The nitty-gritty of US GDP numbers

2012-NOV-13

Contributors to this site have frequent cause to comment on the misleading nature of GDP as a means of measuring the economic growth and well being of a country. The last batch of GDP figures for the United States proves this point in spades. The data showed that the economy grew at a 2% annualised pace between July and September. While this figure did slightly beat market expectations it's hardly cause for celebration. The expectations were only 1.9% and that’s hardly a strong rate of economic growth. Additionally, the 2% growth is based on inflation rates that are traditionally understated, meaning that real growth was actually less than 2% and possibly even negative. There are also some other details beneath the surface of the report that provide more information about the future growth path of the US economy.

A Wall Street Journal report covering the GDP provides further detail regarding some of these components:

“U.S. economic growth picked up in the third quarter as rising consumer outlays and a surge in federal government spending more than offset weaker business investment, falling exports and drought damage, offering a mixed picture of the recovery just weeks ahead of the presidential election.”

Unfortunately the elements of GDP that increased this past quarter are the wrong ones. With a large portion of the United States population still out of work, it’s not a good sign to see that consumer spending is increasing. A real sign of progress would be an increase in savings and investment as opposed to spending more borrowed money on imported consumer goods. While Wall Street and Washington are hooked on the Keynesian idea that consumption is the foundation of economic growth, it simply is not so. If jobs were plentiful and the economy was robust than perhaps this could serve as a more encouraging sign that business is picking up. But within the current context it reflects the continued pattern of consumption when what United States needs is investment and production.

There was also a surge in the level of federal government spending (defence spending saw a notable increase). Keynesian economic ideology might see this as hitting the jackpot. In reality however, it is the exact opposite of what the economy needs. A surge in government spending also means a surge in government debt. The bloated government debt is one of the main reasons the economy is so weak to begin with, and adding more debt in exchange for a short-term boost in quarterly GDP is a terrible trade.

The natural result is that while consumer and government spending increased, business investment was weak and exports fell. This is an excellent example of the crowding out effect where government consumes resources that the private sector would otherwise be able to utilise productively. Because money is being spent on government services and entitlements, it is not available to be invested in productive business or manufactured goods that can be exported. The US economy would ideally want the exact opposite of this relationship with increased business investment and exports, and decreased consumer and government spending. That would help to reduce the trade imbalance and the reliance on foreign goods and serve as a first step towards a real economic recovery.

On the whole none of the information contained in the report is that unexpected. What is important is how the data is interpreted. There is no doubt the policymakers in favor of increasing the role of government will talk about how GDP would have been really low without the contribution of government to save the day. This is the political interpretation. However, from an economic perspective the report not only shows that the current GDP is weak, but that we can expect more of the same going forward.