GDP is Wasted on Me

In an increasingly globalized economy I find it absurd that GDP is still the primary commercially and academically accepted measure of growth in the United States.  For those who think GDP and GNP are just confusing acronyms, see the variety of short definitions and comparisons below as the nuance between the two is impotant.

Gross domestic product (GDP). The market value of goods and services produced by labor and property in the United States, regardless of nationality; GDP replaced gross national product (GNP) as the primary measure of U.S. production in 1991. (http://www.bea.gov)

Gross national product (GNP). The market value of goods and services produced by labor and property supplied by U.S. residents, regardless of where they are located. It was used as the primary measure of U.S. production prior to 1991, when it was replaced by gross domestic product (GDP). (http://www.bea.gov)

Or consider this simple side by side comparison of the differences between GDP and GNP.

GDP vs GNP (Source: http://www.diffen.com/difference/GDP_vs_GNP)

Or for a short lesson on the differences watch this video:

If the Bureau of Economic Analysis (an agency of the U.S. Department of Commerce) is correct, it is ironic that GDP was replaced by GNP at just about the time that the US corporations began systematically off-shoring production and systematically began penetrating global markets with a vengance.

Today US manufacturing industries are in systemic decline, as are most unskilled jobs that don’t require a US presence.  The off-shoring of entire industries and the loss of US competitiveness in many sectors has created what I believe will become a structurally higher full employment rate.  Said another way, an unemployment rate of four to five percent (half of today’s rate and emblematic of full employment)  is most likely never going to return unless the data is manipulated.  Some may recall that president G.W. Bush reclassified fast food workers assembling burgers as manufacturing jobs sometime after 9/11 to help “spur” a recovery.  Our old paradigm of full employment is over, and structurally it is going to only get worse over the next 10-15 years as baby boomers of retirement age choose to work longer than planned to meet retirement goals, and extend their retirement benefits.

A current look at home prices in Detroit Michigan offers a good perspective on the result of loosing entire industries.  Today you can buy a house in Detroit for $5,000.  If you don’t believe me go to zillo.com.  You will find dozens if not hundreds or even thousands of house selling for less than the price of the roof just to eliminate the homeowner’s burden of paying annual property taxes because so many jobs have abruptly and permanently been eliminated.

With US jobs leaving the country and never returning, and US corporations continuing to obtain global competitive advantages in labor, natural resources and technology, I cannot understand why anyone still really cares about GDP as a measure of long term growth trends for the US economy.  The old adage is that US corporations cannot grow any faster over the long-run than the underlying economy.  At some point soon, the new parading will eventually become clear which is that US multinationals WILL be able to grow at a faster rate than the US economy because they are increasingly linked to other economies with much higher growth forecasts than in the US. Consider the data from 2008 to 2012.  Click to link to the Worldbank data page.

The global outlook in summary, 2008-2012 (Source: http://web.worldbank.org)

In fact that is exactly what US multinationals have been planning to do for the last 20 years when they first realized that US growth would eventually and permanently slow down as the country’s economy finally matured, much like has happened in Europe where unemployment has remained well above US rates for many years.  US corporations in pursuit of profits and who have adequately structured their businesses to capitalize on high GDP growth rates around the world will be producing goods and services, many of which may never even be consumed in the US. The widely cited “New Normal” speaks of structurally slow US growth for the foreseeable future where growth is generally defined as economic activity and the creation of new jobs.  I suggest that this may be correct, but it is at best misleading.  Despite slow US GDP growth I suggest that this paradigm ignores significant increases in GNP and the potential for significant upswings in corporate earnings at US multinational corporations.

Americans who have hated big business, bailouts and the continued bifurcation of social classes are in for an alarming shock when they begin to realize that the largest US corporations and their executives will be able to increase profits and all of the metrics that drive executive compensation while large swaths of their companies continue to lose their jobs or remain unemployed.  Great recessions give tightly managed firms an amazing excuse to cut “excess”, where “excess” can be defined as jobs that may have been harder or more costly to eliminate during periods of good economic activity.  This “opportunity” to trim and remain lean is not a cyclical process anymore.  The world has become too interconnected, and the fact that a Ford car sold in the US could have any variety of parts casted, assembled and finished in a variety of countries gives Ford (and US consumers) privileged access to advantages available in other countries.  In return for these advantages, presumably the finished Ford car is cheaper for the consumer at home.  However with US household incomes cut, waning or no better than flat over the last few years, fewer cars are demanded, and therefore consumed at home.  Thus, more and more of US corporate profits will originate and culminate and settle outside of the US.

As a tangent, one “solution” which has been unpopular under the current administration would be to allow US companies a tax holiday to repatriate profits from overseas.  The word “solution” is euphemistic as there is no guarantee that those profits would be used to create American jobs, however therein lies a great policy idea.  Allow a tax holiday for US companies if they choose to use those proceeds to create American jobs.  This might be a bipartisan win on Capitol Hill, but I freely admit a politician I am not.

Most of us know that the stock market and the real economy don’t dance in the same time. Or in simpler terms they don’t always move in the same direction.  If I used recent stock market performance as my benchmark I would be inclined to think that US growth is on the verge of picking up dramatically. Conversely if I took the March 2009 stock market lows at face value, I would have thought the real economy was about to have the bottom fall out (far worse than it did).  I say this with full sensitivity to the many thousands of unemployed Americans, and the length of time many of them have been looking for work.

The stock market is by definition a measure of future corporate profits and is normally considered to be a leading indicator.  Alternatively GDP is generally a lagging indicator, reporting on recent but nonetheless past economic activity.  The stock market recovery since the March 2009 lows, as of November 5th 2010 has proven to be more of a V-shaped recovery while the rebound in domestic economic activity seems to be following a U-shaped recovery with unemployment at sustained high levels, and overall GDP growth muted in comparison to past recoveries.

If GDP is a sign of economic recovery and we are in a U shaped pattern, how can the stock market be moving so dramatically upwards?  Occam’s Razor might lead me to believe that the stock market cares less about GDP and more about US corporate earnings which will be linked more directly to GNP in the “New Normal”.

Curiously I looked into the historical relationship between GDP and GNP.  The chart below was developed from data at FRED (Federal Reserve Bank of St. Louis).  In it I plotted the difference in % terms of GDP to GNP.  When the number is lower (towards -1.2%) then GDP was lower than GDP by 1.2%.  When the number approached 0%, then GDP and GNP were approaching parity (the same values).  None of the data was normalized for current 2010 USD values which should not affect the relationship between the two sets of data.  It is interesting to note that the only other period that looked like this one, back to the Great Depression was recession and following inflationary period in the late 1970’s.  I would argue that our newly globalized economy should create a more dramatic rift between GDP and GNP, particularly if “decoupling” really begins to take foot.  If that were to happen, -1.2% would no longer be the bottom of this cycle, and noone would know how far GDP and GNP would need to diverge before narrowing again.  One thing that did come to mind looking at this chart is that it might be an indicator of secular bull and bear markets. While there are not enough trends to base this on it is interesting to consider.  However if one were to consider this as an indicator for such trends in stock markets, it would be important to note that the secular bear market during the depression saw GDP gaining on GNP vs. today’s relationship where GDP is losing ground to GNP in the current secular bear market.

Click to enlarge.  (Wish all things were that easy!)

GDP Expressed as a % Difference of GNP

Be careful of pundits who us GDP as a fear mongering tool much like they did with terrorism to keep us believing that the world will be forever ailed.  GDP will not recover to the “trend growth” we are used to without severe manipulation and it will be used to pace blame and misplace blame on Capitol Hill.  Most of the uses of GDP will simply be misleading as they are today.  GNP will be, at the very least, a better indicator on which to base meaningful investment decisions.

By the way, I’m not the only one who feels this way.  In this video Joseph Stiglitz offers a number of other failures in the use of GDP as our most common metric to include political misuse, lack of accounting for the use of natural resources, and the consequential, adverse, and often hidden effects of over-focusing on GDP as a measure of national economic prosperity and success.  Joseph Stiglitz – Problems with GDP as an Economic Barometer

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