The Economist June 11th 2022 Finance & economics 75A growthindustry
I
t is fashionablein some circles to lament the “cult of gross do
mestic product”. The pursuit of growth, this criticism goes,
blinds officials to less quantifiable but worthier objectives, be it a
contented population or a clean environment. For many econo
mists, the concern about gdpis very different. They see huge value
in the core mission of the measure: namely, to provide as timely
and accurate a snapshot of the state of the economy as possible, a
lodestar for governments setting policies and for companies mak
ing decisions. Their criticism instead is that gdpoccasionally
struggles to achieve this, and that better alternatives might exist.
This debate has again come to the fore in America because of
an unprecedented gap between gdpand its close relative, gross
domestic income (gdi). In theory the two ought to be aligned. gdp
tracks all expenditure in the economy, summing up the market
value of consumption, investment, government spending and net
exports in a specific period. gditracks the earnings associated
with that expenditure, summing up wages, profits and any other
income. In reality the two never match up perfectly, since the
longsuffering beancounters in statistical agencies must draw on
different sources, released at different times, to tot them up.
The gap between gdiand gdp(officially known as “the statisti
cal discrepancy”) is typically about 1%. Since late 2020, however,
the discrepancy has been much larger. In the first quarter of this
year America’s gdiwas fully 3.5% larger than its gdp. That is much
more than a rounding error. As Ben Harris and Neil Mehrotra of
the Treasury Department wrote on May 26th, when the latest gdi
data were released, it results in remarkably different pictures of
the economy. If gdpis the better reflection of reality, economic
output is still about 2% below its prepandemic trend. If gdiis ac
curate, the economy is 1.2% above trend, a far stronger recovery.
One approach to reconciling gdpand gdiis just to split the dif
ference. In 2015 the Council of Economic Advisers in Barack Oba
ma’s White House laid out the case for doing so, calling the average
the “gross domestic output” (gdo). The crucial point is that both
gdpand gdiderive from entirely independent gauges of output.
Combining them should, on average, reduce measurement errors.
Mr Obama’s advisers found that gdowas an excellent predictor of
later revisions to gdp. For instance, when gdogrowth is half a percentage point faster than gdpgrowth, it is associated with a subse
quent upward revision to gdpgrowth by roughly half a percentage
point. This observation is slowly creeping into mainstream think
ing. The Bureau of Economic Analysis has started publishing the
simple average of gdpand gdi, though few journalists or analysts
bother to mention it in their reports.
Accounting for the huge discrepancy at present is somewhat
trickier. A useful starting point is the observation that the gdigdp
gap opened up at the height of the covid19 pandemic as the gov
ernment’s stimulus flowed into the economy. The sudden infu
sion of cash through transfers to households and loans to busi
nesses appears to have messed up conventional measures of eco
nomic activity. Corporate profits have been uncharacteristically
strong, explaining the vigour in gdi. In principle that should have
been mirrored in much more robust gdpreadings, too.
Matthew Klein, the author of “The Overshoot”, an economics
newsletter (and who worked at The Economist a decade ago), reck
ons that an undercounting of business investment in gdpmay be
the most likely cause. Statisticians have struggled to keep tabs on
all the newfangled ways that companies spend money, from soft
ware to cloud computing. During the pandemic entire business
models were upended to accommodate online shopping and re
mote working; it stands to reason that investment data may have
failed to capture such spending.
Another possibility, running in the opposite direction, is that
incomes have been overstated. Some people and even businesses
may have mistakenly inflated their incomes, at least in a statisti
cal sense. Dean Baker of the Centre for Economic and Policy Re
search, a leftleaning thinktank, noted back in 2011 that there was
a correlation between asset bubbles and gdi. When the stock
market soars, as it did during much of 2020 and 2021, gdi tends to
outstrip gdp. Capital gains are not supposed to count as income in
gdpcalculations, as they reflect the prices of existing assets rather
than production of new ones. But the pattern suggests that people
sometimes may misreport capital gains as ordinary income.Nerds to the rescue
The uncertainty about whether to blame the discrepancy on
undercounted business investment or overstated income does
seem to argue in favour of the simple gdigdpaverage as a mea
sure of economic output. That, however, is not entirely satisfac
tory. In a paper in 2010, Jeremy Nalewaik, then an economist with
the Federal Reserve, showed that gdiwas generally closer to the
mark than gdpin registering fluctuations in the business cycle. It
did a better job of documenting the true extent of the downturn in
200709. Moreover, its outperformance relative to gdpover the
past two years is also more consistent with the runup in inflation.
Policymakers who had paid more attention to gdi may have be
come more concerned sooner about economic overheating.
Frustratingly, initial gdiestimates come out a month after the
first gdpfigures. But researchers are on the case. In a paper pub
lished in January by the Cleveland Fed, economists pulled togeth
er gdp, gdiand a basket of monthly indicators such as the unem
ployment rate and average hours worked in manufacturing. The
result, they hope, is something closer to “true gdp” that can be up
dated on a monthly basis. Encouragingly, it performed well in doc
umenting the recovery from the pandemic. If it proves itself over
time, it will be one more in a dizzying array of indicatorstokeep
track of. But the message is clear: a focus on conventionalgdp
alone is unduly restrictive at best, and misleading at worst.nFree exchange
America’s recovery may be stronger than its gdpimplies