-->Introduction
The Gross Domestic Product (GDP) is one of the broader measures of economic activity and is the most widely followed business indicator reported by the U.S. government. Upward growth biases built into GDP modeling since the early 1980s, however, have rendered this important series nearly worthless as an indicator of economic activity. The analysis in this Installment will indicate that the recessions of 1990/1991 and 2001 were much longer and deeper than currently reported, and that lesser downturns in 1986 and 1995 were missed completely in the formal GDP reporting process. Furthermore, the current economic circumstance is suggestive of an early-1980s-style double-dip recession.
The distortions from bad GDP reporting have major impact within the financial system. For example, Alan Greenspan's heavy reliance on productivity gains to justify some of his policies is equally flawed, since the methods applied to GDP estimation influence the numerator in the productivity ratio. As with the CPI distortions discussed in Installment III, the Federal Reserve Chairman knows better.
With reported growth moving up and away from economic reality, the primary significance of GDP reporting now is as a political propaganda tool and as a cheerleading prop for Pollyannaish analysts on Wall Street.
Reporting Basics
The GDP is compiled and reported by the Bureau of Economic Analysis (BEA) of the Department of Commerce. Quarterly estimates are updated monthly, with the"advance" estimate published at the end of the first month following the close of a quarter. The first and second revisions are called the"preliminary" and"final" estimates. In turn the"final" estimate is revised in annual revisions (usually in July), and every five years or so a benchmark revision is published that revises all data back to 1929, the first year of formally estimated economic activity.[1]
The popularly followed number in each release is the seasonally adjusted, annualized quarterly growth rate of real (inflation-adjusted) GDP, where the current-dollar number is deflated by the BEA's estimates of appropriate price changes. It is important to keep in mind that the lower the inflation rate used in the deflation process, the higher will be the resulting inflation-adjusted GDP growth.
Due to a lack of good-quality hard data, the"advance" GDP report is little more than a guesstimate. The BEA comes up with three estimates of growth, a high, low, and most likely. The numbers then get re-massaged so that the reported growth rate is moved closer to whatever the economic consensus is expecting. There actually is a belief at the BEA that there is some value to economic consensus estimates.[2]
The estimation process does not improve much with the"preliminary" and"final" estimates. The BEA reports that 90% of ultimate revisions to the"final" estimate fall within a range of +3.1% to -2.6%. Where average growth has been about 3.5% over the years, that means that most reporting is not statistically significant. The upward bias shown in the revisions is due to what I call"Pollyanna Creep," where methodological changes regularly upgrade near-term economic growth patterns. These patterns will be explored shortly.
The GDP is a large component of the National Income and Product Accounts (NIPA), representing"the output of goods and services produced by labor and property in the United States."[3] The NIPA was the concept and development of the National Bureau of Economic Research, a private organization founded in 1920. The NBER work evolved into the BEA and the current NIPA accounting.
The NBER remains a consultant to the process and retains the position as official arbiter of U.S. recessions. At one time, the NBER did define a recession as two consecutive quarters of negative GNP/GDP growth that were not distorted by an event such as a truckers' strike.[4] The NBER used trends in indicators such as industrial production and payroll employment to time a recession's beginning and end, to the month. More recently, though, the NBER has abandoned the GDP as a recession indicator and has relied instead on those other economic series. My presumption is this change resulted from an unofficial recognition of the declining value of the GDP reports. In theory, the NBER is apolitical, although the timing of some of its recent calls on the ends of recession are suspect. Specifically, there is no such thing as a jobless recovery. If jobs are being lost, the economy still is in recession.
There Is a Problem in the Basic Structure
As part of the NIPA, the construct of the GDP is heavily reliant on economic theory for composition, unlike other data series such as retail sales or the trade deficit, which are relatively simple surveys that end up contributing to the GDP estimations.
The related Gross National Product (GNP) is the broadest U.S. economic measure and includes the GDP plus the balance of international flows of interest and dividend payments. For net debtor nations such as Guinea-Bissau and the United States, GDP usually will show the stronger growth than GNP, since the outflow of interest payments does not get charged against economic activity. For this reason, the United States switched its primary reporting from the GNP to the GDP in 1991. Put in perspective as of the"final" estimate of second-quarter 2004, annualized real GDP growth was 3.3%, down from 4.5% in the first quarter, while GNP growth for the same period was 1.9%, down from 3.9%.
I respect the intellect and creativity of those who have anchored their careers in academia. Frankly, though, most economic theories have little practical use in the real world. Concepts such as free trade being a boon to the world's economy [5], a weak currency helping turn a nation's trade deficit[6], or personal income including what the average homeowner would receive from himself in rental income if he charged himself to live in his own house, fall in to the"not in the real world" category.[7]
Varied academic theories, often with strong political biases, have been used to alter the GDP model over the years, resulting in Pollyanna Creep, where changes made to the series invariably have had the effect of upping near-term economic growth. Whether the change was to deflate GDP using"chain-weighted" instead of"fixed-weighted" inflation measures, to capitalize rather than expense computer software purchases, or to smooth away the economic impact of the September 11th terrorist attacks, upside growth biases have been built into reported GDP with increasing regularity since the mid-1980s.
The accompanying table shows the net impact of these changes over time. The GNP level for various years from 1929 through 1980 and GDP for 1980 and 1990 are shown in billions of current dollars. Once set, these GNP/GDP levels should not change. With redefinitions and methodological shifts, however, earlier periods have been restated so as to be on a consistent basis with the latest reporting. Accordingly, the GNP/GDP levels are shown as they were reported variously in 1950, 1984 and at present.[8]....
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