The Mess We’re In – Trillions of Dollars of Missing GDP

According to the Congressional Budget Office (CBO) the U.S. has a cumulative output gap of $2.8 trillion so far since the recession began.  That’s trillion with a TR, as in a million millions.  This is the core problem in the U.S. today and for the next couple years.  The recession saw the economy shrink and we simply haven’t aren’t getting back to where we were, let alone to where we could be.

Two of the most basic concepts in economics are the idea of opportunity costs and the technique of the counter-factual.   Both play a part in this analysis.  First, opportunity cost is the idea of the real cost of something or some choice isn’t the money expended but rather what you could have done but didn’t/can’t because of your choice.  Analyzing opportunity costs involves using the other idea, the technique of the counterfactual.  A counterfactual is a hypothetical outcome that could have been or even would have been, but didn’t happen because of the choices made.  People use counterfactuals often, they just don’t call them such.  For example, if you imagine decide not to go to a party and you choose to stay home one night, you might imagine what would have happened if you had indeed gone to the party.  That’s a counterfactual.  It could be good and attractive (you would have had fun at the party and met someone very interesting) or it good be negative (you would have gotten drunk, tried to drive home, and got arrested for DUI).  Comparing actual events to counterfactuals is integral to economic analysis.

In the case of macroeconomics, we often use a counterfactual called “potential GDP”.  Potential real GDP is the amount of real GDP that would have been produced IF we had made policy choices that produced full-employment.  In practice potential real GDP is often estimated by a combination of extending the long-run trend line of GDP from previous decades and of calculating output per worker and multiplying times the number of potential workers.  In this case, the additional workers include not only those presently recorded as “unemployed” but also those workers or part of the population that used to work but are no longer working or classified as unemployed.  It’s a fairly involved statistical undertaking, but fortunately we have the CBO to do the heavy lifting for us.  The numbers and graphs are accessible via the wonderful FRED database at the St.Louis Federal Reserve bank.  The data series is called GDPPOT.

The CBO released it’s latest long-run estimates for GDP.  Here’s a graph comparing potential real GDP to actual Real GDP. It shows actual numbers for 2008- first half of 2011.  From then on it’s the CBO’s best estimates of future actual real GDP given present government policies.

Yeah, that’s an ugly gap between those two lines.  That’s the opportunity cost of lost potential.  We could have been $2.8 trillion dollars better off over the last 3 years (cumulative, not annual). We could have had tens of millions more working. But we didn’t.  More disturbing is that we will continue to underperform for many years.  The CBO doesn’t project getting back to full-employment and our achieving our potential output until the end of 2015 – four years from now.

But now here’s the catch.  The CBO estimates and analysis don’t offer any rationale or reason why they suddenly forecast a recovery in 2015.  Basically they are saying that surely something will happen in 2015 to bring recovery, but they can’t point to any policies or dynamics that will cause such a recovery.

My own sense is that this will take a lot longer to recover given the government’s current focus on debt, deficits, and cutting spending.  It’s the wrong policy mix to achieve full employment given this kind of output gap.  We will eventually get back to full employment – if nothing else, sooner or later people die off and equipment rusts away.  But we’re in the middle of an ongoing depression and current policies won’t change that.  (note I said depression, not a “Great depression”)

 

Hurricanes, Disasters, and GDP

Ok, normally I’m writing about the disastrous effects of changes in GDP.  Today, though, I’m going to write about the effects of disasters on GDP. As I write this, it’s mid-day on Saturday, Aug 27.  Hurricane Irene has just hammered North Carolina and the Outer Banks. Irene is continuing in both it’s push up the Eastern seaboard toward New York City.  I have no idea at this moment how bad the damage will be.  What’s clear is that even if the storm weakens to a tropical storm strength, it will bring extensive flooding and wind damage across a very heavily populated area.

Major natural disasters generally do not have a major long-run effect on the economy and GDP.  This is largely because the U.S. is a really large nation and even the most severe natural disasters such as Hurricane Katrina only directly affect a small portion of the country.  So even if a hurricane or earthquake were to stop 40% of the economic activity in a region, as long as the region is only say 2-5% of the nation, the net effect is a short, temporary “blip” on the nation’s GDP.  Hurricane Irene could conceivably be different because the projected path includes over an estimated 65 million Americans – nearly 20% of the nation.

Asking what the effect of a natural disaster will be on GDP is probably the wrong question to ask.  What we’re really interested in is “what is the effect of the natural disaster on the economy and our living standards?”   It’s just that we are so accustomed to using GDP as a proxy measure for the size of the economy and our living standards.  Unfortunately, GDP as a measure of the economy and our welfare has some weaknesses.  These weaknesses are really important in the case of a natural disaster and interpreting it’s effects.  GDP measures economic production by counting the dollar value of all transactions where something new is produced and sold.  GDP doesn’t measure the value of what we own – our wealth. GDP doesn’t measure the value of services produced that aren’t sold (like charitable acts, household production, etc).  GDP doesn’t measure our capability to produce.  It only measures what we actually produce and sell.

The economic effects of a natural disaster are to change exactly these things that GDP does not measure. The primary economic effect of a major disaster such as an earthquake, hurricane, extensive flooding, or  a swath of destructive tornadoes is to destroy wealth and destroy our capacity to produce.  In macroeconomic terms, a natural disaster is a sudden reduction in our resources: capital equipment, buildings, and available labor. None of this is a good thing.  It reduces our ability to produce goods and services in the future and it reduces our welfare right now.  But that effect won’t show up in GDP measures.

What will show up in GDP measures after the natural disaster is a perverse reaction in the months after the disaster.  This comes because of the re-building activity that comes after the disaster.  Repairing buildings, cleaning up, rebuilding all require paid services, building supplies, labor, etc.  These transactions will show up in GDP measures in the months/quarters after the disaster as an slight increase in total GDP.  But it’s a deceptive increase in total GDP because we aren’t really significantly better off.  We’re just getting back to the condition before the disaster.  GDP counts the fixing, but not the damage done.  This is why we sometimes here commentators say that a “disaster is good for the economy”.  It isn’t really.  It’s good for GDP, but that’s not a perfect measure of the economy.  The mistaken idea that damage or disasters are good for the economy is what economists call the Fallacy of the Broken Window. It was first explained by Frederic Bastiat.

Normally the economic impact a natural disaster will be relatively short-lived so long as there is a mechanism to finance reconstruction and the real resources in the larger nation to do it.  Typically in a developed nation like the U.S., the financing for reconstruction comes from insurance company payouts and government, especially national government, loans and payments. In particular it is the responsibility of the national government to help rapidly restore infrastructure.  If adequate financing and national resources exist, then we rarely find a national impact on GDP or the economy lasting beyond perhaps a 6 months to a year.  The smaller the economy, the greater the potential for longer lasting damage and even a failure to rebuild at all.   That’s the problem in New Orleans five years after Katrina.  The city is now permanently smaller since large numbers of people chose not to return and rebuild.  At the U.S. level, though, it’s insignificant.

The lack of financing and resources can severely damage a very small or poor nation for a very long time.  That’s why Haiti, a small and poor nation, is so dependent upon outside help to rebuild. The other exception that can result in lasting damage and reduction of the economy is when the disaster brings permanent physical damage that cannot be repaired or rebuilt easily.  The nuclear disasters in Chernobyl and possibly Fukishima fall into this category.

So overall, a natural disaster is not likely to be a long-term significant

 

GDP for 2nd Quarter Revised Downward

As is normal practice, the BEA released the second estimate of 2nd quarter GDP growth.  GDP growth was definitely even slower in 2nd quarter than previously reported.  CalculatedRiskBlog tells us:

From the BEA: Gross Domestic Product, Second Quarter 2011 (second estimate

Real gross domestic product — the output of goods and services produced by labor and property located in the United States — increased at an annual rate of 1.0 percent in the second quarter of 2011, (that is, from the first quarter to the second quarter), according to the “second” estimate released by the Bureau of Economic Analysis.

This was revised down from 1.3% and slightly below the consensus of 1.1%.

Exports subtracted more from GDP – as did changes in private inventories. Consumption of services and fixed investment were revised up slightly.

The following graph shows the quarterly GDP growth (at an annual rate) for the last 30 years. The current quarter is in blue.

GDP Growth RateClick on graph for larger image in graph gallery.

The dashed line is the current growth rate. Growth in Q2 at 1.0% annualized was below trend growth (around 3%) – and very weak for a recovery, especially with all the slack in the system.

Calculated Risk goes on to report on the breakdown of what sectors accounted for what part of the growth (or absence of growth).  The two most significant negatives were Personal Consumption of Goods and State/Local Government Spending.  Both contracted sharply and each had the effect of lowering the GDP growth rate by 0.34 points.  A 1.0% annualized growth rate is really not good at all.  It’s horrible in fact.  And that means it’s not the time to be cutting state and local government spending.  The federal government really could do something but there’s no political will in Washington.

Not Retiring Is the New Retirement Plan For Many

CalculatedRiskBlog tells us about a new major study of American workers and their retirement plans.  The study is published by the Transamerica Center for Retirement Studies [note for students: the center is an excellent source of research data and analysis].  CalculatedRisks summarizes:

From Rachel Ensign at the WSJ: For Many Seniors, There May Be No Retirement

Already battered nest eggs took another beating this month with the market’s wild swings. With interest rates essentially at zero since 2008, income from Treasurys and certificates of deposit is pretty paltry. … On top of that, housing prices [leave] homeowners with much less equity to tap.

Here is the survey mentioned in the article: The New Retirement: Working

• The survey found that for many Americans, the foundation of their retirement strategy is simply not to retire, to work considerably longer than the traditionalretirement age, or work in retirement:
–39 percent of workers plan to work past age 70 or do not plan to retire
–54 percent of workers expect to plan to continue working when they retire
–40 percent now expect to work longer and retire at an older age since the recession

• Workers’ greatest fears about retirement include “outliving my savings and investments” and “not being able to meet the financial needs of my family.”

• Most workers will continue working out of financial necessity:
–Workers estimate their retirement savings needs at $600,000 (median), but in comparison, fewer than one-third (30 percent) have currently saved more than $100,000 in all household retirement accounts
–Most workers, regardless of age or household income, agree that they could work until age 65 and still not have enough money saved to meet their retirement needs
–Of those who plan on working past the traditional retirement age of 65, the most commonly cited reasons are of need versus choice
–Many workers (31 percent) anticipate that they will need to provide financial support to family members

When I looked at the report myself, I was struck by this line in the executive summary:

Workers’ greatest fears about retirement include “outliving my savings and investments” and “not being able to meet the financial needs of my family.”

This is related to the point I’ve tried to make in the past (and also here  and here):  Social Security is not a pension plan. Social Security is an insurance program that insures all of us against the possibility of “outliving our savings and investments”.  It is particularly disturbing to hear politicians and those least likely to outlive their investments be in such a hurry to cut Social Security (or Medicare) at a time when uncertainty about investments and savings is rising (just look at the uncertain stock market and housing markets)!

President Obama’s Jobs Advisor Ships Jobs Overseas.

No wonder jobs aren’t being created.  The President listens closely to Jeffrey Immelt, the CEO of corporate welfare recipient large multinational General Electric about jobs policy.  So what’s GE doing about jobs?  Bloomberg reports:

General Electric Co.’s health-care unit, the world’s biggest maker of medical-imaging machines, is moving the headquarters of its 115-year-old X-ray business to Beijing to tap growth in China.

“A handful” of top managers will move to the Chinese capital and there won’t be any job cuts, Anne LeGrand, vice president and general manager of X-ray for GE Healthcare, said in an interview. The headquarters will move from Waukesha, Wisconsin, amid a broader parent-company plan to invest about $2 billion across China, including opening six “customer innovation” and development centers.

The move follows the introduction earlier this year of GE Healthcare’s “Spring Wind” initiative to develop and distribute medical products and services in China, GE said in a statement today. More than 20 percent of the X-ray unit’s new products will be developed in China, LeGrand said.

Read more: http://www.bloomberg.com/news/2011-07-25/ge-healthcare-moves-x-ray-base-to-china-no-job-cuts-planned.html#ixzz1UjwUi6Yu

Income Distribution Does Matter. It’s Wrong Now and Stopping Growth.

When people think about “income distribution” there’s a tendency to think of it only in terms of what different people or households have available to spend.  In other words, we focus on the fairness or equity of whether some households should only have a small amount of money to live off of vs. others who get a large amount of money to live off of.  The debates then often deteriorate into whether or not the households put forth effort (“worked”) for their income and therefore “earned” it.

But there’s more to the issue of income distribution.  A household’s income is not just determined by how much “effort” it’s willing to make or how much “investment” it’s made in the past.  So a household’s income isn’t just how much you work and what education/qualifications you have.  The general level of wages matters too.  And that’s determined at the macro level by institutional arrangements in society.

The nature of production is that it requires both capital and labor.  The joint product is then sold.  This is called productivity.  Part of the income distribution question is “how is the value from joint productivity split up between payments to capital and payments to workers”.

In the U.S. during the Golden Era, the period of World War II until the mid-1970’s, the social contract and institutional arrangements were that the benefits of increased productivity were split evenly between both capital and labor.  Both benefitted.  Starting around 1980 that deal was cancelled.  The social contract has increasingly moved to all gains from improved productivity going to capital and none to labor.  As a result, labor’s share of national income has consistently declined.  The Great Recession was a major blow.  It’s this change in the social contract that is the root source of the frustration and pain felt by so many households.

Garth Brazelton at Economics Revival explains why this matters now.  He explains why we are still in a recession, or at least why the 90% or so of us that work for  a living as opposed to living off of interest and profits are still in recession:

Who cares about double-dip. We never left. Why? because you can’t get out of a recession without consumers/labor income growth. While productivity has grown over the last few years, labor’s share of national income continues to plummet. This implies that others (capitalists / profit-makers) are ‘out of their recession’ but consumers and laborers are not.

The BLS has a nice publication here.

Ordinarily a low cyclical labor share isn’t necessarily a problem because firms can use profits to invest in new business ventures a eventually lower the unemployment rate and provide more compensation in a recovery. The problem here of course is that firms are too busy paying off past debts from poor decisions made a decade ago, or two skittish to do anything substantial with their profits at the moment. So that, in combination with the low labor share of income is like a double-whammy for consumers and laborers who see the haves continue to have and the have-nots continuing to have nothing.