Gross Domestic Product (“GDP”) is one of the most important measures of the condition of our economy. Both GDP in dollar terms and changes over time to GDP can help us understand where things stand today and where they will most likely go over the next several years. As business owners, we spend most of our time analyzing the numbers of our company. But every once in a while—say once a quarter—it is valuable to take a step back and look at the bigger picture.
So where is the economy today? More importantly, where do we expect it to go? Let’s take a closer look.
A primer on the GDP
Put simply, GDP is the value of all of the goods and services produced in the U.S. during a given period of time. It includes both domestic companies as well as the operations of foreign-owned companies located in the U.S. There are two main ways to calculate GDP: the income method (which I won’t cover here), and the expenditure method. The expenditure method calculates what everyone in the economy spent on goods and services to determine the value of all of that “stuff” that was made. The formula is calculated as the sum of:
- The value of goods and services bought by consumers (“C”)
- Capital investments (such as machinery) and increases in inventory made by companies (“I”)
- Government spending (“G”)
- Net exports, calculated as the value of exports minus imports (“Ex-Im”)
Last year, the U.S. GDP was $14.66 trillion, the largest of any country in the world.
GDP is important because it gives us a very clear picture of how each “player” is fairing and their impact on the overall economy. When the “C” decreases, we know that means that consumers aren’t buying as much. This has implications for companies (lower sales) and government (lower tax revenues). In a healthy economy, GDP will grow steadyily and consistently over time.
What do the most recent GDP numbers tell us?
During the first quarter of 2011, GDP grew at an annualized rate of 1.8 percent; this is weak. During the last two quarters of 2010, GDP grew at annualized rates of 2.6 percent and 3.1 percent respectively. While most economists were expecting the first quarter of 2011 to show weaker growth, the 1.8 percent figure was below their expectations. A big reason for this decline in growth was reduced consumer spending. Since the “C” in the equation represents 70 percent of GDP, even slight changes in consumer spending can have a massive impact on the state of the economy.
Further analysis shows that this reduction in consumer spending was due to consumers adapting to the realities of high prices in staples such as food and fuel. As inflation continues to grow and consumers must spend more on their income on necessities, they cut back on other areas of spending.
Exports increased during the quarter at a rate of 4.9 percent. While this is solid growth, it is down substantially from the 8.6 percent experienced during the previous quarter. It is also a cause of concern given how weak the dollar is relative to the currencies of our trading partners. The weaker dollar should stimulate demand for U.S. goods and services abroad since they are now relatively cheap for foreign buyers. Import growth also fell significantly—another worrisome message about consumers. When times are good, consumers like to buy expensive foreign goods.
Government spending also saw significant reductions, mainly due to the fact that stimulus funds were nearly exhausted. So the “stimulative” effect of this additional spending has been felt. Our economy got the “bang” it was going to get out of that “buck”. Whether it was worth it remains to be seen.
While the GDP report may not have been terrible, it also wasn’t very impressive. Under normal conditions we could live with that. But with unemployment at levels near 9 percent nationally, we need very strong growth. As expenditures increase by consumers, companies, the government and foreign buyers, companies will need to hire. But at the moment the growth isn’t sufficient for them to hire to the extent required to make significant reductions in unemployment.
Without good jobs, consumers—the giant “C” in the equation—will be hesitant to spend more. Beyond the unemployment rate, the “underemployment rate” is now at 19.2 percent according to Gallup. This consists of people who have given up looking for work or have accepted part-time work because they can’t find a good full-time job. Combining the unemployment rate and the underemployment rate provides the best measure of how consumers are really doing. Such high rates of unemployment and underemployment are a problem.
Looking forward, the remainder of 2011, and most likely all of 2012, will continue to be difficult for the U.S. economy. Even if no major crises appear, it would be advisable to plan for the worst. I’m sorry I don’t have better news.