Wednesday, July 16, 2014

What is Gross Domestic Product (GDP)?

Spikes in GDP by government spending are only temporary.
Among the most common means of measuring economic status of a nation is the gross domestic product (GDP).

So what is GDP? I think we are safe to use wikepedia in this instance.
The basic measure of a country's economic performance and is the market value of all final goods and services made within the borders of a country in a year. It is a fundamental measurement of production and is very often positively correlated with the standard of living.
Basically GDP is the sum of three products:
  • Consumption by the people
  • Investment by businesses and people
  • Spending by government
The acronym for this is CIG: Consumption, Investment, Government spending. That should make this easy to remember.

However, this marker has come under scrutiny by some economists as it may be misleading. Take, consider, for example, the October, 2009, number, which showed an improvement in economic activity 3.5%. Many economists used this as a sign that the recession ended.

However, if you dissect the sum of the three above products, you will see that that 3.5% is misleading. According to statistics there was no new consumption by consumer;  they were not buying the goods and services produced by businesses; they were not buying houses; they are not buying vacations and TVs and electronics. In fact, according to statistics, consumer spending was down.

Likewise, according to statistics there was no increased investment in businesses or by businesses. They did not create new jobs, the did not spend on new equipment, the did not build new facilities.

So, if you consider consumption by the people and investment by business and people, you see no economic growth.  This is bad, because, in order for an economic recovery to be sustainable, it must come from the private sector

However, if you look at spending by the government, you do see economic growth. This is bad because it shows that the only economic growth was because the government was spending money it collected by taxes.  This, in essence, is artificial economic growth, and is unsustainable growth.

If you look back to this time in Obama's term, it was when he was handing out cash for people to buy cars.  In other words, you see growth because people bought cars because the government just paid $24,000 per car bought during the cash for clunkers program. It was also a time when the government was handing out cash to get people to buy houses, so this also helped spike the GDP.

So you can see, that if you analyze all the numbers, the private sector was not growing in October of 2009, and the government sector was.  Individual people and businesses were not investing money into the market, but the government was busy spending other people's money.

In fact, economic experts have said that half the 3.5% increase in GDP was the result of cars bought during the cash for clunkers program, which, by the way, had expired by October, 2009.  A large portion of the remainder was from houses bought under the house refund program, which was set to expire in November, 2009.

The Obama administration purposefully increased government spending because this is the crux of Keynesian economics.  So, to Obama and his progressive followers, the GDP of October 2009 of 3.5% was good. This was not by accident, it was because Obama is a follower of Keynesian economics.

Keynesian economists believe that that the economy will improve if the government stimulates it by artificially increasing demand. FDR used the same economic system.  Both Obama and FDR increased spending on goods and services in order to create government jobs and increase spending, and therefore GDP, in this way.

However, increasing economic activity through government spending has drawbacks.
  1. Most jobs are temporary.  Creating temporary government jobs by government programs to build bridges, repair roads, plant trees, etc. will create jobs that increase the GDP, but a few months later the GDP will shrink as these jobs are eliminated. 
  2. Money used to pay for government jobs is taken from people who work, meaning they will have less money to put into the market.  
  3. Obama's stimulus package increased the national debt by trillions of dollars that must be paid back at the expense of our economic future. 
  4. Like the cash for clunker program, all government created jobs are only temporary. While they are in effect the GDP may rise, but once they are expired the GDP will go back down again. Thus, a rise in GDP caused by increased government is NOT a sign of an improving economy.
  5. Government programs like cash for clunkers artificially inflates the sale of cars, making economists thin the economy is improving when it's not.  So car companies hire workers only to have to lay them off when the program ends, resulting in a shrinking of the GDP. 
  6. Government spending increases the national dept, forcing future generations to pay it off, and forcing the government to borrow money from other nations, such as China.  The ultimate risk here is that the entire system will collapse, and other nations will lose respect for America. It presently stands at $17,480,794,453,219.59
  7. Keynesian economists use dept to create economic growth.  This comes with severe consequences if that dept cannot be paid off.
  8. U.S. government debt to GDP failed to rise dramatically from 1960 to 2008, but it almost doubled from 2008 to date, just as households took on debt rapidly from 2001 to 2009 and companies quietly increased their leverage.
The only way to get real economic growth is to create incentives like cutting taxes on consumers so they have extra after tax revenue to purchase goods like computers, TVs, cars, houses, telephones, and MP3 players, and services like cable TV and the Internet.

The only way to get real economic growth is to cut taxes and regulations on businesses so they have an incentive to increase investments on things that will boost the economy like new machines, tools, buildings and workers.  This is the only time tested method of getting long-term increases in GDP, and real economic recovery. You have to have growth in the private sector.

So, during an economic recovery you will have an increase in consumer spending and investment by businesses, not the government. An improved GDP is good, but not so much when the reason for that increase is due to an increase in government spending which is funded by increased taxes, increased national debt and printing of more money -- things that decrease confidence in the economy and devalue the dollar.

The private sector is what holds the key to you and me making money. It's where all the good paying, long term, jobs are created. If the private sector does well then the economy is doing well.  If the private sector is doing well, both the unemployment and the U-6 unemployment rate will drop.

Falsely spiking the GDP by government spending is a Keynesian strategy to artificially make economic numbers look better. True economic growth would be indicated by a rise in GDP due to spending by consumers and businessmen.

References:

  1. Exploding Private-Plus-Government Debt To GDP: Davos (World Economic Forum) Conversation Starter
  2. U.S. National Dept Clock