GDP Growth, Recession, Depression and Recovery

Posted by PITHOCRATES - March 18th, 2013

Economics 101

Gross Domestic Product is basically Consumer Spending and Government Spending

In the 1980 presidential campaign Ronald Reagan said, “A recession is when your neighbor loses his job.  A depression is when you lose yours.  And a recovery is when Jimmy Carter loses his.”  A powerful statement.  And one that proved to be pretty much true.  But don’t look for these definitions in an economics textbook.  For though they connect well to us the actual definitions are a little more complex.  And a bit abstract.

There is a natural ebb and flow to the economy.  We call it the business cycle.  There are good economic times with unemployment falling.  And there are bad economic times with unemployment rising.  The economy expands.  And the economy contracts.  The contraction side of the business cycle is a recession.  And it runs from the peak of the expansion to the trough of the contraction.  A depression is basically a recession that is really, really bad.

But even these definitions are vague.  Because getting an accurate measurement on economic growth isn’t that easy.  There’s gross domestic product (GDP).  Which is the sum total of final goods and services.  Basically consumer spending and government spending.  Which is why the government’s economists (Keynesians) and those in the Democrat Party always say cutting government spending will hurt the economy.  By reducing GDP.  But GDP is not the best measurement of economic activity.

Even though Retail Sales may be Doing Well everyone up the Production Chain may not be Expanding Production

One problem with GDP is that the government is constantly revising the numbers.  So GDP doesn’t really provide real-time feedback on economic activity.  The organization that defines the start and end points of recessions is the National Bureau of Economic Research (NBER).  And they often do so AFTER the end of a recession.  One metric they use is GDP growth.  If it’s negative for two consecutive quarters they call it a recession.  But if there is a significant decline in economic activity that lasts a few months or more they may call that a recession, too.  Even if there aren’t two consecutive quarters of negative GDP growth.  If GDP falls by 10% they’ll call that a depression.

There’s another problem with using GDP data.  It’s incomplete.  It only looks at consumer spending.  It doesn’t count any of the upper stages of
production.  The wholesale stage.  The manufacturing stage.  And the raw commodities stage.  Where the actual bulk of economic activity takes place.  In these upper stages.  Which Keynesian economists ignore.  For they only look at aggregate consumer spending.  Which they try to manipulate with interest rates.  And increasing the money supply.  To encourage more consumer spending.  But there is a problem with Keynesian economics.  It doesn’t work.

When economic activity slows Keynesian economic policies say the government should increase spending to pick up the slack.  So they expand the money supply.  Lower interest rates.  And spend money.  Putting more money into the hands of consumers.  So they can go out and spend that money.  Thus stimulating economic activity.  But expanding the money supply creates inflation.  Which raises prices.  So consumers may be spending that stimulus money but those businesses in the higher stages of production know what’s coming.  Higher prices.  Which means people will soon be buying less.  And they know once these people spend their stimulus money it will be gone.  As will all that stimulated activity.  So even though retail sales may be doing well everyone up the production chain may not be expanding production.  Instead, wholesalers will draw down their inventories.  And not replace them.  So they will buy less from manufacturers.  Who will buy fewer raw commodities.

The continually falling Labor Force Participation Rate suggests the 2007-2009 Recession hasn’t Ended

So retail sales could be doing well during an economic contraction.  For awhile.  But everything above retail sales will already be hunkering down for the coming recession.  Cutting production.  And laying off people. Making unemployment another metric to measure a recession by.  If the unemployment rate rose by, say, 1.5 points during a given period of time the economy may be in a recession.  But there is a problem with using the unemployment rate.  The official unemployment rate (the U-3 number) doesn’t count everyone who can’t find a full-time job.

U-3 only counts those people who are looking for work.  They don’t count those who take a lower-paying part-time job because they can’t find a full-time job.  And they don’t count people who give up looking for work because there just isn’t anything out there.  Getting by on their savings.  Their spouse’s income.  Even cashing in their 401(k).  People doing this are an indication of a horrible economy.  And probably a pretty bad recession.  But they don’t count them.  Making the U-3 unemployment rate understate the true unemployment.  A better metric is the labor force participation rate.  The percentage of those who are able to work who are actually working.  A falling unemployment rate is good.  But if that happens at the same time the labor force participation rate is falling the economy is still probably in recession.  Despite the falling unemployment rate.

The NBER sifts through a lot of data to decide whether the economy is in recession or not.  Do politics enter their decision-making process?  Perhaps.  For they said the 2007-2009 recession ended in 2009.  The U-3 unemployment rate had fallen.  And GDP growth returned to positive territory.  But the labor force participation rate continued to fall.  Meaning people were disappearing from the labor force.  Indicating that the 2007-2009 recession hasn’t really ended.  In fact, one could even say that we have been in a depression.  For not only did a lot of our neighbors lose their jobs.  A lot of us lost our jobs, too.  And because the president who presided over the worst economic recovery since the Great Depression didn’t lose his job in 2012, there has been no recovery.  So given our current economic picture the best metric to use appears to be what Ronald Reagan told us in 1980.  Which means things aren’t going to get better any time soon.

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LESSONS LEARNED #54: “Every dollar the government spends is a dollar that the consumer can’t spend.” -Old Pithy

Posted by PITHOCRATES - February 24th, 2011

Consumer Spending Equals Approximately Two-Thirds of GDP

This will be an oversimplified explanation of macroeconomics.  And not to worry.  There will be no math.  Gross Domestic Product (GDP) is the sum total of all spending in the economy.  That spending breaks down into two parts.  Private.  And government (federal, state and local).  The higher the GDP the more spending in the economy.  Which typically means there are more jobs.  People are working.  They’re earning money.  And spending it.  The more they do the more economic activity there is.  And the more economic activity there is the better all our lives are.

Again, we’re keeping it simple.  We’ll use approximate numbers.  Because they’re close enough.  And explain the big picture.  And that big picture is this.  Consumer spending (private) equals approximately two-thirds of GDP.  And government spending equals approximately one-third of GDP.  And that one-third can be broken down as follows.  Defense is approximately 5% of GDP.  Pensions are approximately 6% of GDP.  Health care is approximately 6% of GDP.  Education is approximately 7% of GDP.  These add up to about 24% of GDP.  That other 10% or so of the ‘one-third’ is a bunch of smaller ‘discretionary’ programs.  And some other stuff.

Now, what’s the difference between consumer and government spending?  Well, based on the above, government spending pays for a lot of things we don’t want or enjoy but need.  All the good things in life are included in consumer spending.  Our homes.  Our cars.  Our electronic toys.  Candy.  Lingerie.  Perfume.  Movies.  Dinners out.  Fine wine.  Our cable subscription.  Our Internet access.  These are the things why we work for a paycheck.  And the things we should take care of but don’t (such as retirement and health care)?  Many of us leave it for others to pay (i.e., the government).  Because many of us live in the now.  And don’t plan for the future.

All the Money for GDP Spending comes from the Private Sector

Notice anything else about these numbers?  The ‘two-thirds’ and the ‘one-third’?  If you add them together they equal the total amount of spending.  And why is that?  Why does GDP equal the sum of consumer and government spending?  For a very simple reason.  The government spends our tax dollars.  And those taxes come from consumers.  In other words, government spending would have been consumer spending if the government didn’t transfer that money from the private sector to the public sector.

You know what this means, don’t you?  All the money for GDP spending comes from the private sector.  In other words, the private sector pays for both their spending (consumer spending) as well as the government’s spending.  And every time government spending increases consumer spending decreases.  Because that additional government spending is taking away from the consumers, leaving them less to spend.  Which tells you what about federal stimulus spending?  That’s right, it doesn’t stimulate.  Because it doesn’t add any new money to the economy.  The same money is there.  Just someone else is spending it (the government instead of the consumer).

But what about deficit spending?  When the government borrows money or prints money (i.e., quantitative easing), that doesn’t take money away from the consumers.  That’s adding new money to the economy, isn’t it?  Well, yes and no.  If you borrow a little you pay a little interest.  If you borrow a lot you pay a lot of interest.  And guess who pays the interest?  We do.  That’s another thing they use our taxes for.  Our federal debt is in the neighborhood of $14 trillion.  That’s a lot of debt.  The interest on that debt totals about $200 billion dollars.  And we have to pay this every year with our taxes (not to mention that we have to pay down at least some of this principal).  The interest on our federal debt is close to $200 billion dollars.  And we have to pay this every year with our taxes.  Or we have to borrow more money to pay the interest on what we’ve previously borrowed.  Which increased our total debt.  And our total interest.  So borrowing to ‘stimulate’ just transfers more money from the private sector to the public sector.  Which, of course, decreases economic activity.

Printing money is a completely different story.  It’s far more destructive.  Printing money causes inflation.  Adding dollars into circulation just makes the dollars we have worth less.  Because our money is worth less, it takes more of it to buy the same stuff we used to buy.  Interest rates go up.  Our credit card interest rate goes up.  And the more they print the more living costs.  It was so bad in the Seventies that businesses added Cost of Living Adjustments (COLA) to our pay checks to account for the high inflation.  If they didn’t, prices would rise faster than our wages.  Without it some people wouldn’t have been able to afford to buy their groceries because inflation was that bad in the Seventies.

Government Spending is often for Political Reasons

And if this wasn’t bad enough (and don’t you think it should be?), government spending disrupts the free market.  In so many ways.  First of all, consumers have less to spend.  So businesses sell less.  And create fewer jobs.  And it disrupts the allocation of resources.  The government may purchase the ingredients in the things you buy (to make things no one wants to buy).  Because there are fewer of these ingredients left in the free market, prices go up.  Which means you now pay more at the store.  They could use our tax money to fund a regulatory body that increases the cost of doing business (say adding a carbon tax to the sale price of something).  We pay more for the bureaucracy AND the new tax makes the things we buy more costly.  Etc.

And what makes this even worse is that government spending is often for political reasons.  Not for the consumer’s best interest.  Ever wonder why we use corn syrup for a sweetener?  The rest of the world uses sugar.  We use corn syrup.  Why?  The powerful corn lobby gives boatloads of money to politicians who in turn legislate tariffs on sugar.  That’s a special tax on sugar imported to this country.  It makes it more expensive.  More than using the domestically produced corn syrup.  So we use corn syrup.  In the mean time, everyone buying sugar in the store pays a lot more than people do in the rest of the world.

And then there are electric cars.  No one wants them.  How do we know this?  Because the only way they sell them are with big government subsidies.  This is a disruption of the free market.  As of now, the electric car has very limited uses.  Because it has a very limited range.  (Imagine yourself stuck in rush hour traffic during a blizzard with the heater and your lights on.  How long do you think you will last sitting at a standstill in traffic?)  But government gives businesses subsidies (our tax dollars) to produce these cars.  And government gives consumers subsidies (our tax dollars) to buy these cars.  And the allocation of resources are not per consumer demand but by this government interference into the free market.

Another good car example is the use of flex fuel (E85).  Instead of exporting our corn to impoverished and hungry nations, we’re using food to make ethanol to blend with gasoline to put into our cars.  Because we’re using food for energy instead of food, food prices go up.  Making impoverished and hungry people more impoverished and hungry.

Government Spending is Consumer Spending done Poorly

The private sector begets the public sector.  It gives it life by creating economic activity.  And when the private sector does well the public sector does well.  But the public sector is like a parasite.  It can only survive by sucking life out of its host.  The private sector.  And like parasites, the more they feed the sicker the host gets.

Government spending is often necessary.  But it does nothing to stimulate the private sector.  In fact, it hinders the private sector.  So government should minimize its spending.  Including stimulus spending.  Because it doesn’t stimulate anything but politics.  At the expense of the consumer.

Government spending is consumer spending done poorly.  It rarely is efficient.  It rarely meets its intended goal.  It ends up costing far more than anyone in government ever imagined.  It kills jobs.  And it makes consumers make decisions based not on what they want but what government thinks is best for them. 

Because government does poorly what others do well, the government that governs best is the government that intervenes the least.  If this were not true, we would not be suffering through the greatest recession since the Great Depression.  The Soviet Union would have won the Cold War.  And Greece would not have burned in riots in 2009.  The proof is in the history.  And we ignore it at our own peril.

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