What's In A Recovery? Beware The Flawed Statistic That Is GDP

There is a lot of confusion surrounding the current economic situation that the United States is in. The general media considers a recession as two or more successive quarters with GDP contraction so, according to this way of thinking, a single uptick in GDP signals a recovery.

By Shawn Ritenour
8/07/2012 @ 9:05AM
Forbes

Thomson Reuters’ latest survey of Wall Street analysts’ expectations about next quarter’s corporate earnings has prompted some to wonder whether the canary in the coal mine is beginning to feel lightheaded. According to the Wall Street Journal, those in the know are expecting decreased earnings in the third quarter, the first quarterly decline since the beginning of the official recovery. Of course, with official unemployment stuck above 8 percent and anemic real gross domestic product (GDP) growth, one can be forgiven for wondering just how the experts define “recovery”, and if the American business environment is truly on the upswing.

To understand our current economic situation we must distinguish between a sustainable recovery and one which is as artificial as the flavors in the Kool-Aid being drunk by spendthrift politicians and the Keynesian intellectuals who enable them. Part of the confusion regarding our current economy is how recessions are defined by journalists and officials. The conventional media definition of a recession is two or more successive quarters with GDP contraction. A single uptick in GDP, therefore, signals recovery according to this way of thinking.

The National Bureau of Economic Research (NBER) has been given the official task of dating recessions. The NBER defines recession as a period of declining, not low, economic activity. We could, therefore, have an increase in gross domestic product and income from a very low trough and still live in an economy that is much more depressed than the previous peak and could remain so for a long, long time. This is what we are currently experiencing. Since the last recession began in December 2007, economic activity improved in June 2009, leading to NBER’s declaration that the recession had officially ended. Yet it could be argued today that the economy continues to perform far below 2007 levels.

Our so-called “recovery” is the slowest following any recession since at least before 1970. Employment recovery following the recession remains the worst following any recession since the Great Depression. In fact, our economic performance is worse than Japan’s during its lost decade.

After teasing us with significantly higher rates of growth last year, this year real GDP has slowed to a crawl. Why this manic-depressive economic behavior? I would argue that much of the confusion pertains to problems with GDP itself.

In the first place, it is hard to know which GDP numbers to trust because they are often calculated using inaccurate data and are subject to perpetual revision. Additionally, GDP includes large amounts of government spending, which by nature does not reflect real productive activity. Such spending is not funded by the voluntary purchases by those who earned the money, but by taxes forcibly taken from them. The government does not produce, but rather consumes wealth by taxation, borrowing and monetary inflation. Consequently, when GDP increases due to higher government spending, this indicates less private production and signals that the economy is getting worse, not better.

Recent components of real GDP tell exactly this story. Private investment is significantly lower now than it was at its pre-recession peak, making up a smaller percentage of GDP than it did before the meltdown. Government spending, however, increased steadily through the middle of 2010 and still claims a larger percentage of GDP now than it did before the recession.

Built on such a sandy foundation, any economic expansion is unsustainable, because it not rooted in private investment funded by voluntary savings. It is no wonder that analysts like those surveyed by Thomson Reuters expect depressed corporate earnings in the upcoming quarter. Real recovery is the product of more capital wisely invested by entrepreneurs. Three years after the recession, we still have less private investment and more government consumption.

Government macroeconomic statistics such as GDP or gross domestic income are not a scientific measurement of economic well-being. Beware of equating GDP with the economy and increased GDP with prosperity. There is good reason to think that what the NBER calls our recovery is much more apparent than real.

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