Gross Domestic Product or GDP is one of the most talked about economic indicators. You might have heard about growth rates or projections for GDP on TV, the radio, or podcasts like this one. You might have also heard about GDP in reference to previous recessions or periods of high economic growth.
But what is GDP, exactly? How is it measured? And is it actually a good tool for looking at how well, or badly, an economy is doing?
In this episode of Fiscally Savage, hear what GDP measures, how it’s calculated, whether or not it’s a good indicator of standard of living, and whether or not we should actually care about it.
- [03:10] What is GDP?
- [05:45] The standard formula for GDP
- [06:05] What is the consumption component of the GDP?
- [07:19] What is the government spending component of the GDP?
- [09:10] Why political parties may sometimes want to cut government spending
- [10:40] What is the private investment component of the GDP?
- [11:48] What is the net exports component of the GDP?
- [14:06] On the impact of the news on customer sentiment
- [15:13] Economic activities that are not included in the GDP
- [18:49] How oil and gas exports affect the United States’ GDP
- [21:34] Why Dylan doesn’t think the GDP is a good measure of economic performance
- [26:23] Why does GDP matter?
- [27:32] Closing statements
[00:00:00] Intro: Forget the civilized path. It’s time to break the chains of debt and dependency, take control of our financial lives, and live free. This is the Fiscally Savage Podcast.
[00:00:15] Dylan Bain: Hello and welcome to Fiscally Savage. I’m your host, Dylan Bain. Welcome to our Friday show where we do something a little bit different from what we do on Tuesdays, which is we take something that’s in the news and try to go one layer deeper. And today, I wanna talk about GDP.
[00:00:30] When the Q2 numbers for GDP came out, the US economy had shown two consecutive quarters of negative GDP growth. And there were a lot of people who started immediately talking about recessions. Recessions, if you were to pop open an economics textbook, are defined in that textbook as two consecutive quarters of negative GDP growth. Now, I’ve done an entire episode talking about why that’s not actually a great measure of a recession and why the textbook, like most textbooks, is correct but also not at the same time because those definitions used in the textbooks are for a classroom setting that are completely devoid of all the nuance that actually is in something like, I don’t know, the US economy.
[00:01:17] So the latest GDP numbers that have come out for Q3 shows that the economy grew at 2.6%. Now, whenever you see these numbers, whether it’s inflation, whether it’s GDP growth, those numbers are at an annual growth rate. That is to say that if we looked at what happened in this quarter and then were to take that and expand it over the entire year — so for four quarters — the number you’d come up with is 2.6. Not that the economy grew 2.6% in that quarter. But if we were to expand that out for an entire year, it would’ve grown 2.6% during that time period. And, again, just like two consecutive quarters of negative growth doesn’t mean that there’s actually a recession because a better measure to examine a recession is to look at depth, diffusion, and duration. That is, how deep the recession goes in terms of GDP contraction, how diffused it is across the entire economy, and the duration in which you have those things.
[00:02:15] And in the same way that just a straight GDP number is not really great for measuring a recession, it’s not really great for measuring a boom time either. And we’re gonna get into that here in just a little bit. But I think the first question we actually have to ask is, what is GDP? I think we kind of take it for granted just simply because the second you become interested in finances or the economy at all, you’re gonna run into this GDP number. And we all then run over to Wikipedia, we read the article, or we listen to a podcast very much like this one where they just continue to throw that number around as if it’s apparent or they give you a hyper-technical definition where we all can feel smart for about five seconds, but at the end of the day, we really don’t know anything. So my goal today is to try to demystify GDP and to expand our understanding of it. I also wanna discuss whether or not it’s a good measure of the economy and whether or not we should actually care.
[00:03:10] So let’s just start with gross domestic product. What is gross domestic product, also known as GDP? Well, putting it bluntly, you can kind of think about it like a national income or a measure of all the goods and services that are bought and sold across an economy over a given period of time. Now, the first thing that we should do is we should talk about what is considered the goods and the services and then what is considered an economy. The goods and services here, ladies and gentlemen, are the end products of any particular type of thing, okay? So when you think about it, if you think about a refrigerator, the refrigerator’s going to have a whole lot of different things that are produced, both goods and services that are produced, to get that product to the end product. And if I were to count the steel production, the steel manufacturing when it turns into parts, the assembly of the parts, the transportation of all those parts, I would be double-counting every single piece of that process along the way. So intermediate goods are not included in this. It’s the finished products of the goods and services. And services are counted in the same way. Intermediate services are not considered an end product. So it’s only the final bits that are actually considered as goods and services.
[00:04:27] And what’s defined in an economy, well, pick your poison. We can talk about GDP in the global economy. We can talk about GDP in your local city economy. We can talk about GDP for an individual state within the United States or the United States as a whole. Or we can break it out into North America. In this particular case, we’re talking about the US as a nation and the US economy when we talk about GDP. I could do an entire episode on looking at the GDP of individual divisions within the United States. You know, for example, juxtaposing something like California against Alabama. And maybe I’ll do that in the future, but today’s not that day.
[00:05:02] Now, once we understand what we’re measuring with GDP, the real question is, okay, but then how do we measure it? Because that seems like an awful lot. And you’d be right. But it turns out, we’ve been measuring GDP for decades at this point, almost a hundred years if we’re actually gonna go back to when we first started using it. There is an argument to be made that part of the reason the United States, from a production and support standpointm were so crucial to the First and Second World Wars was because the United States had an ability to measure its economy and be able to make sure it didn’t overheat or underproduce in both of those conflicts. And we still use these same measurement tools that they used back then today.
[00:05:45] Now, we’re gonna get into when we talk about “Is this a good measure?” when we get there. But let’s just talk about the standard formula. The standard formula for GDP is to look at consumption plus government spending plus private investment plus net exports. Okay. So what is each one of those pieces?
[00:06:05] Okay. What is consumption? Well, consumption is the consumption on a private basis — so that is individual citizens and entities, so that includes corporations — of goods and services. Again, these are the end product goods and services. So for example, if you go to the grocery store and you buy a can of beans, that is considered consumption in terms of GDP. The actual metal that went into producing the can of beans is not considered as part of the GDP. Same thing applies that if you decide to hire somebody to cut your lawn, that would be an end product in that chain and, therefore, the sale of their services would be considered part of GDP. The consumption component of GDP makes up about 68.2% of the total GDP number, which means that consumption is far and away the biggest driver of US GDP and the most important component of US GDP. This is why, ladies and gentlemen, things like consumer sentiment are so important. And if you’re listening to an economic show on whatever medium you decide to listen to it on — TV, radio, podcast, etc. — you’re going to hear them talk about consumer sentiment because it drives so much of the economy.
[00:07:19] Let’s talk about that second piece, which is government spending. And it is exactly as it sounds. Now, government spending accounts for about 14.2% of total GDP in the United States. And the government spending is spending on the military, spending on services, spending on public schools. Whatever you think the government is doing with their budgets and this includes local, state, counties, and the federal government. All of that gets lumped into government spending in the economy. And so, right now, we’re running at about 14.2% of total GDP in the United States. But it’s worth noting because you hear this, and this is, oh my gosh, this is one of these political footballs, right? “Government spending’s too high,” “government spending’s not enough,” “government spending is not the right places,” “the government’s bloated,” “the government’s anemic.” Man, we could be here all day. But the greatest part for me when I’m looking at any type of economic data is that it’s data. I can just go look it up. Is government spending as a share of GDP just completely out of control? Well, I don’t know. We could actually debate that. But in terms of the numbers, it’s currently running at 14.2% versus it was above 16% for most of the period between 1952 and 1992. So for that 40-year time span, the average amount of government spending as a share of GDP was much higher than the period that was immediately after it. And we could debate whether this is good or bad. I am presenting a fact. The share of GDP that is taken up by government spending has decreased over my lifetime. Now, of course, it goes up and it goes down. When you do things like invade Afghanistan, have an international pandemic, fighting the Cold War, not fighting the Cold War, these will all influence government spending as a share of GDP.
[00:09:10] This also brings in kind of an interesting point as kind of an aside. Have you ever wondered why certain political parties want to cut government spending when they’re out of power, but when they’re in power, they seem to ignore it? Well, that’s because this component is a direct contributor to the GDP calculation. That’s right, ladies and gentlemen. If you cut a bunch of government spending, you directly hit GDP in a negative fashion. And so, it’s worth considering that part of the political game that we all have to be subject to here in the United States, especially around government spending, has this as one of the major reasons why certain political parties will advocate spending more or less at different times. And ladies and gentlemen, one of the things that I think that we need to acknowledge here is that when the government’s spending, it’s spending into the US economy. That might crowd out private companies, but it’s still contributing to GDP because when the government is spending money, they’re handing it to people in the United States who then go and will spend it in the local economies. This is, of course, not including things like foreign assistance, foreign aid, and foreign military support. But like I said, this could be infinitely nuanced. I’m just trying to present some facts. And if you’re hearing me plug a certain political party versus another one, let me just be a hundred percent clear. There are no innocents in this game. Both parties in the United States are completely guilty of this on every single level.
[00:10:40] Moving on, let’s talk about investment. And investment, in this particular case, it’s a little bit nuanced because when I say “investment,” the average person on the street is going to hear “buying stocks and bonds.” And that’s not at all what the investment piece of this is talking about. What the investment part is talking about is spending by private entities — so, in this case, corporations — on capital goods: inventories, housing, real estate, etc. So this type of investment, if you’re sitting in a community and you see a new office building going up, that’s considered the investment part of this. It’s a capital good. It’s a place where we’re going to use that to make money. Installation of factories, upgrading new equipment, new software — all of that is considered the investment component. So in my professional life, I work within a large corporation. We are bringing out a ton of new software. That is considered investment. It’s the end product that we are purchasing to bring on to manage our business. As investment goes up, we would expect GDP to go up because we’re putting money into the economy with the intention of using that to make more money.
[00:11:48] So where consumption is 68.2% and government spending is 14.2%, the investment part of the economy is 22%. And if you’re following along at home, you’ll notice that this all adds up so far to 104.4%. This is where the last component of GDP comes in. Net exports. Because net exports are, in fact, negative. How do you calculate net exports? Well, you take all the exports we have in the economy minus everything we’ve imported, that gives you net exports, which is about a negative 4.4%. The other way that you hear this a lot when you’re listening to the radio or a podcast or, you know, to the TV is, this is what’s known as the “trade gap” or the “trade deficit.” That is to say, we import far more than we actually export. And even then, this is actually not a great way to measure this because the United States, in terms of total exports into the global economy, is in the top five. We export almost as much now as we did back in the 1970s. We just do it radically different with a heck of a lot less people. And so, what then, of course, is the difference that creates a trade gap? Well, we import a lot more, and that’s exactly where this has gone. But tracking net imports is actually something that you can do to predict what consumer sentiment’s going to be. Remember when we go back to that consumption piece, consumption is based upon people spending into an economy. Well, if you’re buying on Amazon, chances are good you’re buying stuff that’s imported from overseas. So therefore, if you start seeing net exports starting to change, it’s telling you that something globally is occurring that may or may not actually be hitting GDP.
[00:13:37] So again, GDP is consumption plus government spending plus investment plus net exports, which is exports minus imports. And it’s important, I think, to be able to understand that each one of these sections of the economy is monitored by different parts of people, like the Federal Reserve. There’s a ton of economic think tanks, and universities have different ways of measuring this. But at the end of the day, the Fed is the one who typically is collecting and aggregating the data.
[00:14:06] And we can infinitely dissect each and every single one of these both in terms of how much money is flowing into it and what the trends are over time and what type of events in the economy is going to change that number. Consumption, of course, being the biggest piece, the consumer sentiment index is really important because it’s such a huge bit. Well, what starts to actually impact customer sentiment? Well, the news. And so, if you stop and think about it, part of all the doom and gloom can actually trigger a recession or trigger negative GDP growth simply by making people afraid, which would then have them hold onto their cash, which, of course, would drive down customer sentiment. Part of the political game, kind of going back to the government spending type of thing, is if one political party can paint everything as absolutely terrible, they can actually depress GDP consumption. It’s one of these things that in economic circles is debated as to how much this effect would have. But I can tell you anecdotally and know that it has an effect on my family and a lot of the people I spend time with.
[00:15:13] Let’s also have a moment just to talk about what’s not actually included in the gross domestic product. For example, unpaid work. And in this particular case, I’m specifically thinking about stay-at-home parents. Stay-at-home parents, most often it’s a stay-at-home mom, they’re considered not part of GDP but the economic benefit that they are adding into the economy is massive. And if you stop and think about all of the avoided costs that a stay-at-home parent is actually going to contribute to the economy, this is a material element to the economic engine. But it’s not measured or tracked. And so, we’re missing a big part of how the economy’s actually functioning with this unpaid work. And it’s not just stay-at-home parents. It’s also people who don’t work so they can care for relatives. I myself have aging parents, and I’ve also had to have the conversation between myself, my parents, my brother of what will happen if they need assistance on a 24-hour basis.
[00:16:12] Other things that are not included here are the barter economy or non-monetary compensation, okay? And you can read into that, however you think about. But I do trade certain goods for other goods just simply because I can purchase them cheaper or I have access to them. And, of course, I could have a bunch of anecdotal stories from back in the day when my home state of Wisconsin banned margarine sales when people would go across the border in Illinois and bring the margarine back and they would actually trade it for other goods. This is an example of non-monetary or barter compensation.
[00:16:47] Also, goods not for sale. So for example, in my backyard, I have a garden. And when I produce tomatoes and I make tomato sauce and I have a jar of tomato sauce that required inputs, I have a finished product. If I were to sell it, it would be part of GDP. But the fact that it’s for my own consumption, it’s not considered a product of the United States because it doesn’t have a monetary value.
[00:17:10] Which then brings us to things like transfer payments. So money changing hands in a transfer basis. For example, if I transfer money from my savings account to my checking account, that’s not included. Or if I’m deciding that I want to spot, say, my dad a couple of bucks, I transfer money from myself to him, or he’s doing the same for me, from him to myself, those transfer payments are not considered part of GDP.
[00:17:36] Black market, illegal activities, sale of used goods — none of those things are considered part of the GDP because they’re either illegal — they’re not something we are willing to acknowledge as part of the economy — or we’ve already counted them in the case of used goods. Used goods and intermediate goods operate the same way here. If I go sell my car, it’s a used car. We counted that in GDP when I sold it the first time, so I don’t get to double dip on selling used goods.
[00:18:04] And again, ladies and gentlemen, consumption is far and away the biggest driver of GDP. And so, that’s the piece that’s most important to keep track of here. And when you start thinking about that, the government spending component, so when you think about the federal bureaucracy, if we were to cut government spending, it’s going to hit consumption. Those two things are linked. And then, of course, that’s gonna hit investment because consumption has gone down, so there’s less people to sell to. Every one of these components is tied. And the one that we look at the most is the consumption piece. But it’s really important for us to understand that the economy is not a segregated, compartmentalized system. It is a unified whole that operates in unison with itself.
[00:18:49] So let’s just go back to the current economic situation. We know that we’ve had two quarters of negative GDP growth. And then, suddenly in this quarter, we’ve had positive GDP growth. So what gives? Well, the answer is, as always, kind of nuanced. The biggest contributing factor to our GDP growth right now is gas and oil exports. And gas, of course, in this particular case, is natural gas. We’re not talking about gasoline. Why are we importing so much oil and gas from the United States to other places? Well, because currently, Russia has invaded Ukraine. And because of that, Russia has shut off its gas deliveries and oil deliveries to Europe. And we are supporting our ally in that way and, of course, making a tidy profit along the way. Which, of course, is then increasing the exports in that net exports number, which means that it’s not nearly as negative as it normally would be, which is a boost to GDP. Those oil and gas exports are basically the entire thing of the growth right now.
[00:19:53] And that’s really important to understand because that’s not going to last forever. At some point, Europe is either gonna figure out their oil and gas issue — Russia is going to leave Ukraine and everyone’s gonna sing Kumbaya, and then the gas will continue to flow into Europe — or some other unforeseen effect will then tilt the balance in that economy. I can never predict the future, ladies and gentlemen, but I can tell you that at some point, we’re not going to continue the oil and gas exports to Europe just simply because it’s far more expensive for them.
[00:20:23] And so, when you strip out the oil and gas exports out of the most recent GDP report, what you start to see pretty clearly is that the economy was mostly flat. Yeah, we have this export boost, but it’s going to be temporary. The other takeaway with this is that consumer sentiment and consumer spending is still very strong. Even though it’s starting to deteriorate, even though it’s starting to slow down, it’s still strong. And that’s the biggest part of the GDP numbers. Why is consumer spending so strong? Well, it’s a byproduct of a strong labor market, and that strong labor market is pandemic-induced. We can debate all day, ladies and gentlemen, about whether or not the pandemic was as big of a deal, whether or not it actually was plotted out in smoke-filled backrooms, but its effects are very real. And one of those effects is our labor force in the United States has taken a huge hit. Less people, supply and demand, means the labor market for, at least for now, is pretty strong. Wages have continued to increase. And as wages increase, so does — guess what? — consumer spending. So so long as that’s holding out, our GDP numbers will probably be relatively flat.
[00:21:34] So is GDP a good measure? Well, I mean, there are plenty of economists who would debate me, but I’m gonna say no. GDP is a measure and it’s a pretty blunt measure. And at the time in which GDP was developed as a measurement of the economy, it was cutting edge. Unfortunately, for that measure, lots has changed. So the first reason I say that GDP is not a great measure is because the GDP pie is not evenly distributed. Let me give you an example, ladies and gentlemen. Let’s say that we have 10 people sitting at a table and there is one cookie on the table. Now, we can say that, on average, everyone has a 10th of a cookie. Now, we say, well, we want our cookie standards to be able to increase, so we work really, really hard. And now, there’s 10 people sitting at the table and there are 10 cookies at the table. So we went from a cookie standard in which everybody had a one-tenth of a cookie to, on average, everyone having one whole cookie. That’s great if that’s actually how it’s distributed. But if what happened, ladies and gentlemen, is of the 10 people at the table, nine of them are sharing one cookie and the 10th person has nine cookies. Well, yeah, the cookie supply increased, but it wasn’t shared broadly, so the other people’s standard of cookie living did not increase nearly as much as the person who captured most of that growth. It would be amazing if everyone shared in that growth equally, but that’s not how the economy works. Did everyone go from one-tenth of a cookie to one-ninth of a cookie? Well, sure. Yes. Their cookie standards did, in fact increase. But one person went from one-tenth of a cookie to having nine. And that’s kind of how things have gone for the past 40 years in the United States. As GDP has increased, the standard of living for most average Americans has not nearly increased as much as that GDP has unless you are in the top upper rungs of the economic distribution.
[00:23:23] And so, just saying “GDP has grown” doesn’t actually tell me whether the people on Main Street are thriving or not. Which brings me to my second point as to why I don’t think GDP is a great measure. It doesn’t measure the standard of living in the United States. It doesn’t measure well-being, human thriving, or really any Main Street issues. I can have a huge bump to GDP by completely automating a factory and unemploying everybody in a town, but that town now is suffering. And I think we see this broadly across the United States, particularly in rural areas. I grew up in the Rust Belt. In my hometown, there is literally a hole in the middle of the town where the old Chrysler engine plant used to be. Well, Chrysler has, well, their demise is well-documented. But the automotive industry has continued to grow and, for the most part, done pretty well. But my hometown? Not so much. And so, on a GDP level, I can say the GDP of the state of Wisconsin or Southeastern Wisconsin where I grew up has grown because we now have an Amazon warehouse and we have a Uline factory and we have lots of stuff there. But the average person in Southeastern Wisconsin has not shared in that growth nearly as much. And so, GDP looks great and the standard of living in that area is, at best, static.
[00:24:41] And lastly, I’m gonna say “no” because the formula is so simplistic that you can pump a bunch of government spending into the economy and create a sugar high that makes the GDP look great. And we saw this back in 2020 under the Trump administration. When COVID hit, our economy fell off a cliff from a GDP standpoint. We had massive levels of GDP destruction over Q2 of 2020. And that’s when unemployment spiked, that’s when things got really crazy, that’s when we had all the lockdowns. And then, what happened during that time? We saw the stock market crash 30%. We saw Congress get off their duff and actually go do something, and then they immediately put in supports. And what happened in the next quarter? Massive GDP growth. Well, why? Because they passed some of the biggest government spending bills that we’ve ever seen in the history of the nation. That wasn’t real GDP growth. That was a sugar high by pumping trillions of dollars into the economy. And ladies and gentlemen, let’s be real. Tax cuts do this, too. Right after the Tax Cuts and Jobs Act that the Trump administration passed, we saw a big bump in GDP in the following quarter. Why? Because a bunch of companies made a ton of investments. And then they stopped. And that’s why we saw a big bump in GDP in the following quarter, and then it tapered off for the rest of the year as the tax cuts normalized throughout the economy. And then, of course, the other part about this with that investment is that we started to see the labor market start to soften because as people were making more investments, they were also automating a lot more things, which were also starting to destroy jobs. And when the pandemic hit, all bets were off.
[00:26:23] So for those three reasons, I say that GDP is not the greatest measure of the economy. It’s not evenly distributed. It doesn’t take into consideration human well-being and thriving. And it’s completely open to manipulation. Which brings us to our last point. Why should you care? Well, if we’re gonna take control of our financial lives and live free, part of that process is understanding the environment in which we’re working in. Being able to understand the signal through the noise that is the media is crucial for us to know what we have to pay attention to and what is really just outrage porn. This entire thing with GDP is a great example in which a lot of talking heads will just spew a lot of misinformation, not intentionally, but because they’re not actually trying to inform you. They’re trying to capture your attention. And you might not want to care. You might think that it’s just a good idea to turn off the television and walk away. And energetically, ladies and gentlemen, I absolutely agree with you. And the reality is that the people who make decisions that affect our lives, they intensely care about this. So it’s at least worth our while to be aware of how those people are making their decisions.
[00:27:32] That’s all I got for you today, ladies and gentlemen. Again, I’m trying to grow my Instagram following to 200 members, so I would really appreciate it if you go to Instagram, find me @fiscallysavage, and give me a follow. Once I get to 200 members, we’re gonna be doing an “AMA” where you’re gonna be able to submit questions to one of these Friday shows and I will answer them to the absolute best of my abilities. No holds barred on those questions. In the meantime, ladies and gentlemen, please go out there, take control of your financial lives, and live free.
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