Tags: GDP | imperfect | slowing | economy

The Trouble with GDP

By Andrew Packer   |   Tuesday, 09 Oct 2012 07:39 AM

Every day, investors are saturated with stories warning of a slowing global economy. The biggest culprit is China, which faces a slowdown and might “only” grow 4 to 5 percent this year.

Let’s put that in perspective. If the United States or Europe were growing at “only” a 4 to 5 percent rate, we’d be creating jobs like crazy. This would reduce unemployment, and, at the same time, expand the tax base, thus reducing our trillion-dollar-plus deficits.

As it is, with hundreds of billions of dollars in federal stimulus each year, we’ve managed to grow the economy at an anemic 1.5 percent rate. That stimulus will automatically cut back come January as part of the fiscal cliff, which the Congressional Budget Office estimates will shave 3 percent off of our growth — meaning at least a recession with a negative 1.5 percent growth rate.

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Yet, all of these percentages tend to focus on one concept of growth: gross domestic product (GDP).

GDP is simply the total spending of a country, including the private sector and the public sector.

GDP is, in my view, an imperfect economic tool. It doesn’t have precision, and it doesn’t differentiate good economic spending from bad economic spending.

Say, for instance, that a government announces a massive stimulus plan. Since government spending is part of GDP, the government can essentially make GDP whatever it wants. This is part of the reason why China’s had red-hot growth. At the state and down to the local level, there’s been an incentive from the ruling party to spend like crazy to keep the economy growing and jobs going strong.

This is bad economic spending over the long term, as projects default or the government creates massive inflation or creates big deficits to pay for all the projects.

Likewise, improvements in the private sector might not be fully reflected in GDP. When I was growing up, for example, my parents bought an encyclopedia set and the annual addendums. Now we can just get any information we need online. That doesn’t mean that source of wealth has disappeared. The money we spent on those books has been spent elsewhere to otherwise improve our lives.

In other words, we’re better off as a society for having cheaper access to information, even if it shows up as a lower figure in GDP.

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Moreover, I wash and dry my dishes by hand. So, GDP is an infinitesimal fraction lower simply because of the energy I’m not using to run a dishwasher.

Looking at what does and doesn’t work about GDP underscores one key fact. Economics is an imperfect science. There is an art to it, just as there’s an art to investing that goes beyond the facts.

The facts are simple: Most economies around the world are highly dependent on government spending. That’s true of the big three: the United States, the European Union and China. Investors would be wise to focus their investments on companies that aren’t hugely dependent on government spending to thrive. Or outdated industries like encyclopedias.

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