Welcome to Finance and Fury, the Say What Wednesday edition.

This week the question comes from Todd.

“Hi Louis, I just saw Steve Forbes talking about how Gross Output (GO) is going to replace Gross Domestic Product (GDP) as a measure of how well the economy is going? I was wondering if you agree with Steve on GO?

I had heard in the past that GDP was not perfect, but had been used because it was the best option available. Are there problems with GO that will also cause problems when trying to use this measurement to judge the health of an economy? Love to hear your thoughts?”

Thanks for the question Todd – is an important question – So in this episode – we will look at if the replacement of GDP with GO is a step in the right direction – to be upfront – its replacement isn’t a perfect solution as an economic measurements – but there is nothing that is perfect when talking about economics –as Economist Thomas Sowell says – “There are no solutions, there are only trade-offs; and you try to get the best trade-off you can get, that’s all you can hope for.” As we cannot achieve a perfect outcome – we will look at if GO a better trade off to measure economic output when compared to GDP

 

First – go through the basics of GO and compare this to GDP

  1. In economics, gross output (GO) is the measure of total economic activity in the production of new goods and services
    1. It is a much broader measure of the economy than gross domestic product (GDP)
      1. GDP is limited mainly to final output (finished goods and services) that are consumed in the economy – not total output
      2. Most people are familiar with GDP – or at least have probably heard it mentioned – even though it might not have much bearing to their own lives –
        1. But indirectly it does – as it is the standard for what economists and policy makers focus on when looking at economic growth and deciding what policy responses to make – there is an increasing focus on it – especially now as it is the measurement of a recession
      3. Looking back – Following the Bretton Woods conferencein 1944 – Both GDP and GNP became the standard measure of economic growth that was implemented –  
      4. But it has its limitations – and this comes back to the reason why it is used – simplicity – relatively easy to measure – at it takes the net results of economic output – but because it is simple – it is a flawed way to look at economic output
        1. Covered the issue with Government stats earlier in the year – episode was called “How accurate are economic statistics and do they really matter in our daily lives?”
      5. If a computer is sold – then the end result is what is measured – minus all the components that went into making it – so those companies that produce processors or RAM for a computer aren’t included – as these are component parts of the final product – the final product and the component parts can often blur between one another –
        1. If your CPU breaks down and you buy a new component – then this isn’t added to GDP – even though it is technically an increase in economic output
        2. If this computer is then resold later by a business such as cash converters – it isn’t counted as part of GDP as it is not new output – even though it is an economic transaction
      6. GDP ignores other sections of economic output – these areas are known as the informal economy – making up about 60% of economic activity as an estimate – they aren’t included as it is hard to track down and these activities are normally not included in GDP figures
      7. GNP is a little more complete than GDP figures – adds the component of Z of net foreign income – so if you have a company that operates internationally – it counts the net balance of foreign income from operating internationally – while it might seem more complete – it is even more flawed – as it is influenced by the exchange rates and the health of other nations – performance of other nations may not be indicative of the performance of the domestic country that GNP is accounting for
    2. But GO is equal to the value of an economy’s net output – which is the measure of GDP plus that of intermediate consumption
      1. Conceptually – intermediate consumption is equal to the amount of the difference between gross output– normally measured by the total sales value in an economy and net output (which is GDP)
        1. So in other words – rather than taking the net output of the economy – you can take the total sales revenue of companies as the Gross Output – very simplistic way to think about it – but that is the general gist of the concept
      2. As an example – take the US economy – total intermediate consumption represents about 43% of the gross output of an economy – so this means that if GDP was $1 – GO would be $1.76
  • When looking at the actual figures – gross output in the United States is estimated to be $37.2 trillion, compared to $21.1 trillion for GDP
  1. The Australia economy generates an estimated $3.8 trillion in output – GDP is estimated to be about $2 trillion dollars – so this means the intermediate consumption is about 47% of Gross output
    1. intermediate consumption is essentially an expand on the accounting flowwhich consists of the total monetary value of goods and services consumed or used up as inputs in production by companies that are the input components that get the GDP figure – but are ignored by GDP –
    2. This can include all forms of raw materials, services and various other operating expenses that go towards the outputs of the final products – in essence – the CPU, RAM and components that go towards the final product of the computer are counted by GO
  2. Due to this – GDP ignores the business to business sales – as it measures the value add of the final product – doesn’t include the component consumption from business to business transaction – but measures the final output
  3. So GDP ignores in most cases and depending on the nation – almost half of economic activity which is business to business
  1. But some economists go further when looking at GO – whilst they emphasize that GO can be used as an important macroeconomic tool – they also focus on gross output-by-industry – can be better when understanding about the economic workings of a nation – as well as the inner-workings between industries and not just the aggregate GO
    1. Helps to explore which industries within a nation provide the better economic activity
    2. It is starting to emerge that economists regard GO and GDP as complementary aggregate measures of the economy. Many analysts view GO as a more comprehensive way to analyse the economy and the business cycle.
      1. As Gross output [GO] is the natural measure of the production sector, while GDP measure the final output of the economy
    3. But the issue is still that GDP (which is still the gold standard) ignores most of the business to business economic output – so it makes it look like consumer spending makes up the majority of the economy –
      1. Hence – there is a secondary focus on both Business investment and Government spending
        1. Now – Government spending is pretty much the same in both GO and GDP in a nominal dollar figure – however GDP does under represent the important of business economic activity
      2. The intermediate goods or services used in production within an economy when accounted for really show that businesses play a vital role in economic activity – through focusing on GDP – it ignores this and hence policy is made with consumers at the forefront – demand side economics –
      3. Through focusing on GO – we can see that business investment and entrepreneurship and not consumer spending are a more important catalysts for economic growth
        1. As Steve Forbes says – the consumer spending is the effect, not the cause, of prosperity
      4. But what good will focusing more on GO rather than GDP do?
        1. First it will allow economists to better see how the economy ticks – that businesses and entrepreneurship are as important as consumer spending – however – but to what end will this actually affect economic policy?
          1. It is far easier to give hand outs than it is to unwind 60+ years of economic thinking and policy – to skew the economy to a business friendly environment – a lot of policy makers and government economists think that the same demand side policies that they think work on consumers will also work on businesses – handouts – corporate welfare or things like cash boosters – or write offs on assets purchases – but this requires more legislation and now less
        2. I wouldn’t want government or economists to get more involved into this side of the economy than they already have been – less is more when it comes to trying to boost the economy –
        3. However – over time the focus on GO could help to refocus economic thinking – in that the business sector is more important than the government or consumer spending when it comes to the real health of the economy –
        4. As the focus on GDP puts an overweight focus on consumption – resulted in demand side economics – theory that majority of economic growth comes from consumer spending – so the focus of the economic models has been to boost the spending by consumers-
          1. Why not – the aim is to get the best statistical outcome – however – the same approach could be employed with GO – to get the best statistical outcome through still focusing on demand side thinking but applying this to the business sector
        5. But what matters to the individuals – is a better standard of living – the creation of new businesses – which comes from supply side thinking – this is what helps the individual
          1. Lower costs of goods and services due to higher levels of supply – with more businesses to compete – this helps to drive economic growth
            1. The supply is ignored due to the way GDP is reflected in the statistical interpretation
            2. However – using the same economic thinking for GO can result in more corporate welfare which disproportionately benefits the largest companies – which has the potential to further monopolises the markets
          2. As Todd said – GDP is not perfect – and has been used because it was the easiest option available.
          3. When looking at GO as a replacement – It is probably a step in the right direction when understanding how economic functions truly occur – and refocusing more on business activity as a vital sector of the economy and not just consumer spending – whether it will be a replacement for GPD – I think it will be used as a supplementary tool – only been measured since the 90s – takes time for economists to switch thinking
            1. But my view on this – economists and especially policy makers should butt out of the economy – their theories do little good when put into practice – the economy is a complex creature – and the best ways to affect it go beyond what statistics can represent – as stats show a picture but not the optimal policy
            2. Economists can measure it if they want – and they can measure it in any way they want – but similar to GDP – measuring GO is still going to likely result in imperfect policy (or another improper trade-off) due to the way the data is collected
              1. Think about anu Government stat – So many people and transactions to keep track of – relies on data collection –
                1. Relies on surveys and naturally has sampling errors –
                2. Inflation– survey of respondents in their purchases in the basket of goods – non-response and sampling 8,000 households out of the 8.5m households in Australia – 0.094%
                3. This is how it is done though – and state there is a 95% confidence interval – the issue is there is not a great way of measuring these statistics – too many people – too much variation – but monetary and fiscal policy makers need this data to make their decisions –
              2. But the specialised knowledge of a roomful of specialists is always going to be wrong –
                1. Humans are the best at deciding what is right – millions of people involved in voluntary interactions to maximise their own financial situation is better than a handful of policy makers trying to decide what is on their behalf – trying to jam a square peg through a circular hole – even toddlers can get this right – but the economy is not a circular hole
                2. example of a highway – adams story – the construction of the bridge adds to GDP = but living standards probably not maximised- people still running across the highway
              3. There may be good that comes from a new focus on GO – and that is that the perception that demand side economics is the way to go in the future may shift towards a more supply style of thinking – but I don’t think that Governments and policy makers want to reduce their power over the economy – so it may just lead to additional policies on top of demand side – where governments get more involved in trying to force economic growth through additional policies on businesses – so there may be some bad outcomes for this –
                1. Additional corporate welfare at the top end – economists and policy makers may look at GO and say that most of the growth comes from Amazon – so Amazon should get tax cuts or additional corporate welfare – which could further monopolise the market –
                2. This is only speculation – but the very focus on GDP has lead to the need an ever expanding money supply to help boost aggregate demand – Probably do a follow up episode to this – read a interesting study done in relation to GDP focus and the almost perfect correlation to the money supply in the nominal GDP growth – come back to this in a future episode
                3. In summary – as Steve Forbes said – Consumer spending can be the affect – not the cause of prosperity –
                4. You can give people money – but if there is no supply – then they have nothing to spend it on and hence no economic output
                5. And GO is probably a step in the right direction when it comes to understanding the economy – but if it is used as a stat to form policy – it could lead to some orders of consequence that hurt and not help the economy

Thank you for listening to today’s episode. If you want to get in contact you can do so here: http://financeandfury.com.au/contact/

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