Beyond GDP, A New Way To Measure The Economy – Mark Skousen

By Dr. Mark Skousen. First appeared on Forbes in 2013.

Starting in spring 2014, the Bureau of Economic Analysis will release a breakthrough new economic statistic on a quarterly basis.  It’s called Gross Output, a measure of total sales volume at all stages of production. GO is almost twice the size of GDP, the standard yardstick for measuring final goods and services produced in a year.

This is the first new economic aggregate since Gross Domestic Product (GDP) was introduced over fifty years ago.

It’s about time. Starting with my work The Structure of Production in 1990 and Economics on Trial in 1991, I have made the case that we needed a new statistic beyond GDP that measures spending throughout the entire production process, not just final output.  GO is a move in that direction – a personal triumph 25 years in the making.

GO attempts to measure total sales from the production of raw materials through intermediate producers to final retail.  Based on my research, GO is a better indicator of the business cycle, and most consistent with economic growth theory.

GO is a measure of the “make” economy, while GDP represents the “use” economy.  Both are essential to understanding how the economy works.

While GDP is a good measure of national economic performance, it has a major flaw:  In limiting itself to final output, GDP largely ignores or downplays the „make“ economy, that is, the supply chain and intermediate stages of production needed to produce all those finished goods and services.  This narrow focus of GDP has created much mischief in the media, government policy, and boardroom decision-making. For example, journalists are constantly overemphasizing consumer and government spending as the driving force behind the economy, rather than saving, business investment, and technological advances.  Since consumer spending represents 70% or more of GDP, followed by 20% by government, the media naively concludes that any slowdown in retail sales or government stimulus is necessarily bad for the economy.  (Private investment comes in a poor third at 13%.)

For instance, the New York Times recently reported, “Consumer spending makes up more than 70% of the economy, and it usually drives growth during economic recoveries.” (“Consumers Give Boost to Economy,” New York Times, May 1, 2010, p. B1)  Or as the Wall Street Journal stated a few years ago, “The housing bust has chilled consumer spending – the largest single driver of the U. S. economy…” (“Home Forecast Calls for Pain,” Wall Street Journal, September 21, 2011, p. A1.)

Or take this report during the economic recovery:

“Friday’s estimates of second-quarter gross domestic product [1.3%, well below consensus forecasts] provided a sobering look at how a decline in public spending and investment can restrain growth….The astonishingly slow growth rate from April through June was due in large part to sluggish consumer spending and an increase in imports, which subtract from growth numbers. But dwindling government spending also held back growth.”  (“The Role of Government Spending,” New York Times, July 29, 2011.)

In short, by focusing only on final output, GDP underestimates the money spent and economic activity generated at earlier stages in the production process. It’s as though the manufacturers and shippers and designers aren’t fully acknowledged in their contribution to overall growth or decline.

Gross Output exposes these misconceptions.  In my own research, I’ve discovered many benefits of GO statistics.  First, Gross Output provides a more accurate picture of what drives the economy.  Using GO as a more comprehensive measure of economic activity, spending by consumers turns out to represent around 40% of total yearly sales, not 70% as commonly reported. Spending by business (private investment plus intermediate inputs) is substantially bigger, representing over 50% of economic activity.  That’s more consistent with economic growth theory, which emphasizes productive saving and investment in technology on the producer side as the drivers of economic growth.  Consumer spending is largely the effect, not the cause, of prosperity.

Second, GO is significantly more sensitive to the business cycle.  During the 2008-09 Great Recession, nominal GDP fell only 2% (due largely to countercyclical increases in government), but GO collapsed by over 7%, and intermediate inputs by 10%.  Since 2009, nominal GDP has increased 3-4% a year, but GO has climbed more than 5% a year.   GO acts like the end of a waving fan.  (See chart below.)

GOandGDP

I believe that Gross Output fills in a big piece of the macroeconomic puzzle.  It establishes the proper balance between production and consumption, between the „make“ and the „use“ economy, and it is more consistent with growth theory.   As Steve Landefeld, director of the BEA, and co-editors Dale Jorgenson and William Nordhaus state in their work, A New Architecture for the U. S. National Accounts (University of Chicago Press, 2006),  “Gross output [GO] is the natural measure of the production sector, while net output [GDP] is appropriate as a measure of welfare.  Both are required in a complete system of accounts.”

Historical Background

The history of these two economic statistics goes back to several pioneers.  Two economists in particular had much in common – they were both Russian Americans who taught at Harvard University, and both won the Nobel Prize.  Simon Kuznets did breakthrough work on GDP statistics in the 1930s.  Following the Bretton Woods Agreement in 1946, GDP became the standard measure of economic growth.  A few years later, Wassily Leontief developed the first input-output tables, which he regarded as a better measure of the whole economy.  I-O accounts require examining the “intervening steps” between inputs and outputs in the production process, “a complex series of transactions…among real people.”

I-O data created the first estimates of Gross Output.  However, GO was not emphasized as an important macroeconomic tool until my own work, The Structure of Production, was published in 1990 by New York University Press.  In chapters 6 and 9, I created a universal four stage model of the economy (see the diagram below) demonstrating the relationship between total spending in the economy and final output.

final-output

In chapter 6, I made the point that GDP was not a complete picture of economic activity, and compared it to GO for the first time, contending that GO was more comprehensive and more accurately revealed that business investment was far bigger than consumption in the economy.

Since writing Structure, I discovered that the BEA’s Gross Output does not include all sales at the wholesale and retail level.  The BEA only includes value-added data for commodities after they become finished products.  Gross sales are ignored at the final two stages of production.  David Wasshausen, a BEA staff researcher, offers this rationale:  since “there is no further transformation of these goods…to the production process, they are excluded from wholesale/retail trade output.”

Therefore, in the 2nd edition of Structure, published in 2007, I created my own aggregate statistic, Gross Domestic Expenditures (GDE), which includes gross sales at the wholesale and retail level and is therefore significantly larger (more than double GDP).  For a comparison between GDE, GO and GDP, see my working paper.

The BEA has been compiling GO statistics from input-output data for years, but the media have largely ignored these figures because they came out only every five years (known as benchmark I-O tables).  Since the early 1990s, the BEA has been estimating industry accounts annually.  Even so, the data was never up-to-date like GDP.  (The latest input-output industry accounts are for 2011).

That has gradually changed. Under the leadership of BEA director Steve Landefeld, the BEA now has the budget to report the input-output data, including Gross Output, on a quarterly basis, and has already begun publishing quarterly data prior to 2012.  This is a major breakthrough involving the cooperation of the Bureau of the Census, Bureau of Labor Statistics, the Federal Reserve Board, and other government agencies.

Controversies Over This New Statistic

Several objections have been made over the years to the use of GO and GDE. Economists are especially fixated over the perceived problem of “double counting” with GO and GDE.  I am the first to note that GO and GDE involve double counting.  A commodity is often sold repeatedly as it goes through the resource, production, wholesale and retail stages.  Why not just measure the value added at each stage rather than double or triple count? they ask.  GDP eliminates double counting and measures only the value added at each stage.

There are several reasons why double counting should not be ignored and is actually a necessary feature to understanding the overall economy.  As accountants and financiers know, double counting is essential in business.  No company can operate or expand on the basis of value added or profits only. They must raise the capital necessary to cover the gross expenses of the company – wages and salaries, rents, interest, capital tools and equipment, supplies and goods-in-process.  GO and GDE reflect this vital business decision making at each stage of production.  Can publicly-traded firms ignore sales/revenues and only focus on earnings when they release their quarterly reports?  Wall Street would object.  Aggregate sales/revenues are important to measure on an individual firm and national basis.

In my own research, I find it interesting that GO and GDE are far more volatile than GDP during the business cycle.  As noted in the chart above, sales/revenues rise faster than GDP during an expansion, and collapse during a contraction (wholesale trade fell 20% in 2009; retail trade dropped over 7%).

Economists need to explore the meaning of this cyclical behavior in order to make accurate forecasts and policy recommendations.  Double counting counts.

Another objection involves outsourcing and merger/acquisitions.  Companies that start outsourcing their products will cause an increase in GO or GDE, while companies that merge with another company will show a sudden decrease, even though there is essentially no change in final output (GDP).

That’s a legitimate concern.  Similar problems occur with GDP.  When a homeowner marries the maid, the maid may no longer be paid and therefore her services may no longer be included in GDP.  Black market activities often fail to show up in GDP data as well.  Certainly if a significant trend develops in outsourcing or merger & acquisition activity, it will be reflected in GO or GDE statistics, but not necessarly in GDP.  It bears further investigation to see how serious this issue is.  No aggregate statistic is perfect, but GO and GDE offer forecasters an improved macro picture of the economy.

In conclusion, GO or GDE should be the starting point for measuring aggregate spending in the economy, as it measures both the “make” economy (intermediate production), and the “use” economy (final output).  It complements GDP and can easily be incorporated in standard national income accounting and macroeconomic analysis.  To see how, take a look at the 4th edition of my textbook, Economic Logic (Capital Press, 2014), available in paperback and Kindle.

Mark Skousen is editor of Forecasts & Strategies and a Presidential Fellow at Chapman University in 2014.  He is the author of The Structure of Production (New York University Press, 1990, 2007), which introduced the concept of Gross Output as an essential macroeconomic tool.  

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The Faulty Logic of GDP Necessitates an Economic Paradigm Shift – Per Bylund

Reprinted from Mises Institute

Nearly 80 years ago — during the height of the Great Depression — economist Simon Kuznets envisioned a system capable of measuring productivity and economic activity. In a report to Congress, Kuznets proposed charting all economic production with a single measurement that would decrease when the economy struggled and increase when it thrived. He called it gross domestic product, or GDP.

Nations throughout the world embraced GDP as the standard for measuring economic activity; Kuznets eventually won the Nobel Prize for his creation. The popularity of GDP belies its effectiveness, however, as the measure systematically under-reports the significance of production.

#GDProblems

The most recent data from the U.S. Bureau of Economic Analysis showed that the country’s GDP increased by about 1.4 percent in the second quarter of this year, which was encouraging news to some. GDP in the U.S. had increased by about 0.8 percent in the first quarter of the year. While this seems like positive news, it’s difficult to say exactly what it means for the average consumer.

GDP was the only available option for a long time, but it has always been flawed because it assumes a net contribution to consumer value through production. A business that produces a certain good is believed to add only the difference between the product’s monetary value and the cost of all inputs combined.

GDP also mistakenly places too much emphasis on business-to-consumer activity compared to business-to-business transactions, which account for a significant amount of investment and opportunity. In fact, money invested in B2B startups through the end of March increased by about 40 percent compared to 2015 figures.

Moreover, GDP is useless because it measures official statistics rather than actual value. Dollar amounts measured in statistics don’t capture the actual satisfaction — or real value — being produced. It also fails to accurately measure innovations until after the fact, meaning investments are considered a loss until they pan out. An economy investing for future production might, therefore, appear to be contracting.

Quantifying Value

By only measuring monetary values — primarily consumption data under the guise of “produced” goods — GDP ignores the fact that value is added in each step along the production chain. It also specifically tracks expenditure and income rather than well-being.

What truly matters in economic growth is how our well-being has improved: how our lives become more convenient, how we get more time for leisure, and how we can afford everything. This is a matter of perception and ability to consume.

It can be argued that we experience economic growth when prices fall but wages are steady. Those same incomes can buy more goods and services, consequently making us wealthier.

When we talk about inequality, we’re almost always speaking of income rather than well-being. But what does it matter if one person earns $1,000 and another earns $1 million if the goods they both consume are identical? If we’re unable to satisfy more wants by earning significantly more money, income becomes irrelevant.

This is often the case in Western nations, where income inequality is on the rise. The U.S. has seen income inequality increase since the 1970s, with the top 1 percent of U.S. families earning about 25 times as much as the remaining 99 percent. While income inequality is growing, well-being inequality is actually shrinking.

The price difference between a Mercedes-Benz and a Toyota is greater than the gap between having a car and not having one, but the well-being differential is reversed. A Mercedes-Benz doesn’t offer more transportation than a Toyota, but having any car is tremendously better than not having one in terms of well-being.

A Better Indicator

While GDP ultimately fails to track the size of an economy, a different measure offers a much broader view of economic activity.

Economist Mark Skousen has long advocated for gross output as a viable alternative to GDP. Gross output goes beyond finished goods and services that don’t necessarily have a final “value.”

For instance, a business breaking even without any profits still contributes to the economy through production — it consumes inputs to produce outputs, pays suppliers and employees, and provides goods, services, and capital to other businesses. A lack of profit doesn’t mean the economy is smaller or that this business isn’t contributing to the economy. Instead, consumers of its products have added to their well-being.

It’s a matter of perspective. The GDP is based on a faulty theory of the economy as consumption-driven when it’s actually more production-driven. Consumption happens where production facilitates it, through goods and services produced as well as income generated by selling those goods and services.

In a market society, we produce for market needs rather than our own benefit. This allows us to generate income to satisfy our own needs and wants by consuming the goods and services others produce. This allows us to specialize and develop expertise to innovate and simplify our own production, which eventually helps us increase our output, serve more consumers, and generate more money to spend on goods.

Reversing Course

GDP effectively ignores all attempts to improve production because they don’t result in increased consumption. It falsely assumes that consumption drives production; therefore, it’s pointless to map out and measure the latter. In other words, GDP adopts a backward economic perspective.

In reality, entrepreneurs produce what they believe consumers want to buy. The fact that they undertake uncertain production projects helps contribute to our common prosperity and standard of living.

Whereas gross output takes a broader view of economic activity, GDP misunderstands economics by simply counting what statistics capture: net consumption, net profits, net this, and net that. After almost eight decades of flawed logic, we’re due for an economic paradigm shift.