On our radio show we routinely discuss economic indicators that are released by various government agencies, NGOs, and other groups. Some of these you may be familiar with, but I realized that not everyone may know what these indicators mean, where they come from, and why they are important. I have decided to start a multi-week series going a little bit more in depth on these indicators, and I will try to answer any questions that you might have about them. If there is an indicator that you have heard about that you would like to know more about, please feel free to call the show at 904.22.8255, or email me at email@example.com and I’ll move that one to the top of the list.
This week, I am going to discuss the GDP, a number calculated by the Bureau of Economic Analysis. The BEA is part of the US Department of Commerce, which has been in existence since 1903. It is part of the Cabinet of the United States, which falls under the executive branch and is headed by a presidential appointment. The current Secretary of Commerce is Wilbur Ross, a billionaire investor and Trump appointee.
For those of you that are not familiar, GDP stands for Gross Domestic Product, and it is the monetary value of all the goods and services produced in a country during a set time period. GDP is normally calculated on an annual basis, although it is reported quarterly with several revisions after the initial number. GDP is considered to be the best overall measurement of the strength or weakness of a nation’s economy.
GDP is calculated by taking the total private sector consumption, adding in all government spending, adding all investments, adding all exports, and subtracting all of the nation’s imports. As you can see, the number is designed to capture the bulk of a nation’s economic activity, but it will never capture everything. It misses any part of the economy done in cash payments, aka the black market, the underground economy, or the shadow economy. Although this sounds nefarious or criminal, and it does consist of things like drug deals and gambling, there is a side that is not so dark. It can also be something like paying cash for a babysitter, purchasing furniture off of Craiglist, and other perfectly innocent transactions. However, there is no way to track all of these transactions, so you can imagine the size of the underground economy in the United States. Estimates range between 7% and 11% of the total GDP in the United States.
According to the World Bank in 2015, worldwide GDP ranges from the largest, the United States at $18 trillion dollars, to the smallest, to the 195th, Tuvalu (a tiny island nation in the South Pacific), at $33 million dollars. That means that the total economy of the United States is 545 thousand times bigger than Tuvalu, and there are many houses in the United States that sell for more then their entire GDP. Several countries are not ranked, such as Venezuela, Aruba, and Guam, probably meaning that they are either too small or the data is unreliable or unpublished. In case you were wondering, China is second at $11 trillion, followed by Japan, Germany, and the UK.
GDP is a popular measure for many reasons, one of which is because it can be used a measuring stick against other nations. It can also be used as a measure for economic policy, as percentage growth or decline of a nation can be compared over time to other nations. It can also accurately capture the value added by manufacturing, how the finished product can have more value than the individual raw materials. However, there are also criticisms, many of which are valid. One inequality is that GDP growth tends to be greater in developing nations than in developed nations. For years, China had a growth rate above 7%. This is far easier to maintain when transitioning from a rural economy to an industrialized nation. However, that growth rate is most likely unsustainable once that transition is made. As an example, look at the United States. We certainly didn’t grow to where we are today at a 2% GDP growth rate, although recently we have been happy to see that number. Another criticism of GDP is that it is looked at as a measure of material wealth of a nation, when in reality it is more of a productivity measure.
Regardless of your personal opinion of GDP as a measurement tool, it is by far one of the most important economic indicators used today. It has far reaching effects including the Fed’s monetary policy and therefore interest rates, business investment decisions, national economic policy, all of which affect your personal financial situation in ways you may not even realize.