GDP Growth Means Recovery by Definition.

But Does It Really Mean

Economic Growth?

Rex Stanfield
November 28, 2009

It is an understandable assumption and it is true in most normal economic

environments that job growth lags growth of the economy as a whole. That
is, when the economy is in recovery, job growth will not occur right away, but
will follow. But it is not always true. It is only true when job growth occurs at
all, but job growth does not always occur. When it does not, can it really be
considered economic growth at all? Or rather, is it a flaw in the way growth is
measured? The economy can be considered to be growing for one or more
quarters, but not very many, without resulting in any reductions in
unemployment, either in the current quarter or future quarters. It happens
because of the way GDP is measured. That is what happened in the 3rd
quarter 2009 in the USA.

The concepts of recession and recovery are intended to give an indication of

whether the economy is prosperous (growing). They are defined as multiple-
quarter reductions and increases in GDP. But the problem with GDP is that it
can only measure spending, not production. It makes the assumption that
when spending occurs, it is an indication of growth in the economy. It is not a
timing issue - if jobs were created in September by spending that occurred in
February, that would still be economic growth in February. Therefore, using
spending to measure growth is valid, but only if employment results.
Ultimately, the goal is to measure employment. What would be the purpose
of an increasing GDP if it is not going to result in people being employed? But
it is possible. Here is how GDP can grow sans reductions in unemployment.

Employment is the goal. Without employment, nothing else matters. The

purpose of employing workers is to produce. Therefore, the economy needs
to increase demand for goods and services to be created. The amount of
production is equal to the amount of growth, and that growth is what
changes in GDP are intended to measure.

The amount of money that is spent in all economic transactions in the

economy is an indication of the value of what was produced. So, the only
way to measure production is to measure spending. You can't know how
valuable something is that was produced unless you know how much money
someone else was willing to spend on it. If you produce something that no
one wants to buy, then the value is still zero even though something tangible
was created. Money was spent, in the form of wages, but the person,
company, or entity that paid the wages has gained nothing of value to it that
it can sell or use. It may put some short-term money in the hands of an
employee, but no economic growth took place. Money was given for
something of no value. It may as well be a gift. There needs to be value
exchanged on both sides of the ledger. This is the flaw in Keynesian theory,
which in the 1030s had the government hiring workers to dig holes and refill
them. Not all New Deal projects were wasted, like the TVA which created
some value in the form of capital investment to provide clean, affordable
electricity to the population. But most were, and that is why the New Deal
proved to be an impotent strategy in getting the country out of the Great
Depression.

The spending must be in return for something that is produced in the

economy in order for growth to occur. Spending on foreign goods is not
included because it does not result in domestic jobs (the D in GDP). But
foreign investment in domestic jobs is included. If I buy a Hyundai from
South Korea, that is not included in GDP. But if I buy one that was assembled
in Montgomery, the value of the assembly is included in GDP, because
domestic jobs produced it.

GDP = consumption + investment + government + net exports

Three types of entities spend: Individuals (consumption), companies

(investment), and government. Net exports is equal to exports minus
imports.

Consumption creates wealth, and it stimulates investment, which stimulates

employment in turn. So consumption and investment are straightforward
increases in production and are rightly included in GDP. If I make a paper
airplane and you buy it from me for a dollar, economic growth has occurred.
That is, both of us enjoy the benefit of the thing that was produced: You get
the paper airplane to enjoy, and I get the benefit of a dollar that I can
exchange in some other transaction for something else that is of value to
me.

However, not all of government spending causes any net production. But all
government spending is included in GDP. Some government spending
creates something of value. Indeed, the economic purpose of government is
to provide goods and services that cannot be allocated individually to the
population. Once a road is built, the road is available for everyone to use. It
cannot be provided to only one person or only one group of people (toll roads
being the obvious exception and usually not government enterprises). Roads
benefit even those who do not drive on them or have cars - those people
nonetheless take advantage of the transportation that roads provide. They
ride busses, they buy goods that were transported via trucks, etc. The classic
example is national defense. The government operates an armed force that
provides security and political stability and protection from attack to
everyone. The Pentagon cannot provide protection to me and deny it to my
neighbor. Once provided to anyone, it is available to everyone. All people
pay taxes for the government to provide it, and all people receive its benefit.
taxpayers receive something of value using the government as a conduit
between themselves and the those who provide it.

Some government spending, however, is wealth transfer and does not

represent production or economic growth. The government spends money
with no expectation of receiving value in return. The money it spends is
taken from taxpayers without expecting to give those taxpayers anything of
direct value to them. It represents a gift - the taxpayer gives money to the
recipient with no value being exchanged, and uses the government as the
conduit for the transfer. There may be good reasons for it, and an argument
can be made to support the existence of transfer payments. But what cannot
be argued is that transfer payments create economic growth. Because, they
do not result in jobs, now or ever. Farm subsidies also fall into this category.
If and when the US begins a government-run single-payer health care
system, it will also fall into that category, because that will also be a wealth
transfer between taxpayers and patients who do not pay. Health care is a
personal service that is provided to each person individually and not the
entire population as a whole.

So, the formula can be written so that the two types of government spending
are shown separately:

GDP = Individual consumption + company Investment + government

production + transfer payments + net exports

In the USA Quarter 3, GDP increased, but the only component that caused
the increase is wealth transfers. Consumption shrank. Investment shrank,
government production shrank, and net exports were negative because
imports were greater than exports. It cannot be considered sustainable, or
even actual growth at all. If Q4 GDP increases in the same manner, the
country will officially be in recovery because two consecutive quarters of
GDP growth will have occurred, and you will hear the news trumpeted from
the media. But it will not be economic growth, and job growth will not result.
Jobs do not follow wealth transfers as they follow consumption, investment,
government production, and exports. Unfortunately, the way GNP is
measured, government is able to create GDP growth without creating actual
economic growth. And that is what the government in the US is currently
doing.

To represent true economic growth, the formula should be:

GDP = Consumption + Investment + (Government - wealth transfers) +

(Exports - Imports)

© 2009 Rex Stanfield All Rights Reserved