Memorial Day weekend is upon us and American consumers will use this holiday weekend – a holiday that was initially called Decoration Day and was set aside to remember the nation’s war dead – to drive to the malls and shop – an activity that some claim is patriotic in itself since it increases the size of the economy. In fact, when first quarter Gross Domestic Product revisions came out last week, MSNBC published an article stating, “Consumer spending — which accounts for more than two-thirds of economic activity — expanded at a much slower 2.2 percent rate in the first three months of this year instead of 2.7 percent.”
The Gross Domestic Product (or GDP) is a measurement of the size of the national economy. It is defined as the total value of all goods and services produced within a country’s borders. It’s an important statistic because it measures the economic pie that we all divide amongst ourselves. Worker’s wages, corporate profits, government tax revenues, landlord’s rents all come out of the production of the nation (or its GDP). A country becomes wealthier as the size of a country’s GDP grows relative to its population. That is why Presidents, governors, legislators, the Fed Chairman and everyone else trying to score points with the public claim that their actions impact it.
Unfortunately, very few people understand what the statistic actually measures. This is partly because the way that the Bureau of Economic Analysis (BEA) calculates the statistic is actually backward. Remember that GDP is a measure of a nation’s production – the goods and services PRODUCED within the country’s borders. Data on production is very difficult to obtain in an inexpensive or timely manner, but as an accounting equality, a nation’s production is roughly equal to its consumption, and financial statistics can be used to measure consumption in an inexpensive and timely way.
Since the BEA calculates GDP as a consumption measure, most reporters misunderstand what the statistic is and, like the example above, report on it incorrectly. While it may be true that consumer spending was lower, and that is important, SPENDING does not make up a portion of GDP, simply because GDP measures PRODUCTION. If production does not grow at least in line with spending, then real (or inflation adjusted GDP) may not actually be increasing.
This distinction is very important. Consider for example calls to stimulate the economy by increasing spending. Seemingly that sort of policy would make sense to anyone reading the MSNBC article since it says that spending is an important part of the economy. But spending in and of itself does nothing to increase domestic production. Simply put, if I take a dollar from Jim and give it to Jane to spend I have created nothing.
Since most politicians are not trained in economics or mathematics or anything quantitative, they make this mistake over and over again – and their policies do not boost real GDP at all, they simply inflate the economy. If America is to get out of its current “rut” it needs to start producing more, not spending more. Policies that encourage production, encourage hiring, and reduce business costs are much more likely to do this than will borrowing to increase current spending.