Tuesday, May 6, 2014

At Last A Better Measure of Economic Growth

Pete recently got a new motorcycle – a real hum-dinger. He also got a new espresso machine. I asked him which one was better. He looked at me dumbfounded and told me I was an idiot. You can’t compare a motorcycle to an espresso machine.  Yet, the Wall Street Journal decided to publish an article on their Opinion Page (A15) on April 23 by Mark Skousen that essentially amounts to the same thing. Skousen compares apples and oranges and leaves us in a state of bewilderment wherein we now neither know what an apple or an orange is. Specially he says, “It (Global Output) is a better, more comprehensive measure of the nation’s economic activity than GDP, and a better indication of the economy’s growth prospects.” So my spout today is to explain why Skousen is both wrong and confusing.

The article is about an old economic concept that will now be published more regularly. The concept is called Gross Output (GO). There is nothing wrong with this concept. Just like an apple, it is a nice thing to have around. Actually, it is misnamed. It should be called Gross Sales. Why? Because it is a sales figure. GO is the sum of the sales of most companies in the country – those that produce raw materials, assemble units, manufacture goods, render services including those of retail and wholesale companies. GO is essentially the sum  of the sales of all those companies. It will now be published quarterly. I like that. 

Calling GO output, however is misleading.  Sales and output are not the same thing. This is easy to understand. Crotch Rocket Bicycles produced 100 bicycles this quarter. Unfortunately they forgot to hire a salesman and they sold no bicycles.  As a result, they produced 100, sold 0 and had inventory accumulation of 100. Or take the case of the whiskey producer Jim Daniels who had 1000 bottles in inventory. Jim Daniels then produced 700 bottles this quarter. Sales were 800.  So sales were 800, production was 700, and inventories declined by 100. Sales and Output are the not the same thing. If GO is sales then it should not go around calling itself output.

I know a guy who called himself Rocky for many years even though his name was Mike. No big deal. But in this case GO calling itself output is a problem because that word is reserved for GDP. GDP is output. GDP is not sales. So can I possibly be more obnoxious?

                          GO              GDP 
         Sales          Yes               No
        Output         NO              Yes

Why does any of this matter? It matters because apples are apples and they are not oranges. It helps to keep these things straight when you want to make apple juice or orange pie. GO is going to be published every quarter. It will tell us zip about output.
My above examples explain that the difference between sales and output has to do with changes in inventories:  (1) stuff produced this quarter that doesn’t get sold or (2) stuff produced in a previous quarter then sold this quarter.

GDP can rise in a given quarter only if we produce more. And by “we” I mean all the firms in the country whether they extract minerals, assemble cars, or sell insurance policies. Notice that GO, being a sales figure, can rise this quarter even if we didn’t produce more. GO rises because we sold more of current product or we sold more of past production.

Is GO better than GDP? Is sales better than output? The answer is no. Is a left brain better than a right brain? Is a car better than a blood transfusion? These things are mostly not comparable. GO and GDP are both products of measurement of a national economic system. They measure similar but different things. Having both of them published quarterly will be useful but clearly GO will not replace GDP. There is no sense comparing them.

Skousen says that GO is the better indication of a country’s growth prospects. He says it downplays the role of consumer spending in favor of business-to-business sales. Not true. Think of a value chain wherein
            Firm 1 digs up materials and sells them to Firm 2 for $50
            Firm 2 assembles the materials into a product and sells it to Firm 3 for $60
            Firm 3 paints the product and sells it to Firm 4 for $70
            Firm 4 sells the product to me for $80

Cool eh. Anyway, the value of the sales equals $50 +$60 + $70 + $80 = $260. This is the value of GO. What is the value of the total output? It is $80. You can calculate that as the value of the final product sold or you can sum the values of production added at each stage ($50 + $10 + $10 + $10). GDP is $80.

Even without any inventory complication, you can see that GO is much larger than GDP – it took $260 of sales to generate output of $80. You can see that they are both very different concepts or dimensions of a nation’s performance.

Why would GO be a better indicator than GDP? Because GO includes more lines of activity? I don’t think so. Think of bowling pins. The bowler aims at the front pin. If he hits it just right, he knocks over all 10 pins. The bowler doesn’t go to the bar and brag how each of the other 9 pins performed. He puffs up his chest and explains how he smacked that head pin just right!

The economy is the same. If you want to understand economic growth, you focus on cause and effect. All those intermediate sales are like those 9 pins – they just go along with something that started the chain reaction. The key to understanding the economy is not determined by how these intermediate sales react. The key to growth is how you get the chain reactions started. You don’t improve your game by finding ways to avoid the head pin and hit one of the others. 

Most macro policies aim at well-known driving variables. These usually focus on the end consumer or the firms that serve the end consumer. Macro policies rarely try to get Firm 2 to sell more to Firm 3 or to help Firm 3 to buy more paint. It makes no sense to focus on intermediate sales instead of sales to the final customer. Thus GDP and output are what we focus on if we want more growth, knowing full well that once we do the right thing a lot of things will be happening including a lot of intermediate sales.

So I say welcome to GO. Welcome to the quarterly macro indicators club. Having GO along side GDP may help us understand GDP even better. But let’s not waste our time wondering which one is better. GDP will remain the key gauge with or without GO. 


  1. Have you ever considered a career in economics?

  2. Dear LSD. Interesting that you include financial accounting principles in your examples of apples/oranges in ‘splaining economic activity—addressing sales and output and accurately saying sales and output are not the same since changes in inventory should be recognized in that context.

    Additionally—I think—to accurately gauge economic output—that profit should also be recognized. A simple example is that if goods are produced at a cost higher than what they are sold for (released from inventory) the enterprise will incur a loss.

    In your examples only output and sales are considered. If economic indicators at large do not address profit then they mislead—we as a nation could be producing, selling, and depleting inventory at a loss (excluding the service economy, of course). So, in the macro world, what indicators address profit—aka wealth creation founded on producing and selling at a profit?

    Would you not agree that profit—wealth creation via profit—would be a much better indicator than output and sales? Geese, is it possible we could hit 4%-5% growth at a loss—but that profit/wealth creation is inferred? If so, wherein/how does wealth creation occur? An inquiring mind wants to know.

    1. Good point Charles. Value added at each stage subtracts cost of inputs from sales -- meaning that profits are included at each stage of value added. This is interpreted as the return to capital. Thus the value of each firm's production includes the value of labor and capital....I don't think profits are a better indicator of output or future output. It all depends on that the firms do with that profit.

  3. Add a little squiggley thing to the bottom of the "O" and it becomes "GQ" which has about as much impact as GO.

    1. Actually, GO could be interesting and useful because it is a way at looking at the supply chain. GDP ignores all those intermediate sales. If something is going on along that chain then GO could add some information that GDP omits.

  4. Hello,

    I would like to obtain copyright permission on behalf of Professor Homer Erekson and the Texas Christian University to use one of your publications in the course: FINA 65003: Economic Environment of Business - Erekson (Spring 2015 - Session 1). Would you please review the request below? Thank you for your time and consideration.

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    Course: FINA 65003: Economic Environment of Business - Erekson (Spring 2015 - Session 1)
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    Title: At Last a Better Measure of Economic Growth
    Author: Larry Davidson
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    Date Published: 2014
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