u s claim of 3 5 economic growth is smoke and mirrors

U.S. Claim of 3.5% Economic Growth is Smoke and Mirrors

October 30th, 2009 | By: CFN


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BLS 10292009The elite media is euphoric, saying the Obama stimulus package worked and we had 3.5% economic growth this quarter!

Unfortunately when I explain to you how the U.S. Government comes up with that number you are going to realize why the CBO likely never has an accurate forecast and why most economists are worse than weatherman at predicting economic trends. What I am about to explain to you is a tad arcane but Poligazette and my IUSB Vision readers are some very smart people and I have confidence that you will grasp this just fine.

The first thing that must be understood is the difference between a growth in GDP (Gross Domestic Product is the total sum of production within the borders of a country in a given year adjusted for inflation) and a growth in real GDP per capita. It is possible to claim that your economy is in “recovery” even at 1% growth (Joe Biden) but since 2% of production growth in the United States is because of improvements in technology and capital goods; and another 1% is needed for population growth, an economic growth rate of over 3% is required to reliably increase the GDP per capita of the United States. The GDP per capita is the most important measure of the standard of living and wealth of the average citizen.

With a claimed GDP growth rate of 3.5% and a non farm unemployment rising past 10%, how can each citizen be producing more per person while the unemployment rate is skyrocketing with another 530,000 NEW jobless claims just in the last month? This would have to mean that American consumers went on a spending spree to drive that number up or that each worker became way more productive and must be working lots of extra hours and overtime to get that per capita GDP up….

If you are starting to think that something sounds fishy you would be right.

I had a brief chat and open lecture with noted economist Bradley Schiller today. He told me that with the new 3.5% number that per capita GDP must be up and with unemployment also up the overtime worked hours must be way up. As you can see from the graphic, Schiller was wrong.

The graphic is from the Bureau of Labor Statistics from October 29th.  As you can see the hours of persons worked is way down in both categories. The total output is also down so how can this be? Where did the 3.5% growth come from? Could it be that Americans went on that spending spree? Sorry consumer confidence is down 5.7 points this quarter.

How can the output per hour have increased so high on the graphic when hours worked and total output are way down?  Did Americans go into overdrive and suddenly become become super workers? The answer to why that number is artificially inflated is the same reason why the GDP number has been artificially inflated.

So how does the  the US Government measure GDP? They use an old and very flawed Keynesian formula.

GDP= C+I+G+(X-N)

C = consumer consumption of goods and services measured. I = capital investment like building factories, production robots, machine tools etc. (X-N) is exports minus imports and since we have a large trade deficit that is always a negative number. G= government spending and this is where the smoke and mirrors come in.

Since GDP has to equal total production of the workforce, this means that if Mr. Bernanke at the Federal Reserve prints up a bunch of money and Nancy Pelosi spends it,  congratulations, each worker in the United States just became more productive on paper. This is the effect that a $1.7 trillion yearly deficit for 2009 has on an economy. For the sake of comparison the yearly deficit spending for 2007  was a “measly” $211 billion.

This is why the old, flawed Keynesian model is favored by politicians, socialists and other leftist ideologues, because on paper it means that the more you spend the better your economy is and the more productive you appear. What this amounts to is that there is no economic dip, depression, or problem that cannot be fixed by government spending. It gets worse, because of another flawed Keynesian concept called “leakage” they actually believe that government spending is MORE efficient in growing the economy than tax cuts. When Vice-President Biden said that we have to greatly increase deficit spending so we don’t go bankrupt, now you know why.

The reality is that most government spending does not create much if any wealth and much of it simply amounts to a transfer payment. Government is gargantuan and bureaucratic. Government money is spent for political reasons and not for economic reasons or efficiency.Thus the “multiplier effect” government spending has on the economy is much less than creating real wealth like creating things or investors building a factory.

There is even an argument to be made that much of the “G” variable for government spending should be counted as a negative number towards GDP because each dollar government spends eventually is a  dollar taken from you or an investor to spend it. GDP exploded after 1947 when government spending dropped from 188 billion to 58 billion.  It also should be mentioned that the larger government is, it engages in more  arbitrary, regulative and taxing behavior that also drives down consumer and investor confidence. Deficit spending also drives up inflation.

The old Keynesian model is what a majority of economists believe because this is what they are taught in school; they simply never think for a moment to challenge it. This is a big part of the reason why government economists are so bad at cost/revenue forecasts.  The economic collapse and the inability of 80% of  economists to see it coming helped to convince me that most economists are great at applying flawed theory and don’t really understand economics.

It should also be noted that some economists are saying that one percentage point of the alleged 3.5% growth measure was due to the cash for clunkers program which studies have shown mostly was utilized by those who had planned to buy a car anyways this year; so the program just borrowed some spending from the future that will result in dips in auto sales for the next two quarters. In either case, the economy really isn’t improving anywhere near the degree that the elite media and some politicians say it is.

At best the current GDP formula is not a very good measure of an economy. A new formula for GDP needs to be constructed and tested.

Cross posted at IUSB Vision.

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  1. Doomed

    October 30th, 2009 at 14:09

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    Cash for clunkers was another driver of the GDP for this last quarter.

    They are now being called out on their numbers of jobs created by the stimulus…They claimed 30,000……they are now being forced to drive that number down….

    But after almost 10 months….Remember….we were promised 3 million new jobs in 3 years…….at this rate they only have 2,990,000 more jobs to go.

    We were promised green technology…that money is going to more scientists to write reports claiming AGW is real and were all going to die. Its not going to produce windmills or solar panels.

    15 percent of the stimulus has been spent……85 percent remains unspent. But we do own General Motors.

    This president ignores Afghanistan where American troops are being killed and injured while he spends every day of his administration on the campaign trail campaigning for socialized medicine. While our young men and women die in a far away land he only seems to care about getting his tripod agenda passed in the 2 years he has to get it done before the American people vote his LUNATIC congress out of office.

    We have been promised a lot by this fellah. He has delivered on nothing and accomplished nothing other then to show us that without a teleprompter he cant speak or think.

    Afghanistan is burning and he makes speeches about Health care. Our economy is floundering and he promises debt of unimaginable proportions. This government reminds me of the drug addict prodigal son who shows up and promises he is clean for the umpteenth time only to find him pilfering your jewelry box which is empty from the last 20 times he has pilfered it.

    What promises are coming next and when will the people stop buying into a fist full of lies by the Democrats and this president? Promise them you are moderate….until they give you the keys to the bank vault.

  2. Tully

    October 30th, 2009 at 17:16

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    I agree entirely on the smoke & mirrors aspect, but some nits to pick:

    Schiller is right that overtime hours are up for those still employed full-time. You can see the increase in OT under “hourly compensation.” The rise in those figures is actually diluted somewhat by the increase in part-time employment, which tends to rise during a recession.

    More telling, you can see from the graphic that the bigger boost is in productivity, which is hardly surprising. During layoffs the least productive labor is generally the first to be laid off AND companies concentrate on their highest-value-added functions, which leads to an increase in the generic productivity measures. This you can see confirmed under “output per hour.”

    A new formula for GDP would not be useful. All the measures are there, and what you ask for essentially amounts to a new measure outside the modeling framework. That could indeed be useful, just not as a replacement for the standard GDP measure. What would be even more useful would be for the government to quit representing the GDP measure as things it is not, and as indicating things it does not.

  3. CFN

    October 30th, 2009 at 22:16

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    Hi Tully,

    Thanks for your comment, but some nits to pick. :-)

    I did not say that there would be NO overtime, but rather there would have to be enough to make up for half a million a month in layoffs WHILE increasing the GDP by 3.5%, or 2.5% because 1 of those percents is the cash for clunkers blip that will lower GDP over the next two quarters.

    Your right that a part of what is going on is that the least productive are being laid off, but in fairness the most productive are often paid more so that could be a part of the hourly compensation rise as well.

    Don’t get me wrong, Schiller is a good economist. He is right on over 80% of the time I have seen his views which for an economist is stellar.

    However I very much take issue with your statement that a new GDP formula would not be useful.

    To define the GDP as the current measure of output within a nations borders in a specific period of time and then to use a formula which can easily be demonstrated doesn’t accomplish that and in too many cases is not even directionally accurate is problematic. Simply put the formula does not accomplish the definition of GDP.

    We should redefine GDP or come up with a formula that actually matches the definition of GDP.

    Most importantly to dare claim, as the Keynesian model does, that a government transfer has a better GDP wealth creating effect than a bank or an investor making new factories, R&D or machine tools is preposterous on its face. While the money that government spends does have some multiplier effect, it is much smaller because the broken window theory applies.

    According the the Keynesian formula, we could tax the people 90% and jack up government spending to make up for the loss of consumption in the formula and literally tax & spend ourselves into prosperity because according to the theory the change in marginal propensity to consume due to leakage makes government spending more efficient than tax cuts, which anyone, especially those who have ran a business can tell you is simply insane.

    If you wish to keep the old formula that’s fine, but to claim that it measures the total output within a nations borders in a specific time period is a folly, because it does no such thing.

  4. Tully

    October 31st, 2009 at 07:16

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    Simply put the formula does not accomplish the definition of GDP.

    Um, it’s self-defining. The total market value of all the goods and services produced within the borders of a nation during a specified period. The flaws with using GDP as a definitive indicator of overall economic health (which it is not), including the inherent problems of accurate factor measurement, are well-known by (competent, non-ideological, empirical) economists. It’s the public that doesn’t understand the flaws of that misbegotten usage and the pols who misrepresent it (and not always out of ignorance) that are the core of your complaint. You’re essentially complaining that A + B + C = D doesn’t give you the information G through Z that it’s misrepresented as containing, or that someone else is claiming that A + B + C actually equals F. There are already alternate ways of measuring national income/output, and they add up to the same thing (empirically) with little variation. Off the top of my head, there are income, output, and expenditure methods of calculating national income/output. GDP is the expenditure method.

    Now, the idea that the current admin (specifically Romer & Bernstein as the primary sources) is using (VERY) flawed assumptions about Keynesian multipliers to plug into their neo-Keynesian models and make BS claims when predicting future effects on GDP is one I wholeheartedly agree with. THEY ARE. Blatantly. But that has little to do with the simple definitional concept of GDP, which is the nit I was picking. The problem is not with the definition of GDP, but with the way it’s being misrepresented as something it is not. The definition of GDP has darn near nothing to do with the modeling assumptions being used and/or abused to project the effects of policy on future GDP growth. There is no inherent assumption in that definition of the things that have you torqued.

    Look at it this way: The White House EPA claims your HuppMobile is rated at 20 mpg in town and 23 on the highway, and you agree. But they’re gonna put a Magikal Potion in it that will make it get 25 mpg. They pour the Magikal Potion in your tank. You drive it around the city and only get 16 mpg. Someone else takes it out on the highway and comes back to tell you that it gets 20 mpg on the highway. The discrepancy here is NOT due to the definition of miles per gallon (Miles/gallons), but to the assumptions plugged into that formula when attempting to make predictions about future performance after the Magikal Potion. The definition of MPG itself is blameless, the calculation used to determine actual mileage inherently accurate. Blaming the White House EPA for making false claims is on target. Blaming the definition of miles-per-gallon is not.

  5. CFN

    November 1st, 2009 at 10:34

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    While you make some good points for how Romer and company manipulate the numbers, in that we agree.

    The problem still exists. The formula in question treats government spending equal to private consumption and Capital Investment. Doing so is nuts. There are more and more economists coming to this conclusion, which to me has always been obvious. To anyone from the Austrian School of economics or is a fan of Hayek.

    The book, “Where Keynes Went Wrong” by Hunter Lewis is a good start.

    I do not claim and never did claim that GDP is something it is not. To me words mean things, GDP has a definition, that definition means something. The current measure of it isn’t a measure of that definition with a degree of credibility that I, and many more others, find compelling. Not only are the assumptions that are used to come up the variables easily manipulated, but the assumptions that the formula itself implies borders upon the laughable.Beyond saying that we appear to simply be at an impasse on this issue. There are those, especially government economists, who swear by these models, which is why their results are almost always wrong.

  6. Doomed

    November 1st, 2009 at 16:41

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    I make 1000 dollars per month. My bills are 1500 dollars per month.

    I get a loan for 6000 dollars and spread it out for 12 months. Has my productivity gone up? Is my household suddenly more productive because my income has gone up 50 percent?

    Do I really make 1500 dollars per month? Has my standard of living increased?

    Yes I really make 1500 dollars per month and my standard of living has increased. The question becomes is this GDI an accurate measurement of reality and the question is no.

    The more we borrow……aka 1.4 trillion as opposed to 200-400 billion the more skewed the GDP numbers are going to be because we are inflating the standard of living which is what the GDP really measures in the end.

    If you borrow more, you will inflate the GDP more.

    So in conclusion…..AS the Obama administration borrows us to bankruptcy that nice GDP figure will lie to us to our graves.

    Remember I do believe that Ronald Reagan subscribed to the Ricardian experience and every president since then has maintained this philosophy to justify their continued borrowing.

  7. Tully

    November 1st, 2009 at 23:27

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    The problem still exists. The formula in question treats government spending equal to private consumption and Capital Investment … I do not claim and never did claim that GDP is something it is not. To me words mean things, GDP has a definition, that definition means something. The current measure of it isn’t a measure of that definition with a degree of credibility that I, and many more others, find compelling.

    The problem is not what you think it is. You want GDP to mean something other than it actually means, and to convey MUCH more information than is inherent in the definition itself. The problem there lies not with the measure or the definition thereof but with your mistaken perception of what it actually is and what it is supposed to tell you. Because the definition of GDP is not the problem. Your perception of it is.

    As I said, GDP is eternally misrepresented as being a useful welfare measure, among other things. And it is NOT. It is simply the mathematical definition of overall economic activity over a defined period of time, without double-counting, as expressed in monetary terms. Just as MPG is a measure of fuel consumed for distance travelled, expressed in mileage terms. Nothing more, nothing less. As I said, there are already other ways of measuring GDP, and within the bounds of measurement error they produce the same results. Because GDP is what it is, just as a 1G standard average gravitational field is 32.2 ft/s2.

    To continue the MPG analogy, in essence you want the MPG figure to also tell you how much future wear and tear changing fuel formulations will cause to your vehicle and the future effect and cost on your maintenance schedule of subbing in other fuel components, etc., and are thus arguing to re-define MPG as something else entirely (as a predictive measure) because it doesn’t inherently contain that info in the first place. But all MPG is meant to measure is actual miles traveled per actual gallon of fuel used, just as all GDP measures is actual total economic activity. Not the potential additional damage to your engine from pouring Obama’s Magikal Potion into your tank, whether or not said Potion actually does what it’s claimed to do. For example, the Magikal Potion may indeed boost your mileage as claimed (or not) but at the future cost of devolatilizing your gaskets and hoses and stressing your valves and drive train and clogging up your fuel filter and fouling your plugs and/or injectors. The fault there does not lie with the measure of MPG or the definition of it. Redefining “gallons” will not change anything, nor give you better insight into the measure. A pint of G will still be a pint.

    What GDP is also not: A measure of quality of life. A measure of capital stock, or changes in same. A measure of non-monetary activity. Etc.

    Better go back and re-read those authors, because I think you’ve missed something very crucial along the way. Namely the difference betweeen GDP as a simple measure and the inherent problems of predicting future GDP response to changes in its components.

  8. CFN

    November 4th, 2009 at 14:01

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    With all due respect, you have managed to convince me that you simply do not understand what GDP is or what it claims to measure.

    You imply that I claim that GDP is to measure double counting. What I said was is that multiplier effect of I, G and C are not the same and should not be treated as such. Those are two totally different things and it is clear that you do not understand the difference between the two. Wool having added value to it when it is made into spun cloth and spun cloth being made into a jacket would be double counting and indeed double counting is not and should not be counted in GDP.

    That is very different from the multiplier effect. One of the things that the multiplier effect helps to show is the difference between true creation of material wealth and the creation of paper money which is a mere representation of wealth. Your “future MPG analogy” shows beyond reasonable doubt that you do not understand the concept.

    You said,

    “What GDP is also not: A measure of quality of life. A measure of capital stock…”

    Wow …. GDP per capita is not only a measure of quality of life, it is THE PRIMARY measure of quality of life in economics save for some political and other externalities and this is stated in every economics text book I have ever seen.

    And not a measure of capital stock… again I say wow. The stated Keynesian definition of I sub g in the GDP formula is capital investments, IE the creation of factories, machine tools, etc which are the tools used in the creation of wealth, which again is very different from merely adding value to cotton or wool.

    While you have pronounced me wrong in my article, you have been very careful not to directly address some of my best arguments in it. With all due respect and as nice as I can put this, you have managed to convince me that you are merely talking smack.

    The school I attend is ranked by the Princeton Review and US News as one of the top business and economics schools in the United States. I have discussed this topic at length with several professors to make sure that my thoughts are clear on this matter and they are.

    While I came up with these conclusions on my own, I have discovered that there are more and more economists who have come to this same conclusion and I keep discovering more books stating the same thing. If you saw Rush Limbaugh with Chris Wallace last Sunday he made the same key observation that I have.

    While my article on this matter is not the majority view, I am far from alone, and I have the comfort of knowing that historical results side with my point of view.

    I bid you good day.

  9. Tully

    November 4th, 2009 at 18:27

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    CFN, no, that’s NOT what you said, and I implied no such thing. I am not talkin’ smack. Not only do I understand the difference, I hold graduate degrees in monetary and developmental economics, taught both at the college level, and have worked in the field in the real world for a couple o’ decades. I suspect I had my first econ degree before you were born, and I read von Mises and Hayek long before that. I’m trying to correct an apparent fundamental confusion on your part about the difference between a simple fundamental measure and your apparent (justifiable, correct, IMHO indisputable) belief that some models used to predict the possible future readings of that measure are badly formulated and/or unsuited for the purposes used. You are confusing the latter with the former, and laying blame on the former for the faults of the latter, calling for the former to be abolished and reformulated to better suit you.

    The school I attend is ranked by the Princeton Review and US News as one of the top business and economics schools in the United States.

    Kudos on your school spirit. I’m sure they have excellent instructors and top academic professionals who would instantly grasp the distinction I am pointing out. You are apparently unable to distinguish between the measure itself and some predictive modeling approaches that contain inherently flawed assumptions about the future effects of changes in the various components of the measure on future GDP, between a present-time measure derived from extant empirical data and a theoretical prediction of what that measure will be in the future derived using assumptions not inherent in the measure itself, between what a thermometer actually says today and the flaws in the assorted theoretical modeling tools a weatherman might use to predict what that thermometer will say tomorrow or next month or next year. It isn’t the thermometer that requires adjustment when the forecast is wrong. It’s the modeling framework.

    I repeat: GDP represents what it is defined as representing, whether it it is measured as income, expenditures, or output, whether that measurement is done by Keynesians or neo-classicists or monetarists. All of whom, I note, use the same measure, whether they call it GDP or GDI. Don’t confuse what the BEA does (measures)with what the CBO or the Fed does (predicts).

    What GDP as a measure does NOT represent nor inherently contain are the assumptions used in some models to predict the “expected” effects on future GDP of different types of spending. There is NO inherent assumption about Keynesian multipliers (a concept Keynes actually borrowed from Hawley, though it goes back at least as far as the Physiocrats, but never mind) in the measure itself, only in models used to predict future GDP. You are IMHO 100% correct that many K and neo-K models use demonstrably flawed (IMHO) fundamental assumptions both real and theoretical about multiplier effects of changes in GDP components. You are completely incorrect in believing that this is somehow inherent in the generic empirical measure or definition of GDP as CIGX. It is not. GDP is just a measure, a definitionally correct one, whether calculated by the income, output, or expenditure methods.

    You are, in essence, blaming the thermometer for meteorologists making bad forecasts, and clamoring for a new and improved thermometer to fix that. The problem is not the thermometer. The problem is the models.

    Better go check up on the inherent flaws of using GDP per capita as a proxy measure of quality of life (or of any kind of quality, for that matter) or of GDP measuring capital stock. GDP is often (and inaccurately) used as a proxy measure for QoL, BUT expressing GDP per capita as a QoL measure carries the blatant income-equality assumption that societal wealth is evenly distributed across the populace, a condition that does not apply anywhere outside of perhaps a few tribal villages. GDP measures GROSS societal consumption/production over a set period of time, not individual wealth. Averages do not give you any detail on particulars, something you should know from Stats 101.

    Additionally GDP as a measure contains zero inherent assumptions as regards national capital stock, only an empirical statement of how much of the overall spending captured in the measure was spent for new investment. Capital stock is existing accumulated investment after depreciation and cannibalization. The GDP measure tells us absolutely ZILCH about the existing overall level of capital stock, only about the gross input to same over the defined time period. It tells us nothing about depreciation or expenditure of previously existing capital stock in the economy — the *I* in CIGX is not netted against existing capital stock anywhere in CIGX, nor does *I* speak to the quality and future productivity effects of the measured investment. Just as the *G* does not speak to the erosive crowding-out effects of government spending on the future economy.

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