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

Edward Lotterman The Commerce Department s Bureau of Economic Analysis last week distributed its advance estimate of U S Gross Domestic Product for the first quarter of GDP measures the total arena 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 financial sector is performing Despite acknowledged one-off material anomalies it proved a very slight decline from the start of the year This is not good news it means the nation s financial system 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 financing leadership spending and net exports the three majority 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 arrangement policies are the worst of these The odds that we are sliding into recession defined generally as two consecutive quarters of negative increase are high Any recession is likely to be severe But this bulk preliminary of three estimates of a quarter s GDP shows little that is definite This coming Tuesday May will bring us a review on U S International Transaction in Goods and Services March The more reliable second estimate of January-to March GDP comes out May April s U S International Exchange 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 summary 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 significant to remember Don t make it bigger than it is Journalists have gushed Economists agree that GDP is by far the the greater part major indicator of how an business 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 central 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 pivotal 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 healthcare or the climate that is bad unless such damages can be measured in monetary terms such as medicinal bills they must be accounted for in other approaches 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 arrangement You may think sports initiatives 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 Specific 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 facts Now understand what is counted Econ students memorize that GDP equals consumption plus venture plus executive 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 physiological 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 preponderance go into goods or services ultimately bought by households It is fundamental to avoid double counting these So majority business spending falls into financing These are physical investments by which economists refer to equipment machines and infrastructure used in production that last a long time Understand that this commitment component of GDP does not refer to financial capital such as putting money into stocks bonds mutual funds or bank accounts The cabinet category includes all ruling body spending on goods patrol cars aircraft carriers locks and dams school buildings and school supplies and compensation of regime employees Importantly it does not include transfer payments of money to individuals via Social Safeguard SSI SNAP or novice aid grants For both consumption and physical assets the value component used is the industry price of the good or arrangement in question What did we pay for the underpants yoga lessons or locomotives that we bought But there is no sphere value for students educated or protection afforded by the USS Harry Truman So ruling body 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 selected other nation So we need to calculate the net amount Whenever we import more goods and services than we export we have a pact 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 truly 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 critical figures 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