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The Real 'Real' GDP

On Prostitutes, Drug Dealers & Economic Forecasters

by JACK RASMUS

This past Friday, May 30, 2014, the US government released its revised estimates for the first quarter 2014 US Gross Domestic Product.  The initial April estimate of GDP for the first quarter showed the US economy stagnating, at only a 0.1% growth rate.  Last week’s revised data showed, however, a significant further downward revision of first quarter GDP to a negative -1.0% growth, i.e. a contraction.

Politicians and analysts had initially forecast in April a slowing of GDP growth to around 1.2%. They then adjusted that in May to a slight -0.5% contraction of growth for the first quarter. But the -1.0% GDP revision last week was twice as bad as their consensus estimates.  Despite their missed forecasts, which initially explained that ‘bad weather’ was the cause behind the GDP decline, forecasters continue to insist that the -1.0% GDP contraction was due to bad weather during January-March 2014.

From Bad Metaphors to Bad Forecasting

When economists, pundits, and politicians can’t explain real causes—or wish to avoid bringing them to public light—they blame the weather.  But weather metaphors are an excuse, not an explanation.  If the bad weather were the cause of last week’s revised -1.0% GDP decline, then forecasters’ estimate of only a -0.5% drop in GDP would still leave a remaining -0.5% decline to be explained. But no explanation has been put forward to explain the additional -0.5% contraction.  How the economy can go from a 4% growth rate in the third quarter 2013 to a -1.0% barely three months later, a swing of 5% in a matter of a few m onths, has not been explained—except of course to blame it on ‘the weather’.

While weather might have been perhaps a minor factor in some east coast regions of the country, it was certainly not a factor nationwide. The bad weather metaphor approach to economic explanation also fails to explain why luxury retail sales, at Tiffany’s and other high end retailers, expanded at double digit rates throughout the bad weather months. Apparently the rich aren’t as deterred by weather from spending while middle Americas are. Buying milk at the grocery store is somehow postponed by bad weather, but buying diamonds and baubles at the jewelry store is not. Nor does ‘bad weather’ in January-February explain why a number of key economic indicators continued to decline in March and even April, when ‘bad weather’ was not a factor.  Somehow bad weather deterred home sales more than usual this past winter, even though home sales were declining well before, and have continued to do so after March 2014. Or ‘bad weather’ advocates argue that industrial production slowed in the winter because of the weather, when one would suspect bad weather would boost energy utilities’ output and industrial production during such weather. So much for bad weather forecasting.

A Non-Weather Explanation of Recent GDP

As far back as last November 2013 this writer was forewarning that the 4% growth rate of third quarter 2013 did not represent any real future growth trend; it was not indicative of any kind of sustained economic recovery. (see my ‘Economic False Positives: US GDP & Jobs Reports’, Counterpunch, November 11, 2013).

The growth in the third quarter was comprised in large part of business inventory investment bouncing back from low first half 2013 levels, on the one hand, and drive further at the same time by businesses moving up into the quarter inventory spending that would have otherwise occurred in early 2014. This latter shift occurred because businesses were anticipating—in  retrospect incorrectly—that consumer retail spending would surge in the holiday season in the fourth quarter.

For example, after contributing only .18 to GDP in the first half of 2013, inventories surged to .71 contribution to the third quarter 2013 total GDP gain. That’s almost three-fourths of the third quarter’s 4% GDP gain in July-September 2013. But the year end 2013 consumer sales surge businesses anticipated, and stocked up for, never happened.  Overall retail sales grew only 0.2% in December. Given no consumer response to the prior inventory buildup during the holidays, the contribution of inventories to fourth quarter GDP dropped to virtually zero.  Not surprising, business inventory spending thereafter contracted even more sharply in January-March 2014 once again.

But the January-March 2014 decline of -1.0% was due not only to slowing of business inventory investment. It was due even more to the slowing global economy and its related effect on US net exports.  Both US exports and business equipment investment also contracted sharply from the last quarter of 2013. An economic explanation for the -1.0% GDP fall would thus have to account for why both business inventory and business equipment investment declined and why exports weakened.  It would also have to take into account that consumer spending in the January-March period was itself due largely to a one time factor—i.e. a big increase in health care services spending as the Affordable Care Act took effect. Without this health care spending effect (which will not be a factor in the second quarter 2014), the -1.0% GDP decline would have been even worse.

The point is that none of these factors—the business inventory, business equipment, exports slowdown, or healthcare spending due to ACA—were particularly sensitive to ‘weather’, good or bad. What that in turn means is that forecasters’ ‘weather argument’, i.e. that good weather during April-June will mean a GDP ‘snap back’ growth of 3-4% once again (see the lead business page article, The New York Times, of May 30, 2014), is as absurd a prediction as the same forecasters’ original ‘bad weather’ argument was erroneous.

A non-weather metaphor explanation of the -1.0% GDP is: businesses overestimated households’ consumption recovery in the face of the latter’s continuing disposable income decline last year, a decline that has been occurring for five years now every year. Businesses overstocked inventory in late summer 2013 in anticipation of a holiday season retail sales surge that never occurred. They then responded by quickly reducing investment, both on inventory and business equipment. (This is a pattern, by the way, that has been evident at least three times in the US economy since 2009).

Simultaneous with the business inventory and equipment pull back, the global economy continued to slow over the winter, with particular problems emerging in China, Europe and Emerging Market economies.  These negative factors were temporarily dampened by consumer spending on healthcare in the first quarter 2014, on the ACA sign ups in particular. However, other areas of consumer spending slowed, as did residential construction and state-local government spending.

Going into the second quarter 2014, the consumer factor is weakened; the US dollar is rising in value and thereby threatening exports further, and business inventory and equipment spending will continue to slow until it becomes more clear that consumers are really spending again. The latter is not likely, however, given continued real disposable income decline for average consumer households, now in its fifth consecutive year. Meanwhile, and state-local government spending may be expected to continue to slow as well, continuing their trend of the first quarter, and no housing recovery is in sight after its slowing.

Without the ACA healthcare spending in the first quarter it is certain the -1.0% GDP decline would have been much greater.  But that -1.0% was an overestimation for other reasons as well.

1st Quarter GDP Even Worse Than -1.0%

First, included in it is the overestimation of GDP growth due to the redefinition of GDP that occurred last summer 2013.

A number of progressive economists have been pointing out that real investment in equipment has been in a long run declining trend in the US for at least since 2000.  That means a declining contribution of investment to GDP over the longer term.  This decline was recently ‘upward adjusted’ in part by US government in 2013 by redefining what constitutes investment.

As described in a previous article (‘Economic Recovery by Statistical Manipulation’, Counterpunch, July 31, 2013), effective beginning last year (and retroactively to prior years) the US now counts as business investment certain categories of what were once considered business ‘expenses’ and not investment. In addition to counting expenses as investment, businesses can also now put an arbitrary price on the value of certain ‘intangibles’, like copyrights, trademarks, patents and other such items, and now consider them business investment as well. In this manner, business investment appears larger than it actually is, and the long term trend decline is offset to some extent. Every GDP estimate therefore now has, all things equal, a higher business investment contribution to GDP than before.

It was recently estimated by the business  periodical, The Financial Times, March 12, 2014, that this redefinition adds about 3.6% to US GDP. On a $17 trillion US economy that amounts to about $600 billion a year. That’s not any actual new activity added to US growth, just an increase in growth by redefining it. Without this redefinition, the first quarter 2014 GDP decline of -1.0% would no doubt have experienced an even greater decline, to roughly around -1.3%.

Global Rush to Redefine GDP

The US changes in GDP represent just one of many such redefinitions designed to boost lagging GDP numbers in a number of countries in the past year. At one extreme is Nigeria’s recent redefinition, which effectively doubled its GDP to $510 billion annually overnight, making it the largest economy in Africa. China’s methods for estimating its GDP have for years been viewed with some doubt.  Most economists consider that around 1 to 1.5% of China’s GDP represents an overestimation for various reasons of definition and data gathering difficulties.  A number of other developing markets have similar problems with their GDP definitions.

Other redefinitions and changes have been occurring in the European Union, including east Europe, the Baltics, and even Austria. Most recently, however, are the economies of Italy and the United Kingdom, where economic recovery has been lagging for more than five years and where official double dip recessions and GDP growth rates of less than 1% have been the norm for most of the years.

As reported in the global Financial Times just last week, for example, both the UK and Italy are adding income from prostitution and from drug dealing to their GDP estimates. Britain estimates that prostitution services will add $17 billion to its GDP. That and other changes concerning drug dealing and other previously unaccounted for services will boost the UK GDP by 5%, according to the Financial Times of May 30, 2014.

Prostitution, Drug Dealing, and Future GDP Growth

Exactly how one would estimate the price of prostitution and gather the data on price and volume of activity for such critical services will no doubt prove interesting. Will UK statisticians go out and survey their 60,000 estimated prostitutes and drug dealers, as to how much they charge their ‘Johns’ and how much the dealers are ‘marking up’ their smuggled shipments of cocaine and heroin into the UK from offshore? Not likely. What they’ll probably do is simply ‘throw a statistical dart’ at the wall and cherry pick a price and volume of activity that suits them.

But that’s not all that different from a good many methods now for estimating GDP. For example, a good part of the Rent component in US GDP involves the assumption that homeowners pay themselves rent, which is then rolled up into GDP estimates.  Another assumes that quality improvements in smartphones are going up so fast that prices are actually going down.  You didn’t actually pay $800 for that iphone 5, in other words. Despite the charge on your credit card, it was really much less. And change your business logo, says it’s worth whatever you think, add it to your investment costs, and get a government investment tax credit for it while you’re at it.

Going forward, in the case of the UK and its newly accounted for prostitution drug dealing services, there will be the additional question of estimating how much the ‘prices’ for these services have actually risen every year in order to adjust to real GDP. Perhaps the bureaucrats will do a survey phone call instead of a direct interview? For certain the drug dealers will be glad to speak to a government official. Then there’s also the problem of quality changes affecting price for a prostitute’s ‘trick’ or a drug dealer’s ‘bag’ of goods. What constitutes a quality change, and therefore a reduction in inflation and subsequently a rise in real GDP? No doubt some bureaucrat in charge will simply ‘guestimate’ price, quality, and amount of activity to get to a real number to plug into UK GDP growth.

One can only speculate how much recently lost economic growth might be restored to the US economy, should the US in turn copy the UK by including prostitution and drug dealing. No doubt hundreds of billions, perhaps a trillion, might be added to US GDP growth estimates.  That’s even greater than including research & development expenses as ‘investment’.  The possibilities for further growth are limitless. The US could restructure college education curricula to reflect these new occupational opportunities of the future.  After all, ‘contingent’ labor is the new dominant labor market trend in the US. Adding curricula for these new GDP services couldn’t be any more obscene than training students for finance and how to create new forms of financial securities that end up in bankrupting cities and school districts, and destroying grandma’s 401k.

The US economy has been rapidly replacing real jobs in goods producing industries with service jobs for decades now. Only 12% of the economy now comprises goods production and less than 8% construction.  Service jobs have been replacing higher paid goods producing jobs for decades, followed in recent y ears by even lower paying service jobs replacing service jobs, as part time & temp service jobs with no benefits are becoming the new norm. At least prostitution and drug dealing pay well, one can set one’s own hours of work, and there’s enough income left maybe even to buy an Obama’s health insurance plan.

Jack Rasmus is the author of the book, ‘Obama’s Economy: Recovery for the Few’, Pluto Press, 2012, and ‘Epic Recession: Prelude to Global Depression, Pluto, 2010.  He hosts the weekly radio show, Alternative Visions, on the Progressive Radio Network. His blog is jackrasmus.com, his website www.kyklosproductions.com, and twitter handle @drjackrasmus.