Real World Economics: GDP is important, but must be kept in context

Edward Lotterman The Commerce Department s Bureau of Economic Analysis last week circulated its advance estimate of U S Gross Domestic Product for the first quarter of GDP measures the total region value of all final goods and services produced in the country over a period of time and is one of the key indicators of how an market system is performing Despite acknowledged one-off figures anomalies it manifested a very slight decline from the start of the year This is not good news it means the nation s financial sector contracted but the response to it has been overwrought If instead of a decline in output it had been a increase the hubbub would be much less Of the four basic elements to GDP consumption resources cabinet spending and net exports the three greater part closely related to domestic production were all positive The decline came from a sharp increase in imports clearly driven by fear of President Donald Trump s forthcoming tariffs Companies that import supplies were stocking up before the higher prices kicked in The anomaly is how the bureau factors in the impact of these imports into its estimate of overall GDP The quarter ended a month ago The tariffs are now kicking in This rise above usual import levels almost certainly has already flipped to a sharp drop that will worsen and be reflected in the second-quarter estimate come July Let it be clear Trump s overall economic policies are bad They will harm our nation His agreement policies are the worst of these The odds that we are sliding into recession defined generally as two consecutive quarters of negative development are high Any recession is likely to be severe But this the bulk preliminary of three estimates of a quarter s GDP shows little that is definite This coming Tuesday May will bring us a record on U S International Commerce in Goods and Services March The more reliable second estimate of January-to March GDP comes out May April s U S International Deal in Goods and Services will be out a week after that These will all tell us more about where we are headed However we then need to wait until July for the advance document on second-quarter GDP That will give us even more certainty on how well our goose is being cooked In the meantime if you want to understand events that are unfolding begin by understanding GDP First it is a measure of the value of output That is crucial to remember Don t make it bigger than it is Journalists have gushed Economists agree that GDP is by far the bulk fundamental indicator of how an economic activity is doing Over years in this field I have never heard any economist say that nor seen it in any textbook GDP is an key indicator taken together with several others Full stop Second GDP has distinct limitations Every -year-old taking intro macroeconomics at the U must memorize these by the second week They are detailed in every textbook Yet one constantly hears complaints like but people don t realize that GDP ignores The blank is filled with one of the limitations that are detailed in every macro textbook Here are the key ones to remember GDP is a measure of the value of new things produced It does not subtract things produced in previous periods that are thrown away Do that and you get net domestic product GDP is a measure of flow not a balance sheet of assets and liabilities It measures new lumber gasoline or steel cranked out but is not adjusted for trees cut down oil pumped or iron ore mined GDP is not adjusted for external effects either positive or negative If producing something harms wellbeing or the circumstances that is bad unless such damages can be measured in monetary terms such as anatomical bills they must be accounted for in other solutions If a product benefits people beyond those who bought it that s great But again this positive side effect must be measured chosen other way GDP makes no value judgement about the inherent goodness or badness of any good or provision You may think sports exercises for disadvantaged teens do more for society than strip clubs or that yoga classes are better than shooting ranges or vice versa but what goes into GDP is the money paid for each activity Certain goods may reflect societal bads If more people get drunk and drive and crash then we will spend more money on tow trucks body shops ambulances emergency rooms orthopedic surgeons undertakers and tombstones all of which will add to GDP A crime wave may force people to spend money on pepper spray triple door locks car and home alarms safe rooms and self-defense classes All will add to GDP Do these limitations mean that GDP is useless No not at all It remains vital information But again it must be taken in context with other input Now understand what is counted Econ students memorize that GDP equals consumption plus assets plus governing body spending on goods and services plus net exports All these involve final goods ones that need no more handling before being used So purchases of food clothing shelter anatomical care and so on make up consumption by households the largest component of GDP This includes consumer durables things like appliances or vehicles that serve for years but does not attempt to factor in the lifelong value these goods supply beyond the period in which they were purchased Purchases of expendable items like parts by businesses are different since the greater part go into goods or services ultimately bought by households It is vital to avoid double counting these So the greater part business spending falls into commitment These are physical investments by which economists refer to equipment machines and infrastructure used in production that last a long time Understand that this financing component of GDP does not refer to financial stake such as putting money into stocks bonds mutual funds or bank accounts The administration category includes all leadership spending on goods patrol cars aircraft carriers locks and dams school buildings and school supplies and compensation of administration employees Importantly it does not include transfer payments of money to individuals via Social Assurance SSI SNAP or aspirant aid grants For both consumption and physical financing the value component used is the field price of the good or system in question What did we pay for the underpants yoga lessons or locomotives that we bought But there is no territory value for students educated or protection afforded by the USS Harry Truman So administration spending in GDP comes from the amount spent itself with no estimate of its value to society This results in anomalies In Nebraska I- parallels the Union Pacific s triple-tracked main line The rail line produces millions in revenue each day for the UP but I- supposedly produces no measurable monetary value to society beyond Nebraska DOT spending on maintenance Net exports or exports minus imports are the final category and here s where we get what happened in last week s initial first-quarter estimate If we produce bulldozers or airplanes sold abroad that is part of our nation s production But when we import cars or toys those are the production of particular other nation So we need to calculate the net amount Whenever we import more goods and services than we export we have a commerce deficit on goods and services That equals negative net exports Whenever imports climb GDP shrinks The new Kia car or LG TV produced abroad counts in household consumption but it wasn t produced here so we need to subtract it off in the net exports category to get an accurate estimate of what we did produce Imports jumped in the past quarter in the weeks after Trump amped up his tariff talk Importers rushed to get product here and through customs before the tariffs were really charged The big jump in imports made a big drop in net exports and hence the drop in overall GDP Our nation and the world are in very troubled waters And vital information points to come out later will reflect this People naturally want to know what is happening But the information we use to justify our perceptions necessities to be kept in context Related Articles Real World Economics The buck stops Trump or so it appears Ed Lotterman What if the Fed set a trap for Trump Real World Economics Powell hits first Trump hits back Real World Economics The Minneapolis Fed was right all along Real World Economics The flaws in Trump s liberation reasoning on tariffs St Paul economist and writer Edward Lotterman can be reached at stpaul edlotterman com