few can agree on its specific determination. Using QoQ comparisons, the actual amount of inflation will be insignificant between quarters unless we enter a high inflation or deflation cycle.
As population is growing at over 1% per year – the data is given a 1% headwind to overcome.
If this graph is correct, we have had little real economic growth this century.
Summary
Use of NIPA income for economic modeling is transparent and straight forward. Quarterly data does not go back far enough to test past economic cycles. But use of this NIPA Income data provides an improved and more realistic picture of the economy.
Using total NIPA income as an economic indicator does not create a perfect solution. It also is not the total economy, just more of the total than GDP.
Disclosures: None
Related Articles
|
-
The Seeking Alpha 100
See allThe top 100 stock
market authors
selected for publication
Seeking Alpha 100 » -
Fastest Climbers
Authors with the largestSee all
increase in followers
in the last 7 days
Fastest Climbers » -
Top Commenters
Top commenters,See all
as ranked by their peers
Top Commenters » -
Top Instabloggers
The 100 most active
Instabloggers.-
1
TraderMark
-
2
Don Dion
-
3
Cliff Wachtel
-
4
Mike Havrilla
-
5
James Quinn
Top Instabloggers » -
1
-
Top StockTalkers
TopSee all
StockTalkers.
Top StockTalkers »
But from lst graph with adjustments for population growth, it appears that not only are we not growing but that the rate of decline is still very worrisome. However, I wonder if many illegals have temporarily returned home for lack of work. I don't know the answer, just posing it for consideration. One of the things that has helped GDP growth over the years (and likely will be an even more important contributor in the future) will be increases in population growth.
But the adjustment that you made is really an adjustment to ascertain growth in the economy on a per capita basis. I'm not certain if that is helpful in determing total change in output for a nation. It would seem that it is more a measure of the productivity of the population.
On Aug 09 09:57 AM Ferdinand E. Banks wrote:
> Well Steven, a non economist - Swashbuckler - can understand what
> you are saying, while a brilliant economics teacher like myself doesn't
> get the entire message. Maybe I don't get it because you are trying
> to do in a short article what logically requires a long article -
> and perhaps a very long article..
Perhaps my comparison to food is poor. The simple fact is unlike food that has nutritional value cooked or not, GDP without deeper analysis is pretty much worthless. To prove my point thoroughly, it can't even see a recession until it's already in full swing. Such a number is not mystical and certainly not all it's cracked up to be. Just like hearing about corporate earnings without knowing how the money was earned. That's why having bank disclosure and transparency is so important. Their #, earnings in this case is meaningless without proper accounting, and I don't mean legal accounting where the government says it's ok to keep things off the books and assign arbitrary value (basically not discounting loss) on their bonds, mortgages, derivatives, debt instruments, and other assets.
So can we learn from Steven Hansen's article without accepting his number. Yes, we have learned that smart people can think of many sunch numbers and one is not neccesarily better or more telling than the other without asking, what's really going on inside the equation.
Assigning ANY positive economic value to government activity, especially a positive "government income", is specious at best, duplicitous at worst. Since it is the proclivity of government to spend all that it gets and to conspire to get even more "income" for the next fiscal year, government activity should, economically, be considered a negative on the economy. Government, on aggregate, is an actual drag on the economy.
The FAA, FBI, CIA , INS, pre-9/11 and the SEC, FDIC, FNMA, FRE (need I go on) in the last ten years come readily to mind. Whatever government may add to the US economy, with such tangibles as infrastructure, it takes away later with perfidy and incompetence. The reckoning balance is never in favor of the taxpayer, therefore "government income" will always a net loss to the economy.
My company, Ethical Markets( USA and Brazil ) and GlobeScan , the London-based survey firm conducted a survey on Beyond GDP for the EP in ten countries, Results also at this site , and at EthicalMarkets.com and GlobeScan.com
You said, "GDP without deeper analysis is pretty much worthless. To prove my point thoroughly, it can't even see a recession until it's already in full swing. Such a number is not mystical and certainly not all it's cracked up to be."
For anyone who misses the significance of this statement, GDP is a scorecard (and flawed, as commenters and the author have pointed out) of economic activity. It does not predict anything. Of course GDP does not see a recession until it is in full swing. GDP tells you what has already happened, not what is coming. (Well, sort of tells you what has already happened, if you are willing to accept the part of the story represented by GDP.)
The fact that GDP is flawed as an economic indicator is most recently exemplified by the rise in 2Q/08 GDP in the middle of a recession, as officially declared by the nber. Of course, the call of a recession start in December, 2007 (per nber) can be debated, as well. I recall the author has discussed this point several times in the past here on SA.
Geezer Bela - - -
You either were not aware or decided not to recognize the author's past work discussing the potential problems with nber's call of 12/07 when you wrote: " Hansen's thesis is that the current recession began in Q4 2007."
Mark Bern - - -
Good comments. The author did not mention it here, but he has pointed out that real GDP has been in a long-term decline in previous articles. My own articles have documented that decline, which started about 50 years ago and reached an inflection point in the early 1980's to decline more steeply since then. If GDP is expressed per capita, the decline is steeper still.
As you point out, per capita GDP might be related to productivity. This is a topic worth examining in detail because the official productivity measurements show productivity increasing for quite a long time (many years). I think the reason is that GDP per capita should correlate with productivity of society as a whole, while productivity statistics correlate to what is produced by the labor force or, perhaps, by the employed, both of which have had declining representation in the total population. I'll look at the numbers - maybe there is a story worth telling there.
GDP is a broader measurement of economic activity. It attempts to measure (with debatable success - see several comments above) the the value of all goods and services produced within a nation's borders regardless of the nationality of the producer. GNP excludes the domestically produced products and services of foreign corporations. A brief definition can be found at Encarta
encarta.msn.com/encycl...
You wrote; "Maybe I don't get it because you are trying to do in a short article what logically requires a long article - and perhaps a very long article.. "
Of course you are correct. However, there are limits to what SA readers will tolerate in length of articles (and SA editors probably have some limits as well). I welcome this article and accept its limitations as not qualifying at the Ph.D. thesis level. However, I do think it offers a great deal of clarification to a topic that keeps getting brought up piecemeal. I would urge you to accept this for what it is (a succinct summary of some important issues) and not reject it for what it is not (a detailed academic research document). Now maybe I am getting more out of this than you because of my much lesser experience in academic economics. So feel free to give me a lecture if I deserve it, but also let me appreciate the added organization of issues that this article (and some of the comments) has allowed for me.
i guess the real point which did not come out clear enough - but is the opposite of sunnsea's "Real US GDP is probably around $3 to 4 trillon".[although i agree with this statement]
we do not make anything. we only have 11 million people involved in manufacturing. this recession, and the great depression were caused by non-gdp economic factors.
gdp tries to measure what we make, but our economy is much larger. if we want a measure of what we make - GDP is good.
if we want to understand what is really going on, we must look for broader economic tools.
i openly admit this method is not perfect, and still does not capture the total economy. but i does capture more of the real economy you and me use to REALLY make our money than using GDP only.
and thank you John Lounsbury for accurately clarifying my position.
Yes if looked at from a "Sales Point". If you have all your needs met are you not "Rich". (However In Socialism One Exists, Yet Never Really Lives From The Standpoint Of "Effort To Reward")
Always think about what "Statistics Represent". GDP is not a measure of "Wealth" - It is "Supposedly" A Metric Of "Wealth Production".
A Mind Game:
If tomorrow - for a month - nothing was produced, imported or "thrown away" - If order persisted - would calamity come. GDP = Zero in this case. I am positive that the human race would persist. (does not mean there would not be suffering of those not prepared or already "On the Edge")
WAAYYYY Over Simplification To Be Sure.
According To Human Precept - It Only Becomes An '"Issue" If You Are Personally Effected.
Many are "Becoming Personally Effected".
The Powers That Be Are Hoping To Increase "Reliance On Services" To "Quell Dissent" As Of Late. How Will It Effect GDP If All Are On The Government "Dole". How Many Will "Bite The Hand That Feeds".
The Price Of Freedom Is Eternal Vigilance.
Slavery Does Not Always Involve Shackles.
On Aug 09 10:13 AM American in Paris wrote:
> Of course GDP does not include sales of used cars. The used car was
> included in GDP when it was made! Similarly, only sales of new houses
> are included because sales of 'second hand' houses were included
> when they were first built.
>
> By excluding subsequent transactions of a good, GDP avoids double
> counting.
>
> Imagine a poor country where there are lot of sales of second hand
> goods. To include these sales would make the country look like a
> rapidly developing country when in fact it is dirt poor.
This would be a better measure of - Who Is Contributing Most To "Production". (too bad it would more than likely be "Extremely Fudged" by Those Nations With A Popularity Complex. ALL Statistics Are Subject To Sampling)
To All - Civil Discourse Allows For Exploration Of Complexity And Nuance - Thank You For Your Adherence.
Great Humans Crave Knowledge And Are More Cynical OF Their Own Short Comings.
Pessimism Is "Optimism With Contingency".
Thanks for clarifying the point that not only is GDP flawed as an economic growth indicator, but specifically because it emphasizes measures of new manufactured goods. Something becoming less relevant in today's economy.
My own takeaway from this article was that the definitions, techniques and procedures for calculating GDP are so convoluted, it's fairly easy to make it whatever it needs to be. Hence, the consumptionless and jobless recovery. Another case for simplicity and transparency.
You are correct that even this is if you take their revisionist version of economic history as truth. I still thenk they don't really properly account for the level of pain being suffered by the general public right now. Not just GDP business is suffering. A lot of non-GDP business is suffering even worse. Cash for clunkers just drives the GDP number up when they buy a new vehicle at the cost of less buying of used vehicles non-GDP. Thus the GDP rigging is alive and kicking still. History is written by the victors. GDP is a component of that.
hdr.undp.org/en/statis.../
Hazel made reference, above to what the European Parliament is doing. These perspectives expand the purpose and intent.