The Absurdity of Conventional GDP Accounting

Bob Murphy writes:

The fundamental confusion in conventional GDP accounting is that it relies on spending as a measure of economic output. Yes, there is a certain logic in this; if businesses sell $15 trillion worth of stuff, then their customers must be buying $15 trillion worth of stuff. Yet it is still a very dangerous game, because it leads people to confuse accounting tautologies with economic causality: they think that the way to boost economic growth is to hike government spending, for example.

Yet things are even worse. Because policymakers and the pundits routinely refer, not to GDP itself, but to GDP growth, then “contributions to” or “subtractions from” GDP growth are actually second derivatives of the various variables involved.

For example, consider the recent GDP report. The Forbes article tells us that “inventories” subtracted “60 basis points from overall GDP.” What the heck does that even mean? How can goods sitting on warehouse shelves affect the ability of workers to take resources and produce output?

Of course, the ultimate explanation here is that the first pass at calculating GDP looks at the final spending by customers. Then, we look to see how much inventories changed during the period. For example, if customers spent $15 trillion on final goods, but during that period inventories fell by $1 trillion, then actual new production that period must only have been $14 trillion.

OK, so since inventory was apparently responsible for shaving 60 basis points off of GDP in the 1st quarter, I guess inventories across the US fell from 4q 2013 to 1q 2014, right?

Nope, that’s not right. The BEA report tells us (and note that that hyperlink will only be valid until the next BEA news release): “The change in real private inventories subtracted 0.57 percentage point from the first-quarter [2014] change in real GDP after subtracting 0.02 percentage point from the fourth-quarter [2013] change. Private businesses increased inventories $87.4 billion in the first quarter [of 2014], following increases of $111.7 billion in the fourth quarter [of 2013] and $115.7 billion in the third [quarter of 2013].”

Now we see why I was talking about second derivatives. Private inventories have been increasing in each of the last three quarters. But the increase (in dollar terms, and a fortiori in percentage terms) has itself been shrinking each quarter. That’s why inventories “subtracted” 2 basis points from GDP growth in 4q 2013, and “subtracted” 57 basis points (which the Forbes article rounded to 60) in 1q 2014.

If you want to see a more careful exposition of these ideas, and a simple numerical example to pinpoint the craziness, read my article at Mises.org cleverly titled, “Inventories Don’t Kill Growth–People Kill Growth.”