Wednesday, October 1, 2008

Are GDP figures useful in indicating a recession in a globalized economy?

Do we need a substitute to GDP growth as a means of determining whether an economy is in recession? GDP is calculated by: GDP = C + I + G + EX – IM.

In this article, Menzie Chin observes that the reason the US feels like they are in recession, while GDP has repeatedly been reported to grow, is that though net exports (EX-IM) have been improving, C, I, and G have been stagnant or declining.

So the US is producing more, but much of that value is being exported away, instead of consumed by domestic consumers. Moreover, because of improved productivity, the increase in exports does not lead to much improved domestic employment. Hence, domestic consumption remains stagnant.

GDP could continue growing, with C, I, and G, remaining constant, for as long as there’s a foreign market willing to buy America’s excess production that is not consumed by its domestic consumers.

In answer to my question, GDP (Gross Domestic Product) is still relevant to determining whether an economy is growing or in recession. But the other GDP -Gross Domestic Purchases, which Menzie uses to illustrate his point in the article, should be used more often to validate whether the domestic standard of living is deteriorating.

This is how it's always been in much of the developing world. Years of economic growth may have resulted in constantly improving national accounts, but comparative advantage that comes from maintaining low wages, instead of true value creation, does not a vibrant domestic consumer economy make. So their continued growth have rested on the American consumer continuing to buy their excess production.

With the US finally forced to follow the same economic growth formula as the rest of the world, we are now missing a key ingredient to keep the global growth engine humming – the willing and able consumer.

A global recession is imminent. This time, the whole world's in it together. We said so here and here.

No comments: