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.