“How can I possibly put a new idea into your heads, if I do not first remove your delusions?” – Robert Heinlein
For several years now, I have been advocated the need for adding a new national aggregate statistic called Gross Output (GO) that measures total spending at all stages of production and not just the final stage (GDP).
I believe that GO fills in a major piece of the macroeconomic puzzle. It establishes the proper balance between production and consumption, between the “make” and the “use” economy, and one that is consistent with growth theory.
Most importantly, GO and my 4-stage model of the economy are compatible with standard national income accounting and neo-classical macroeconomic analysis. You don’t have to rewrite the textbooks, just add it into the chapters.
Now for the good news. I recently received a letter from Steven Landefeld, the director of the Bureau of Economic Analysis (BEA), the official government agency that releases GDP data every quarter. He wrote me that starting next year, the BEA will begin publishing an expanded aggregate statistic that is similar to my own GO, every quarter along with GDP.
This letter confirms that the BEA recognizes the need for a more comprehensive measure of economic activity and will be reporting this new aggregate (called Gross Output) in addition to the quarterly reports on GDP.
What’s Missing in GDP?
Here’s why GDP is proving to be insufficient as “the” national income statistic: By focusing exclusively on final output, GDP measures only finished goods and services, what economists call the “use” economy. In limiting itself to final output only, GDP largely ignores or downplays the “make” economy, that is, the supply chain and intermediate stages of production required to produce all the finished goods and services.
This narrow focus of GDP has created much mischief in the media, government policy, and boardroom decision-making. For example, journalists are constantly overemphasizing consumer and government spending as the driving force behind the economy, rather than saving, business investment, and technological advances. They note that consumer spending is by far the biggest part of GDP, followed by government. Private investment is a distant third. Consequently, reporters in the Wall Street Journal, the New York Times and other media are constantly making misleading statements such as, “Consumer spending represents 70% of the economy and therefore is the main driver behind economic growth,” or “cutbacks in government spending were a drag on the economy.”
Yet if you look at the 10 Leading Economic Indicators put out monthly by the Conference Board, retail spending and government outlays are not leading indicators for any of the 13 countries the Conference Board covers, while data in earlier production stages (such as manufacturing orders, capital goods, or building permits) are prominent.
To remedy this defect, I have created Gross Output (GO), a measure of total spending at all stages of production in one year. GO estimates gross spending patterns in intermediate production (goods-in-process or the “make” economy) and final output (the “use” economy). I draw from “gross business receipts” data collected annually from the IRS.
GO is a real eye-opener. It turns out that the “make” economy (GO) is more than twice the size of the “use” economy (GDP) and is 3-4 times more volatile over the business cycle. It demonstrates that business investment (the supply side of the economy) is much bigger than consumer spending (the demand side of the economy), thus dispelling the notion that consumer spending is the main driver of economic growth. Consumer spending turns out to represent only about 30% of total economic activity (GO), not 70% as constantly reported.
Introducing a 4-stage Model of the Economy
To illustrate the “make” economy, I have developed below a “general” 4-stage diagram of the economy. It is a universal model of the production process of all goods and services, and provides the essential balance between the “make” economy and the “use” economy. It’s a simple but powerful diagram that students can easily grasp.
The following working paper summarizes the latest data and how the 4-stage model and GO can be incorporated into the standard neo-classical model and national income account in the textbooks.
I have incorporated this 4-stage macro model and GO into my own textbook, Economic Logic — the new 5th edition has just been released by Capital Press. It retails for $48.95, but if you go to SkousenBooks, you pay only $35 with free shipping in the U.S.
In conclusion, GO should be the starting point for measuring aggregate spending in the economy. It complements GDP and can easily be incorporated in standard national income accounting, growth theory, and macroeconomic analysis.I am giving a series of lectures the 4-stage macro model and GO at Chapman University and several other institutions over the next few months. I am also leading a panel on GO and Economic Logic at the next APEE meetings (www.apee.org). Any comments you have on this new development would be much appreciated.