At the time of this writing, the standard way to measure the economy’s health, or how the economy is performing, is by calculating the Gross Domestic Product(GDP). This post will explain how GDP is calculated; that explanation will then help explain and lead into why GDP, contrary to popular teachings, is not the best way to measure the true health of the economy.
GDP is defined primarily as the sum of a country’s domestic consumption(C), government spending(G), investment(I), and net exports(NX). Investment refers to expenditures by enterprises – the idea being that business expenditures represent investments in things like better capital equipment, additional machinery, etc. Net exports means the difference in a countries exports and imports.
While it may stand to reason that the more consumption there is an an economy, the more money, and therefore, the more wealth, the economy has. After all, many may ask, how can you consume unless you have wealth? However, there are several problems which need to be addressed.
Prices & Costs of Consumption
Let’s take C and I as the most relevant aspects of GDP for this section. Let’s now say for example, that the average consumption in an economy is $3,000 per month to cover all expenses, such as rent/mortgage, gasoline, utilities, eating out, leisure activities, and everything else; this can all be summed up and referred to as the cost of living. Ideally, in robust and growing economies, the cost of living should be declining over time. Think about food supplies. Prior to the invention of agricultural tools and machinery, preceding the days of groceries stores, food supplies weren’t abundant. In those older times, food prices and costs were therefore higher, as the available resources at the time for food production were costlier and only able to produce a fraction of today’s(at the time of this writing) food output. But according to the logic behind GDP, people spent more money on food, meaning that C was higher, which would push the GDP in those former times higher than today’s GDP. However, can it truly be claimed that just because consumption was higher, the economy was better, especially if the cost of living was higher too? Especially when food supplies were less abundant, and food insecurity and starvation were both higher in those older times, the economy was clearly not better, even if consumption was higher. Or, let’s say health insurance premiums skyrocket, or that gasoline prices also increase. Consequently, people would generally spend more money on such commodities, and so consumption would also become higher. However, even though people would be spending more money, and consumption would consequently be higher, which therefore boosts GDP, the economy would not be genuinely better in such a scenario. In fact, the increased cost of living is a sign that the economy is truly worse than before; which makes the consumption-based measurement of GDP rather misleading, if not inaccurate, when used to measure the true health of the economy.
Regarding investment, I, this too is not a reliable measure of economic health. Like personal consumption, just because businesses spend money, which GDP would count as investment, it does not mean that the business spending ends up getting used productively. For example, business expenditures on stock buybacks, merges & acquisitions, and leveraged buyouts, are, in reality, not productive investments in capital equipment and enhanced production. Instead, such financial engineering maneuvers only have benefits on paper, usually in the form of higher stock prices and potentially higher dividend payments to shareholders, both of which only benefit a small percentage of the general economy. Yet, by the measurement methods of GDP, such unproductive expenditures of money would be considered productive investments, when they should not.
Let’s now tackle the government spending, G, component. This is the most important part, as government spending is always a drain and reduction in overall economic output, rather than an asset or addition. The word always is intentionally used in the previous sentence, as shall be justified and explained in the subsequent sentences. First of all, it is imperative to understand that any spending by government can only occur in three possible ways; taxation(better referred to as theft), borrowing, or printing money(better known as inflation). Let’s start with taxation. Any time a government raises money through taxation, it is draining the overall output and productivity on the economy. After all ,the only ones with taxable money are those who are productive enough to earn that taxable money in the first place. By issuing taxes, the government steals money that would have otherwise been put to productive use; although the opportunity cost of taxation tends to be invisible, the opportunity cost is very real and major, the invisibility of it notwithstanding. Philosopher and economist Frederic Bastiat called the phenomenon of the previous sentence the Broken Window Fallacy, whereby a broken window triggers spending, mainly on window repairs, but therefore detracts spending from other things that would’ve been spent; but those things that would’ve otherwise been spent on are invisible, and tend to therefore be dismissed and/or uncounted. Regarding how government’s borrow money, governments usually borrow from a central bank, like the Federal Reserve in the United States. A couple major problems need to be well understand regarding the borrowing mechanism. By borrowing money, the government has to issue taxes, whether immediately or at some time in the future, to repay the debt and interest. Therefore, borrowing today to add to the GDP produces the negative auspices of higher future taxes, which thereby reduces future GDP. Especially in the context of the U.S. economy at the time of this writing, one might argue that the central banks can keep printing, or in some other fashion, create money, and also creating more inflation, indefinitely, this is ultimately not permanently sustainable or advisable. Furthermore, government borrowing, usually at relatively low, sub-market, interest rates, crowds out private investment by causing the interest rates for private and other non-government borrowers to raise, thereby making private investment, including entrepreneurship into new business ideas and productive ventures, more costly and lesser in magnitude. After all, if lenders can get risk-free rates from crediting the government, they will invariably have to charge higher rates to private enterprises and all other non-government entities that aren’t risk free borrowers. By printing money, the third way government can acquire money to spend, this creates the inflationary effect of raising prices. As explained in the section on consumption, inflation leads to higher consumer prices, which reduces the affordability of goods and services the economy produces, and therefore reduces the standard of living for the people in the economy. Therefore, it is wrong for GDP to count government spending as an enhancement to the overall output and health of the economy; in fact, government spending should be counted as a reduction of the the overall output and health of the economy. Government does not produce assets, it simply takes productive assets from a select few productive citizens and distributes those assets to other citizens; no new assets are created in the process.
Unlike C, G, and I, it makes sense to include the last component of GDP, net exports, should be used as a factor to measure the overall health of the economy. However, the issue of whether a positive or negative net exports figure is more preferable isn’t so black and white. On the one hand, a country that has positive net imports, meaning that the country imports more than it exports, could potentially be a robust economy. Countries import rather than produce themselves because the imports are less expensive than domestic production. Therefore, countries that import for cost-savings are actually optimizing their countries’ economies. After all, how could any country be a net exporter if no other country is willing to be a net importer? While it is possible for all countries to totally avoid international trade, a state known as autarky, in which global imports and exports are both zero, such a scenario would not be optimal for the global economy. This is because some countries can produce certain goods at a lower cost than others; this concept is often referred to as comparative advantage. Therefore, it makes sense for countries to import those goods which they cannot domestically produce at a cheaper price. A good case-study is the trade relationship between U.S. and Canada. During the post-World War II era, the U.S. developed into a solid manufacturing country, with numerous factories and other industrial real estate, which made the country a net exporter. Canada, on the other hand, couldn’t build its factories and develop its manufacturing asset base at as low of a cost as the U.S. could. Therefore, it made more sense for Canada to import manufactured goods from the U.S., rather than produce domestically, because imports to Canada costed less than domestic Canadian production. In this case, the U.S. had a comparative advantage in manufacturing, to which Canada took advantage of by trading with, by importing from, the U.S.
As long as a country isn’t totally dependent on imports to sustain its economy, there is no inherent cause for concern or alarm for a country to be a net importer. As long as a country can revert to domestic production to replace trade when necessary, even if domestic production would be costlier, than there would be no major cause for concern. Conversely, as long as a country is not dependent on exports to sustain its economy, there would be no major cause for concern.
The question now becomes, if GDP, the mainstream way to measure the economy’s health, is not the best measurement, method, then what is? Mark Skousen, an economist and professor at Chapman University, offers an answer, which is Gross Output(GO). As Skousen states below:
Gross Output: A Better Economic Measure than GNP or GDP
A much better indicator of the economy is gross output (GO), which totals the entire supply chain leading to final production, rather than Gross National Product GNP or Gross Domestic Product (GDP), which measures the end consumer spending. As Wikipedia states:
Mark Skousen introduced gross output as an essential macroeconomic tool in his work, The Structure of Production in 1990; see also Mark Skousen, “At Last, a Better Economic Measure”, Wall Street Journal (April 23, 2014) According to Skousen, GO demonstrates that business spending is significantly larger than consumer spending in the economy, and tends to be more volatile than GDP. Earlier-stage and intermediate inputs in GO may also be helpful in forecasting the direction of economic growth. He contends that gross output should be the starting point of national income accounting, and offers a more complete picture of the macro economy.
In 2019, Skousen made the following comments:
GO is super slow right now, and in fact, the supply chain (B2B spending) was slightly negative in the 1st quarter 2019, probably due to the Trump(the U.S. President at the time) trade war. In July, the U.S. government announced that real gross output (GO), the broadest measure of economic spending, rose only 1.6% in the first quarter, much less than real gross domestic product’s (GDP) increase of 3.1%.
The Economic Leading Indicator Index, (LEI) put out by the Conference Board, declined for the first time this year in June. The Conference Board reported, “The US Leading Economic Indicators Index fell in June, the first decline since last December, primarily driven by weaknesses in new orders for manufacturing, housing permits and unemployment insurance claims.”
But the LEI is not a good indicator since it mixes falsified government statistics (Stock prices, a Leading Credit Index, Interest rate spread, and consumer expectations) with some real indicators.
The stock market does not lead anything, but reacts, and much of the institutional spending in stocks comes from first use of new federal dollars loaned to Wall Street brokers. Consumer expectations is a contrived figure and is anything but reliable and the leading credit index is proprietary, so no one knows what’s in it. They don’t tell us what percentage weight they give to it either. As for interest rates, they are manipulated by fed policy so, while it does affect the economy, it is not a true indicator of what’s the true interest rate should be without the Federal Reserve artificial dictates.
A negative yield curve — where short-term rates [for bonds] are higher than long-term rates — also is evidence of a possible recession. The last two times we had an inverted yield curve (2000 and 2007) we had recessions. If the inverted yield curve continues, it would suggest a slowdown ahead and perhaps the end of the 11-year bull market.
There is growing talk in the White House for the need to stimulate the economy to prevent a recession, through tax cuts and more government spending. More importantly, monetary policy is already starting to loosen. As the following chart indicates, the broad-based money supply (M3) is now growing at 9.3% a year in the United States.
In addition to Gross Output, another better measure for the health of the economy would be the cost of living index. The cost of living needs to cover the costs of the goods and services that people consume. This includes real estate costs, such as rent or mortgage, health insurance, gasoline, utilities, and food, as a few examples, which tend to be, as of the time of this writing, the most common and heaviest expenses for people’s cost of living. If those expenses rise, especially dramatically, the cost of living hike would mean the economy is less robust, and the standard of living would therefore be in decline in such a state. The standard of living is inversely related to the cost of living; as the cost of living increases, the standard of living declines, and vice-versa. It would make sense to include other measures too, but ultimately whichever measure civilization decides to use must measure the following;
-The quantity, and quality, of goods/services that an economy can sustainably produce. GO does this by measuring the quantity of production by businesses through the entire supply chain.
-The cost per quantity of those goods/services. As this measure cost goes up, the economy worsens as a result, and vice-versa.
-The cost per quantity of goods/services, referred to as CGS, per median and/or average income of the people, referred to as INC. Mathematically, this can be represented as CGS/INC. Conceptually, even if CGS increases, if INC rises at a greater rate, then that would represent an improvement in the economy, and vice-versa. As such, anything that decreases CGS and increases INC represents an improvement in the economy, and vice-versa. Ultimately, this measure answers the fundamental question; are people able to afford the goods/services they need to live a life of minimum satisfactory quality, the latter of which each individual/family must decide uniquely, and can be an essay topic by itself. One example could be the ability to pay off all family expenses, such as childcare, mortgage, cleaning, vehicles, utilities, leisure etc. in under 40 hours of weekly work.
-The quality of goods/services produced and distributed in the economy. This point addresses phenomena such as the invention of superior goods to replace old ones, such as more advanced computers, ovens, fridges, laundry machines, vehicles, as some examples. Other examples could be inventions of new products, sort of like the Cotton Gin in the late 18th century, which facilitated increased efficiency in the production of cotton for its era.
-The level of savings, especially when compared to an economy’s debt level. If an economy has to borrow money, rather than produce and earn the money itself, to finance the economy’s expenses, then such a situation is unsustainable and represents a weak economy. Especially if the debt burden increases faster than the savings rate, this represents further weakness. However, debt by itself in an economy isn’t necessarily a sign of weakness. If an economy goes into debt for purposes such as investment into productive output, like factories and successful enterprises, then such a debt would actually benefit an economy, as long as the economy produces enough future savings to eventually repay the debt, and interest expenses. After all, lending, and consequently borrowing i.e. debt, can only exist if another party exists who has saved sufficiently. Somebody can only borrow and go into debt if somebody else has saved.
-On a related note to savings, the ability of people to afford all retirement expenses. Especially once people lose their physical, and perhaps other, abilities to work, be productive, and earn income, savings, and support from others like family, is the only way to sustain a lifestyle. If enough people who can no longer work or be productive possess sufficient savings, or outside support, to sustain their retirement, then this represents a sign of strength in the economy; ideally all retired people should be in this situation. Conversely, if people can no longer earn income but lack enough savings or outside support to cover their living expenses, then this represents a sign of weakness in the economy.
While these measures to properly measure the status and health of the economy may not be comprehensive, these are just some ideas and proposed measures to supplant GDP, the flawed measure used as of the time of this writing.