What is the Gross Domestic Product (GDP)?

        “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 5.9 percent in the fourth quarter of 2009 (that is, from the third quarter to the fourth quarter) according to the “second” estimate released by the Bureau of Economic Analysis.  In the third quarter, real GDP increased 2.2 percent.”[1] –February 26, 2010

 The key question about the economy—“how are we doing?” –is often presented in terms of the GDP. Is GDP going up or down? Going up is good, except when it goes up too quickly suggesting inflation.  Going up too slowly—or worse—going down—is an indicator of a weak economy or a recession.

 The GDP, like any measure used in statistics, must be valid (meaning it actually measures what it says it is measuring) and reliable (meaning it measures the same things in the same exact way every time).  What exactly does the GDP consist of?

 To find out, I went out to the Bureau of Economic Analysis website- http://www.bea.gov/. Located within the U.S. Department of Commerce, it is responsible for measuring GDP and all National Income and Products Accounts.

 The BEA captures the complexity of the GDP as a measure in its definition: 

         GDP includes market production and some non-market production. GDP is composed of goods and services that are produced for sale in the “market”—the generic term referring to the forum for economic transactions—and of nonmarket goods and services—those that are not sold in the market, such as the defense services provided by the Federal Government, the education services provided by local governments, the emergency housing or health care services provided by nonprofit institutions serving households (such as the Red Cross), and the housing services provided by and for persons who own and live in their home (referred to as “owner-occupants”). However, not all productive activity is included in GDP. Some activities, such as the care of one’s own children, unpaid volunteer work for charities, or illegal or black-market activities, are not included because they are difficult to accurately measure and value.[2]

 But gathering that data to make these estimates is challenging. As J. Steven Landefeld, Director of the BEA writes, the GDP is “fundamentally based on detailed economic census data and other information that is available only once every five years.” [3] The challenge, he explains, is using other data and making estimates between those five years. For the monthly estimates, some data are not available so they go back in time to extrapolate. As the data becomes available, they make adjustments to prior reported data and that is reflected in their press release announcing the revised 4th quarter GDP growth quoted above. “There is a need to balance accuracy with timeliness,” he states.

 BEA reports that they have a good track record with their estimates. Still, caution should be exercised when looking at monthly changes to the GDP and not take it as an absolute fact. It may also be harder to predict changes when the economy is in a downturn because the past is no longer a great predictor of the future. (This is the driving forward while looking through the rearview mirror problem). In these situations, the trend data will give a more accurate picture.

 When trying to measure complex phenomena it is important to remember that perfection is worthy to strive for but never fully attained. Demands for absolute perfection do not serve here. The GDP is a very comprehensive approach and has the advantage, like the definition of poverty, to be measured reasonably consistently over time. It therefore serves its purpose of providing a single summary statistic that is comparable over time. It is best seen as an indicator of the general state of the economy.

 As a side note: the GDP is also used as the base for comparison of federal budget. The federal deficit, for example, is presented in dollars but also as a percent of the GDP. Simple budget data says that the projected federal budget deficit of $1.3 trillion equaled 8.3% of the GDP for Fiscal Year 2011. In comparison, the federal budget deficit in Fiscal Year 2008 was $455 billion, or 3.2% of GDP. I am not sure, however, how to gauge what those percents mean—is 8% good or bad for the economy and the taxpayers?

[1] http://www.bea.gov/newsreleases/national/gdp/gdpnewsrelease.htm

[2] Measuring the Economy: A Primer on GDP and the National Income and Products Accounts, September 2007,  http://www.bea.gov/national/pdf/nipa_primer.pdf

[3] “Taking the pulse of the Economy: Measuring GDP”, J. Seven Landefeld et al.

Joural of Economic Perspectives—Vol. 22(2) Spirng 2008:  pages 193-216

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