IDEAS ON LIBERTY
Economics on Trial
Beyond GDP: A Breakthrough in National Income Accounting
by Mark Skousen
“It is apparent that a large part of a country’s total production serves for the production of capital goods and not for the production of consumer goods, and that the production of capital goods must itself become a specialized branch of manufacturing.” —Wilhelm Ropke 1
Good news! The U.S. Department of Commerce, which compiles Gross Domestic Product (GDP), has just added a new national income statistic, Gross Output (GO), as a measure of total spending in the economy. I have been making the case for this new statistic for over ten years. Now it is a reality. In The Structure of Production (1990) and Economics on Trial (1993), I was critical of GDP for two reasons:
First, GDP is a Keynesian concept that measures only the output of final goods and services and excludes intermediate production. Second, government spending is included in GDP data, an autonomous addition to national output.2
Both peculiarities of GDP have led to much mischief. In the first case, by focusing solely on final output, many economists and commentators in the media have concluded that consumer spending is more important than capital investment in an economy, based on the fact that consumption expenditures usually represent about two-thirds of GDP. In the second case, including government spending in GDP has led many pundits to believe that an increase in that spending—even if accomplished through deficit spending—will automatically increase economic growth (or conversely, a cut in government spending will inevitably lead to a recession). Both conclusions are false.
Most students of economics are unaware of the fact that GDP was created by Simon Kuznets during World War II to quantify final aggregate demand according to the new economics of Keynes. As such, GDP ignores all intermediate spending in the economy, based on the tenuous argument that earlier stages of production constitute double counting.
However, the goods-in-process sector of the economy—the natural resource, manufacturing, and wholesale stages—are important for several reasons. Austrian economist Eugen von Bohm-Bawerk and German economist Wilhelm Ropke, among others, demonstrated that interest rates and technology greatly influence the structure of production and that changes in the early stages are especially important in the business cycle.
In an effort to measure intermediate production, The Structure of Production introduced a new national income statistic, Gross Domestic Output (GDO)—a more complete measure of spending at all stages of production—as an “Austrian” alternative to the Keynesian GDP. It counts spending (sales or revenues) of firms at all stages of production, not just at the retail level.
GO: A New National Statistic
For a decade I thought my criticisms of GDP had fallen on deaf ears and no one was interested in using a new national income statistic like GDO that accurately included total spending in the economy, not just final output. However, I am happy to report that the Commerce Department’s Bureau of Economic Analysis has just begun to publish a new series called “Gross Output,” an annual measure of total spending at all stages. GO is defined as Intermediate Input (II) plus GDP (final output).3
Intermediate Input (II) represents the sale of all products in the natural resource, manufacturing, and wholesale markets. GDP represents the final retail market.
I am currently working on a professional paper analyzing GO and II statistics and how they increase our understanding of the economy. Since this paper will not be published for some time, let me give you a few of my preliminary conclusions. Overall, much of the data appears to confirm several Austrian themes.
First, the data support the Austrian theory that the structure of production lengthens as an economy grows. Indeed, from 1987 until 1998 real GDP rose from $6.1 trillion to $8.8 trillion, or 39 percent (using 1996 as a base year). But real Intermediate Input (II) increased from $4.3 trillion to $6.5 trillion, or 53 percent, much faster than GDP. In other words, the producer/capital goods market grew more rapidly than the consumer/retail good market. This suggests that the number of stages of production increased.
Second, the data seem to confirm the Austrian view that production in the intermediate processes tends to be more volatile than final output and thus more sensitive to the business cycle. For example, during the 1990-91 recession, real GDP fell $31.5 billion, while real II fell $74.6 billion—more than twice retail sales. Since then, intermediate production has grown substantially faster (41 percent) than consumer spending (27 percent) from 1991 to 1998. I would like to test these statistics during previous boom-bust cycles (such as 1973-75 and 1980-82), but unfortunately, the data for II and GO are incomplete prior to 1987.
Third, GO data support the Austrian argument that business investment—not consumer spending—is the driving force behind economic growth. The Keynesian argument that consumer spending is the largest sector of the economy is specious and is based on a misunderstanding of GDP statistics. It is true that personal consumption expenditures typically represent 67 percent of GDP, but GDP is not total spending in the economy. On measuring total spending (GO), one sees that the capital/producer goods industry is substantially larger than the final consumer/retail goods industry. Using 1998 data, we find that personal consumption expenditures amount to $5.8 trillion, only 38 percent of GO, and gross business investment (which includes all intermediate production, plus gross fixed investment) amounts to $7.9 trillion, 52 percent of total spending.
In sum, intermediate production does matter, and GO is a better indicator of what is happening in the entire economy, not just the retail sector. Hopefully, the next step will be for the Commerce Department to release up-to-date quarterly data for GO and II as they currently do for GDP. We could learn a lot more about the direction of the economy with these new Austrian national income statistics
1. Wilhelm Ropke, Economics of a Free Society (Chicago: Henry Regnery & Co., 1963), p. 43.
2. See The Structure of Production (New York: New York University Press, 1990), chapter 6, and Economics on Trial (Homewood, Ill.: Irwin, 1993), chapter 4.
3. See “Improved Estimates of Gross Product by Industry for 1947-98,” Survey of Current Business 80:6 (June 2000), pp. 24-63. Table 8 measures Gross Output 1987-98, and table 9 measures Intermediate Input 1987-98.
Ralph Musgrave says
Let’s say there is a widget factory where the final stage in the production process is to paint the widgets, which is done in a special paint shop building. One day there is a management buy-out of the paint shop, but they continue just as before: painting the widgets, and selling them on at the same price as before.
Anyone with some common sense can see that nothing much has changed. But according to Austrians, national output or income or something has risen (by the total amount the new paint firm pays for unpainted widgets).
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