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May the source be with you, but remember the KISS principle ;-)
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Core inflation as a Potyomkin Village of the real (headline) inflation
Lack of transparency, problems with following GAAP standards
Continuing progress should not lead not to ever-escalating levels of consumption, but to a society where improving productivity and technology would provide higher quality goods, better health and more leisure.
As Paul Krugman has pointed out, generally Europeans are more comfortable with such an idea then americans. Americans place too high priority on quantity sometimes in detriment to quality ("house slaves" are example of overconsumption in this case overconsumption of housing) and that's was GDP reflects. quality of items consumed are out of the picture and that's a problem. The term Conspicuous consumption was coined by the US economist for a reason. This idea was further investigated by John Kenneth Galbraith in his famous book The Affluent Society
In a recent article by Samuel Brittan (Financial Times) put it very well:
A typical talk on BBC’s Radio Three might start by bemoaning the consumer society, with its passion for shopping and the rush to make pointless purchases. It might then bemoan the nervous strain in the quest for economic growth and the lack of time or energy for more worthwhile activities.
But then comes a more interesting twist. All this frenzy of pointless activity is required, it is said, to keep the economy going. Without it, the implication is, production would dry up and jobs disappear, and we would wallow in semi-permanent depression.
The contention is that the economy would collapse if we ceased to demand more and more, a belief sometimes called the saturation bogey. Many practical businessmen, who have no time or inclination for political economy, suppose that we must go on churning out more and more to survive, whether or not we enjoy the process. The US president Calvin Coolidge remarked in 1926: “The chief business of the American people is business.” UK politicians used to ask what would happen when every family in the country had two cars.
The clue to the whole matter is provided, as so often, by a dictum from Adam Smith: “Consumption is the sole end and purpose of production; and the interests of the producer ought to be attended to, only so far as it may be necessary for promoting that of the consumer.” To demonstrate the falsity of the belief that we must continue to feed the productive machine with ever more ridiculous demands, let me indulge in a brief thought experiment.
Let us take a medium-sized, western economy with no major population change and negligible net migration or other problems. What might then happen if a majority of people were to turn their backs on further improvements in their real spending? The basic answer is that, in this no-growth new world, people could enjoy the fruits of technological progress with a mixture of increased leisure and a more congenial and relaxed working life. The reduction in labour input would be voluntary and completely different from what happens in an economic slump.
Some political economists have looked forward to this state of affairs. John Stuart Mill regarded what he called the “stationary state” as a delight rather than a disaster. He could not believe that the perpetual struggle to get on and elbow other people out of the way was other than a temporary phase in humanity’s progress. Keynes also looked forward to such a world (in his essay “Economic Possibilities for our Grandchildren”) when “we shall honour the delightful people who are capable of taking direct enjoyment in things: the lilies of the field who toil not, neither do they spin.” He allowed for the persistence of a minority of people who would feel satisfaction only if their behaviour made them feel superior to their fellows, “but the rest of us would no longer feel under any obligation to applaud”.
There is another view, stated most eloquently by Joseph Schumpeter. As he put it: “Capitalism is by nature a form or method of economic change and not only never is, but never can be, stationary.”
Let us concede at once that the resulting system would not look much like capitalism as we know it. But even in such a society there would be great advantages in retaining competitive markets based on private ownership. Those who have now, belatedly, discovered Schumpeter and quote him out of context do not realise that, writing in the 1940s, he expected entrepreneurial capitalism to have died out long ago and be replaced by some variant of state socialism. He failed to see how unworkable the latter would be. Like many other seers he was an excellent analyst, but a poor prophet.
As soon as we add more realistic conditions, the saturation bogey becomes more and more remote. Even if demand for conventional consumer goods were to peak, there might still be demand for more public services and more expenditure to relieve poverty at home and abroad. Most western countries are likely to see net immigration for the foreseeable future, which would bring with it opportunities for new investment without any need for whipping up artificial needs and anxieties. This is not to speak of devoting a margin of extra production to dealing with environmental threats, whether or not of a global warming variety.
This preliminary observations suggest that GDP is a too broad and thus questionable measure of economic growth. As such it should not be absolutize as the sole metric of the economy growth as such usage in many respects contradict common sense. In a way the calculation of GDP became just a complex (and by-and-large counterproductve) ritual not unlike some religious rituals like calculation of certain dates.
It does not necessary correlates with well-being of the people a the term "jobless recovery" implies: for most working people any period of slow growth is not that different from recession. See Olivier Vaury, Is GDP a good measure of economic progress, Post-Autistic Economics Review, issue 20 . Recently there was an interesting new evidence that suggests that shifting production overseas has inflicted worse damage on the U.S. economy by creating "phantom GDP"
BusinessWeek's analysis of the import price data reveals offshoring to low-cost countries is in fact creating "phantom GDP"--reported gains in GDP that don't correspond to any actual domestic production. The only question is the magnitude of the disconnect. "There's something real here, but we don't know how much," says J. Steven Landefeld, director of the Bureau of Economic Analysis (BEA), which puts together the GDP figures. Adds Matthew J. Slaughter, an economist at the Amos Tuck School of Business at Dartmouth College who until last February was on President George W. Bush's Council of Economic Advisers: "There are potentially big implications. I worry about how pervasive this is."
By BusinessWeek's admittedly rough estimate, offshoring may have created about $66 billion in phantom GDP gains since 2003 (page 31). That would lower real GDP today by about half of 1%, which is substantial but not huge. But put another way, $66 billion would wipe out as much as 40% of the gains in manufacturing output over the same period.
It's important to emphasize the tenuousness of this calculation. In particular, it required BusinessWeek to make assumptions about the size of the cost savings from offshoring, information the government doesn't even collect.
GETTING WORSEAs a result, the actual size of phantom GDP could be a lot larger, or perhaps smaller. This estimate mainly focuses on the shift of manufacturing overseas. But phantom GDP can be created by the introduction of innovative new imported products or by the offshoring of research and development, design, and services as well--and there aren't enough data in those areas to take a stab at a calculation. "As these [low-cost] countries move up the value chain, the problem becomes worse and worse," says Jerry A. Hausman, a top economist at Massachusetts Institute of Technology. "You've put your finger on a real problem."
Alternatively, as Landefeld notes, the size of the overstatement could be smaller. One possible offset: Machinery and high-tech equipment shipped directly to businesses from foreign suppliers may generate less phantom GDP, just because of the way the numbers are constructed.... ... ...
Phantom GDP can also be created in import-dependent industries with fast product cycles, because the import price statistics can't keep up with the rapid pace of change. And it can happen when foreign suppliers take on tasks such as product design without raising the price. That's an effective cost cut for the American purchaser, but the folks at the BLS have no way of picking it up.
The effects of phantom GDP seem to be mostly concentrated in the past three years, when offshoring has accelerated. Indeed, the first time the term appeared in BusinessWeek was in 2003. Before then, China and India in particular were much smaller exporters to the U.S.
The one area where phantom GDP may have made an earlier appearance is information technology. Outsourcing of production to Asia really took hold in the late 1990s, after the Information Technology Agreement of 1997 sharply cut the duties on IT equipment. "At least a portion of the productivity improvement in the late 1990s ought to be attributed to falling import prices," says Feenstra of UC Davis, who along with Slaughter and two other co-authors has been examining this question.
What does phantom GDP mean for policymakers? For one thing, it calls into question the economic statistics that the Federal Reserve uses to guide monetary policy. If domestic productivity growth has been overstated for the past few years, that suggests the nation's long-term sustainable growth rate may be lower than thought, and the Fed may have less leeway to cut rates.
In terms of trade policy, the new perspective suggests the U.S. may have a worse competitiveness problem than most people realized. It was easy to downplay the huge trade deficit as long as it seemed as though domestic growth was strong. But if the import boom is actually creating only a facade of growth, that's a different story. This lends more credence to corporate leaders such as CEO John Chambers of Cisco Systems Inc. (CSCO ) who have publicly worried about U.S. competitiveness--and who perhaps coincidentally have been the ones leading the charge offshore.
In a broader sense, though, the problem with the statistics reveals that the conventional nation-centric view of the U.S. economy is completely obsolete. Nowadays we live in a world where tightly integrated supply chains are a reality.
For that reason, Landefeld of the BEA suggests perhaps part of the cost cuts from offshoring are being appropriately picked up in GDP. In some cases, intangible activities such as R&D and design of a new product or service take place in the U.S. even though the production work is done overseas. Then it may make sense for the gains in productivity in the supply chain to be booked to this country. Says Landefeld: "The companies do own those profits." Still, counters Houseman, "it doesn't represent a more efficient production of things made in this country."
What Landefeld and Houseman can agree on is that the rush of globalization has brought about a fundamental change in the U.S. economy. This is why the methods for measuring the economy need to change, too.
Also many components of GDP (FIRE -- finance, insurance and real estate) might be partially anti-social and their fast growth might be detrimental for the health and prosperity of society. Jesus attitude toward bankers is well known and probably was not without the reason ;-) There are several well-known problem with GDP:
The arguments presented above cast doubt on the usefulness of GDP as the main “pilot” of economic policy. If the thermometer is wrong, then the policy based on it should be wrong too. Also people are very adaptable and if some numeric scale became an official goal. people demonstrate tremendous ability to abuse any numeric scales of measurement both by fraud and by corruption of the initial goals and purpose of the measurement.
But even if we assume the GDP is a useful metric there are some concerns about the validity of the official figures: Ronald R. Cooke in his editorial American GDP published 01-17-2008 at Financial Sense noted:
In another life (circa 1962), I was an auditor for AT&T. Nothing spectacular. Mostly cash and property reviews. Then some business process analysis. It was my good fortune to have two older gentlemen as partners. They graciously decided to teach this green college kid how to be a good auditor. It was a great learning experience. One of the tricks they taught me was called the “reasonable test”. If the data under audit was within the parameters of like data from other audits, then it was reasonable to assume there were no problems of procedure or management. If, on the other hand, the data did not seem to make sense versus circumstantial criteria, then it would be reasonable to assume further audit investigation was warranted. This technique of measuring the quality of information has become a cornerstone of my work ever since.
In early November, 2007, the Commerce Department’s Bureau of Economic Analysis (BEA) announced the United States had achieved a third quarter Gross Domestic Product (GDP) of 3.9 percent. That number was later updated to 4.9 percent. Those numbers set off my “reasonable test” alarm. How, I wondered, with an accelerating rate of inflation and declining economic activity, could the United States turn in such a stellar performance?
The BEA’s report flunked the reasonable test.
GDP
The BEA reported American GDP in billions of Current Dollars (the money we actually spent for goods and services) for Q3 2006 and Q3 2007. It also reported this same data adjusted for inflation using “chained” 2000 dollars. As of December 20, 2007, the quarterly data, using seasonally adjusted annual rates for the National Domestic accounts, yields the Current-Dollar and “Real” Gross Domestic Product data shown in the following Table. It shows that annual GDP growth in current dollars grew from 4.53% in Q1 2007 to 5.30% in Q3 2007. Using inflation adjusted chained 2000 dollars, economic growth grew from 1.55% in Q1 2007 to 2.84% in Q3. Not bad.
But wait. Does this imply an inflation differential of only 2.46% for Q3? And do we really believe the inflation differential actually declined from 2.98% in Q1 to 2.46% in Q3? Didn’t the value of the dollar decline over these three quarters?
GDP in billions of current dollars
% Change from year ago quarter
GDP in billions of chained 2000 dollars
% Change from year ago quarter
Inflation Differential
2007q1
13,551.9
4.53%
11,412.6
1.55%
2.98%
2007q2
13,768.8
4.67%
11,520.1
1.89%
2.78%
2007q3
13,970.5
5.30%
11,658.9
2.84%
2.46%
The BEA’s Price Index for Gross Domestic Purchases (which measured prices paid by U S. residents) increased by just 1.8% in Q3. By contrast, the Labor Department’s Bureau of Labor Statistics (BLS) CPI-U inflation index was 2.36% for this same period. Which number is a better measure of inflation? Can we trust either number?
And to further compound the confusion, the BEA has reported a current dollar gain of 6.0% for Q3. BUT this is against average GDP for all of 2006, rather than a comparison of Q3 2006 vs. Q3 2007.
Collecting the copious amounts of data used to compute GDP has to be a tedious and sometimes frustrating job. Unfortunately, sophisticated analysis and hard work does not guarantee credible results. The BEA’s conclusions appear to be a bit optimistic.
Simple Net GDP Calculation
Pundits frequently ignore current dollar GDP (the total production of goods and services priced as though they were purchased with current dollars). Instead they use a number that has been adjusted downward called “Real” GDP that deducts the rate of inflation and makes other adjustments to current dollar GDP in an attempt to compare GDP from one period, with the GDP for a subsequent period, using dollars of a constant value .
I dislike the term “Real” GDP. There is nothing sacred about using inflation adjusted dollars as a measure of economic performance. Current dollar GDP is just as “real” as any other measure of value and provides a useful way to compare multiple sets of data from period to period. We should remember. Consumers can not spend inflation adjusted dollars to purchase goods and services. They can only pay their bills with the money that is actually in their pocket – current dollars. So .. if we want to adjust current dollar GDP for inflation, then let us do just that … and call it “Net” GDP. In other words, Net GDP is the percentage increase (or decrease) in current dollar GDP for a specified period vs. the current dollar GDP of a like prior period, less the rate of inflation from the prior period to the specified period. In the following example, seasonally adjusted current dollar GDP increased from $13,266.9 billion in Q3 2006, to 13,970.5 billion in Q3 2007 – an increase of 5.30%. The BLS reported a seasonally adjusted price index increase of 2.36% for these same two periods. If we subtract the BLS CPI from BEA current dollar GDP, that gives us a net increase in GDP of 2.94% from Q3 2006 to Q3 2007, - far less than the GDP gain of 4.9% reported by the BEA.
BEA Q3 2007 GDP Growth in Current Dollars from Q3 2006
5.30%
Increase of Q3 2007 GDP vs. Q3 2006 GDP
BLS CPI-U Q3 2006 vs. Q3 2007
2.36%
Deduct Q3 2007 Rate of Inflation
Net GDP
2.94%
Net GDP
If we take the BEA seasonally adjusted quarterly current dollar Gross Domestic Product percent change for Q3 2007, and compare it with this same data adjusted for chained 2000 dollars, the “inflation” differential is only 1.1 % even though the BEA price index was 1.8. In addition, note that while real world food and fuel prices have been going up, the inflation differential has been going down.
How is this possible?
BEA GDP Data
10/29/2007
GDP percent change based on current dollars
GDP percent change based on chained 2000 dollars
Inflation Differential
2007q1
4.9
0.6
4.3
2007q2
6.6
3.8
2.8
2007q3
6.0
4.9
1.1
If you go to www.tce.name and click on the Cultural Economics tab, you will see my essay of the rate of inflation: “CPI: Sophisticated Economic Theory, Terrible Ethics”. To quote from that essay: “If we use the weighting and data points from the above factoids to calculate an alternative estimate of CPI (the Consumer Price Index), we get a very different picture of American inflation from Q3 2006 to Q3 2007. There is a dramatic increase in food and housing costs. …... Granted.
Accuracy would require the acquisition and analysis of a lot more data than assembled for this effort. But the large discrepancy suggests something is wrong with either the survey methodology or the process of analysis. Whereas the BLS reported a CPI increase of 2.36% for this period, the actual rate of inflation was more like 4.02%.”
Ok. I like my economics simple, uncluttered, and straight. Assuming the credibility of the BEA current dollar estimates, let’s deduct my alternative CPI from the BEA data to estimate economic performance.
BEA Q3 2007 vs. Q3 2006 GDP in Current Dollars
5.30%
TCE CPI-U Q3 2007 vs. Q3 2006 Dollar value inflation
4.02%
“Net” increase in Q3 2007 GDP
1.28%
Using this methodology, could one conclude America’s economy posted a modest performance in Q3 2007? And by the way:
which number reflects contemporaneous comments on the economy:
the 4.9% gain in GDP reported by the BEA, or the above estimate of 1.26%?... ... ...
Conclusion
GDP is one of the most closely watched economic statistics: It is used by the White House and Congress to prepare the Federal budget, by the Federal Reserve to formulate monetary policy, by Wall Street and the media as an indicator of economic activity, and by the business community to prepare forecasts of production, investment, and employment. Because of its extremely sensitive business and political ramifications, reported GDP (current or chained) needs to be accurate, unambiguous, and trustworthy.
And this brings up an interesting point. One of the issues in this election cycle is trust. Can we trust the information we receive from the Federal Government? Congress? The Administration? Federal agencies? Aside from outright falsification, and intentional or intrinsic bias, data and information can be rendered untrustworthy by establishing a misdirected premise for the methodology or by overly sophisticated manipulation.
Hopefully, we will elect a management team in November that has the ability to review our measurement objectives and the analytical processes used to achieve them. In other words:
In God We Trust. All others need an occasional audit.
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Last modified: September 20, 2008