An Alternative Measurement To GDP That May Be More Realistic For Main Street

GDP gets all the attention as a measure of how well our economy is doing but it has problems, big problems. There are philosophical problems such as the fact that GDP doesn’t adjust for resource usage or debt, so a sustainable economy will look the same as a bubble economy, but there are also a myriad of technical problems with the measurement.

The formula is GDP = private consumption + gross investment + government spending + (exports – imports) which seems straight forward enough but leads to some odd peculiarities. The two most obvious concern government spending and trade. As long as the government spends money (and inflation doesn’t rise) then GDP goes up. Period. There is no measure of diffusion or multiplier, so contracts that don’t do a good job of creating jobs or spreading wealth look the same as those that do. Also, the trade balance exports-imports means that when global trade was collapsing and both exports and imports were plummeting, it actually showed a positive contribution to GDP. This is because imports were falling faster than exports were. In the last quarter, trade was up significantly, but it was a negative contribution since imports rose faster than exports. This makes no sense.

There are similar problems for “gross investment.” For instance inventories are seen as a positive contribution to GDP even though large inventories may be a bad sign because it suggests that production is greater than demand. It could also mean that companies anticipate future demand and are ramping up, but that isn’t the measurement. Also inventories for some reason act on the second derivative. In the last quarter we got a 1% contribution to GDP from inventories even though they fell. They just fell less fast. Why that is positive, I have no idea.

I could go on. The point is that there is tenuous connection between GDP and what people on the street are experiencing.

However, the Philadelphia Fed releases a measurement called the state coincident indexes. This is described as follows:

The coincident indexes combine four state-level indicators to summarize current economic conditions in a single statistic. The four state-level variables in each coincident index are nonfarm payroll employment, average hours worked in manufacturing, the unemployment rate, and wage and salary disbursements deflated by the consumer price index (U.S. city average). The trend for each state’s index is set to the trend of its gross domestic product (GDP), so long-term growth in the state’s index matches long-term growth in its GDP.

What they are saying is that they measure four of the most direct measurements of how “main street” is doing and then come up with a number that historically has a high correlation to GDP. Looking at both GDP and the indexes is a good way of determining how the dynamics of GDP growth are turning appreciable gains at the state level at the worker level. Calculated Risk has the graph for Q3, a time when GDP was 3.5%. It was declining in 41 states and rose in 7. Moreover, the increases were much smaller than the decreases on average. That goes a long way in describing why people are saying they don’t see any signs of a recovery on the ground.

There is also a graph for the 80s onward of how many states are rising and how it corresponds to recessions. The take away points from that are that we currently are at the level that represented the worst of the prior recessions, that the index traditionally can rise extremely quickly as the recession ends and that the historical relationship may be falling apart. Notice that in the last recession the index rose quickly in most states but then the majority started contracting again and it took almost two years to go to the typical “growth” stage where nearly all states are expanding. That measurement is much closer to what most people were describing at the time rather than a quick recession. This is definitely a measurement that should be paid attention to going forward.