GO Slow: New Leading Indicator Predicted Slowdown in GDP

by Mark Skousen
Presidential Fellow, Chapman University
Editor, Forecasts & Strategies

For the previous two quarters (Q2 and Q3, 2017) Gross Output, the new broader measure of the economy that includes the supply chain, was growing at a slower rate than GDP.  According to my research, that suggested a slowdown in GDP.

Today the Bureau of Economic Analysis released the advance estimate for Q4 2014 GDP.  After two consecutive quarters (Q2 & Q3) of 3%-plus growth in real terms, the GDP grew only 2.6% in Q4 — just as GO predicted.

For some time now, I’ve been arguing that gross output (GO), the top line in national income accounting, is a more accurate measure of total economic activity.  Because it includes business-to-business (B2B) transactions in the earlier stages of production, GO can anticipate changes in GDP (the bottom line) as much as 12 weeks in advance.

Since the first quarter of 2017, GO has been growing at slower rate than GDP.  In Q2, real GO rose at a tepid 1.7%, substantially less than 3.1% for GDP, and in Q3 2017, real GO accelerated at 2.7% growth rate, but still less than the 3.1% real GDP growth for the 3rd quarter.  I concluded in November, “Second quarter GO suggests potential slowdown in the economy, despite the currently rising GDP.”  Please reference the 2017 Q2 and 2017 Q3 press releases for more information.

The following chart provided by David Ranson, chief economist at HCWE & Co., shows the relationship between GO, II and GDP since the third quarter of 2016.

GO

Data: Quarterly seasonally-adjusted chain-type quantity indices of intermediate inputs, gross output and gross domestic product (Bureau of Economic Analysis).

 

As David Ranson comments:  “In this chart we compare the growth of gross output (GO) and intermediate output (II) with the growth of GDP over the past year (all in real terms). The chart begins with the third quarter of 2016 because, prior to that, all three variables were moving in close parallel. At that point a substantial divergence opened up, as the growth of intermediate output (and GO) raced ahead of GDP growth. That implied an acceleration in GDP growth which we have been experiencing. Now, just-released third-quarter figures for GO and II suggest that a re-convergence has begun: in the second and third quarters of 2017 growth in GO and II has fallen below the growth rate of GDP. That implies that GDP will stabilize and possibly decelerate later in 2018.”

 


For more information on Gross Output (GO), the Skousen B2B Index, and their relationship to GDP, see the following:

Mark Skousen, “At Last, a Better Way to Economic Measure” lead editorial, Wall Street Journal, April 23, 2014: http://on.wsj.com/PsdoLM

Steve Forbes, Forbes Magazine (April 14, 2014): “New, Revolutionary Way To Measure The Economy Is Coming — Believe Me, This Is A Big Deal”: http://www.forbes.com/sites/steveforbes/2014/03/26/this-may-save-the-economoy-from-keynesians-and-spend-happy-pols/

Mark Skousen, Forbes Magazine (December 16, 2013): “Beyond GDP: Get Ready For A New Way To Measure The Economy”: http://www.forbes.com/sites/realspin/2013/11/29/beyond-gdp-get-ready-for-a-new-way-to-measure-the-economy/

Steve Hanke, Globe Asia (July 2014): “GO: J. M. Keynes Versus J.-B. Say,” http://www.cato.org/publications/commentary/go-jm-keynes-versus-j-b-say

David Ranson, “Output growth data that the economy generates months earlier than GDP,” Economic Watch, July 24, 2017. HCWE, Inc. http://www.hcwe.com/guest/EW-0717.pdf

Mark Skousen, “Linking Austrian Economics to Keynesian Economics,” Journal of Private Enterprise, Winter, 2015:  http://journal.apee.org/index.php?title=Parte7_Journal_of_Private_Enterprise_vol_30_no_4.pdf

To interview Dr. Mark Skousen on this press release, contact him at mskousen@chapman.edu, or Ned Piplovic, Media Relations at skousenpub@gmail.com.

 

2ND QUARTER GROSS OUTPUT SHOWS SURPRISE SLOWDOWN IN ECONOMY

Washington, DC (Thursday, November 2, 2017): Gross output (GO), the top line of national accounting and a leading economic indicator, grew at a slower pace than GDP in the second quarter 2017, indicating a sudden slowdown in economic activity.  Mark Skousen, editor of Forecasts & Strategies and a Presidential Fellow at Chapman University, states, “My research shows that whenever GO grows slower than GDP, it suggests a potential decline in economic growth and if this trend persists, a recession could follow.  While GO grew at a slower pace, there is no still no evidence of a recession.”

Based on data released on Thursday, November 2, 2017 by the BEA and adjusted to include all sales throughout the production process, nominal adjusted GO (GO*) increased at an annualized rate of 2.9% in the second quarter of 2017, which is significantly lower than the previous quarter’s increase of 6.0%[1]. Nominal adjusted GO for the second quarter of 2017 grew at slower pace than the 4.0% nominal GDP growth and the 3.6% growth of the unadjusted GO reported by the BEA.

Real GDP, the bottom line of national income accounting, rose at an annualized rate of 3.1% in the second quarter 2017.  Real GO* generally grows at a higher rate than real GDP during an economic expansion.  However, in Q2 2017, real GO* grew at only 1.7%.

Skousen states, “By focusing solely on final spending and the end of the economic chain, GDP can sometimes be a misleading indicator of economic performance.  GO is a much better, more comprehensive view of total economic activity along the entire supply chain, and indicates a less positive outlook right now.”

In fact, according to a recent study by David Ranson, chief economist at HCWE & Co., GO anticipates changes in GDP by as much as 12 weeks in advance and thus serves as a new leading indicator: http://www.hcwe.com/guest/EW-0717.pdf

Skousen B2B Index Also Slows Dramatically

The Skousen B2B Index, a measure of business spending throughout the supply chain, increased at 2.6% in Q2, which is significantly less than the 8.1% growth rate from the previous quarter. This is the first slowdown after four consecutive quarters of strong B2B growth of 5% or more. In the second quarter, B2B transactions rose at an annual rate of 1.4% in real terms.

After four quarters of strong growth, the adjusted GO rose at slower pace, but still increased to reach $41.27 trillion. The current adjusted GO is more than double the size of GDP ($19.25 trillion), which measures final output only.

Supply Chain Activity Continues Increasing, But at a Slower Pace

Out of the 29 Industries and sectors defined within GO, 26 sectors rose compared to the previous quarter. The mining sector grew 8.3% in the second quarter 2017, the most of any sector, but this was relatively small compared to the 62.7% annualized growth in the first quarter 2017. Moreover, the mining sector accounts for just 1% share of total GO, which diminishes the impact of this small increase on the overall GO.  In contrast, the manufacturing sector is almost a fifth of total GO (18% share). Therefore, the 1.2% annualized growth of the manufacturing sector has a much greater impact on the total GO. With a 2.6% annualized growth rate, durable goods outpaced non-durable goods, which fell 0.2% compared to the previous quarter.

Another sector with an 18% share of GO is the finance, insurance, real estate, rental and leasing sector. In the second quarter, this sector grew at a 7.0% annualized rate in nominal terms, which is higher than the 6.7% increase in the first quarter 2017. The finance and insurance subsector, which accounts for 8% of total GO by itself, rose 11.1%.

Compared to the previous quarter, spending fell significantly in only two sectors. The largest drop of 4.8% is in the agriculture, forestry, fishing and hunting sector. The Construction sector was down 5.7%. The aforementioned non-durables sector and the accommodation and food services sector were virtually flat with no change to the previous quarter. These four sectors combined account for a 17% share of the total GO. Therefore, the negative performance of these few sectors had a noticeable impact on the overall GO growth.

The other surprise in 2nd quarter GO was the dramatic slowdown in wholesale and retail trade. Compared to Q1, total retail trade rose only 0.3% and the Wholesale trade actually fell a marginal 0.1%.

Total government spending (11% share of total GO) increased 2.9% in the second quarter. This growth rate is marginally lower than last quarter’s 3% growth rate. The federal government grew at an annualized rate of 2.2% in nominal terms and state and local government grew at a slightly higher rate of 3.2%.

GROSS OUTPUT

GO and GDP are “Top Line” and “Bottom Line” of National Accounting

Gross output (GO) and GDP are complementary statistics in national income accounting.  GO is an attempt to measure the “make” economy; i.e., total economic activity at all stages of production, similar to the “top line” (revenues/sales) of a financial accounting statement.  In April 2014, the BEA began to measure GO on a quarterly basis along with GDP.

Gross domestic product (GDP) is an attempt to measure the “use” economy, i.e., the value of finished goods and services ready to be used by consumers, business and government.  GDP is similar to the “bottom line” (gross profits) of an accounting statement, which determined the “value added” or the value of final use.

GO tends to be more sensitive to the business cycle, and more volatile, than GDP. During the financial crisis of 2008-09, GO fell much faster than GDP, and afterwards, recovered more quickly than GDP. Still, it wasn’t until late 2013 that GO fully recovered from its peak in 2007. The fact that the adjusted GO has continued to grow faster than GDP (most of the time) is a positive sign.

Business Spending (B2B) Grows Slower Than Consumer Spending

We have also created a new business-to-business (B2B) index based on GO data.  It measures all the business spending in the supply chain and new private capital investment.  Nominal B2B activity increased 2.6% to $23.67 trillion.  Meanwhile, consumer spending rose to $13.3 trillion in the second quarter, which is equivalent to a 3.5% annualized growth rate. In real terms, B2B activity rose at an annualized rate of 1.4% and consumer spending rose 2.5%.

GROSS OUTPUT

“B2B spending is a pretty good indicator of where the economy is headed, since it measures business spending along the entire supply chain,” stated Skousen.  “The fact that business activity has slowed down in the 2nd quarter is a bit surprising, given the pro-business legislation is that expected to become law soon.”

About GO and B2B Index

Skousen champions Gross Output as a more comprehensive measure of economic activity. “GDP leaves out the supply chain and business to business transactions in the production of intermediate inputs,” he notes. “That’s a big part of the economy.  GO includes B2B activity that is vital to the production process. No one should ignore what is going on in the supply chain of the economy.”

Skousen first introduced Gross Output as a macroeconomic tool in his work The Structure of Production (New York University Press, 1990). A new third edition was published in late 2015, and is now available on Amazon.

Click here: Structure of Production on Amazon

The BEA’s decision in 2014 to publish GO on a quarterly basis in its “GDP by Industry” data is a major achievement in national income accounting. GO is the first output statistic to be published on a quarterly basis since GDP was invented in the 1940s.

The BEA now defines GDP in terms of GO. GDP is defined as “valued added,” that is, “the value of the goods and services produced by the nation’s economy [GO] less the value of the goods and services used up in production (Intermediate Inputs or II].”  See definitions at https://www.bea.gov/newsreleases/industry/gdpindustry/gdpindnewsrelease.htm

With GO and GDP being produced on a timely basis, the federal government now offers a complete system of accounts. As Dale Jorgenson, Steve Landefeld, and William Nordhaus conclude in their book, A New Architecture for the U. S. National Accounts, “Gross output [GO] is the natural measure of the production sector, while net output [GDP] is appropriate as a measure of welfare. Both are required in a complete system of accounts.”

Skousen adds, “Gross Output and GDP are complementary aspects of the economy, but GO does a better job of measuring total economic activity and the business cycle, and demonstrates that business spending is more significant than consumer spending,” he says. “By using GO data, we see that consumer spending is actually only about a third of economic activity, not two-thirds that is often reported by the media. As the chart above demonstrates, business spending is in fact almost twice the size of consumer spending in the US economy.”

Note: Ned Piplovic assisted in providing technical data for this release.

For More Information

The GO data released by the BEA can be found at www.bea.gov under “Quarterly GDP by Industry.” Click on interactive tables “GDP by Industry” and go to “Gross Output by Industry.” Or go to this link directly: http://www.bea.gov/iTable/iTable.cfm?ReqID=51&step=1#reqid=51&step=3&isuri=1&5102=15

For more information on Gross Output (GO), the Skousen B2B Index, and their relationship to GDP, see the new website, www.grossoutput.com (still in development), as well as the following:

Mark Skousen, “GO Beyond GDP:  Introducing Gross Output as the Top Line in National Income Accounting,” presented as the 2017 Schumpeter Lecture in Stockholm, Sweden, sponsored by the Swedish Entrepreneurship Forum:  http://entreprenorskapsforum.se/wp-content/uploads/2017/10/PS_Skousen_web.pdf

Mark Skousen, “At Last, a Better Way to Economic Measure” lead editorial, Wall Street Journal, April 23, 2014: http://on.wsj.com/PsdoLM

Steve Forbes, Forbes Magazine (April 14, 2014): “New, Revolutionary Way To Measure The Economy Is Coming — Believe Me, This Is A Big Deal”:

http://www.forbes.com/sites/steveforbes/2014/03/26/this-may-save-the-economoy-from-keynesians-and-spend-happy-pols/

Mark Skousen, Forbes Magazine (December 16, 2013): “Beyond GDP: Get Ready For A New Way To Measure The Economy”:

http://www.forbes.com/sites/realspin/2013/11/29/beyond-gdp-get-ready-for-a-new-way-to-measure-the-economy/

Steve Hanke, Globe Asia (July 2014): “GO: J. M. Keynes Versus J.-B. Say,” http://www.cato.org/publications/commentary/go-jm-keynes-versus-j-b-say

David Ranson, “Output growth data that the economy generates months earlier than GDP,” Economic Watch, July 24, 2017.  HCWE, Inc. http://www.hcwe.com/guest/EW-0717.pdf

Mark Skousen, “Linking Austrian Economics to Keynesian Economics,” Journal of Private Enterprise, Winter, 2015:  http://journal.apee.org/index.php?title=Parte7_Journal_of_Private_Enterprise_vol_30_no_4.pdf

To interview Dr. Mark Skousen on this press release, contact him at mskousen@chapman.edu, or Ned Piplovic, Media Relations at skousenpub@gmail.com.

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[1] The BEA currently uses a limited measure of total sales of goods and services in the production process. Once products are fabricated and packaged at the manufacturing stage, the BEA’s GO only adds “net” sales at the wholesale and retail level. Its official GO for the 2017 2nd quarter is $33.2 trillion.  By including gross sales at the wholesale and retail level, the adjusted GO is $41.27 trillion in Q2 2017.  Thus, the BEA omits $7.8 trillion in business-to-business (B2B) transactions in its GO statistics.  We include them as a legitimate economic activity that should be accounted for in GO, which we call Adjusted GO.  See the new introduction to Mark Skousen, The Structure of Production, 3rd ed. (New York University Press, 2015), pp. xv-xvi.