Free Market Central Interview: Mark Skousen On Why "Gross Output" Is Way Better Than GDP At Telling Us How The Economy Is Doing [Watch]

After Wall Street’s recent wild swings, President Trump reassured the nation that “the fundamentals of this economy are very strong.” One of them is “gross domestic product,” popularly known as GDP, which measures spending on finished goods and services. GDP grew 2.6 percent in the fourth quarter of 2017 and is expected to grow far more in the first quarter of this year. But is GDP the best measure of economic activity?

A growing number of pundits and prognosticators say that a better barometer is Gross Output (GO). This little-known indicator tracks the business spending that takes place starting with purchase of raw materials, down to production of the finished product. The Bureau of Economic Analysis recently began publishing quarterly GO numbers. Free Market Central recently asked economist Mark Skousen, the foremost advocate of Gross Output, to explain “GO.”

What is Gross Output and how does it differ from GDP?

Thanks for asking. Gross Output is a broader, more accurate measure of total spending in the economy. It measures spending or sales at all stages of production. Thus, GO is the "top line" of national income accounting and includes the value of the supply chain. GDP is the "bottom line" that measures the value of all final goods and services only. So GO and GDP complement each other.

What does Gross Output tell us about the economy that GDP doesn’t?

GO reached over $41 trillion dollars this year, more than double GDP. It's more volatile than GDP and better shows what's happening in the business cycle. It also demonstrates that business spending is more important than consumer spending in the economy. Business drives the economy, not consumer spending! GDP leaves out a huge chuck of the economy.

What percent of the economy do you estimate GDP leaves out?

By focusing solely on finished goods and services, GDP measures less than 50% of total actual spending in the economy.

Why do you say that?

GDP measures only spending by consumers, business and government for "finished" goods and services. For example, GDP includes the purchase of a car or a house, but does not include the steel in the car or the lumber in building the house.

But aren’t the steel and the lumber, taken on their own, also finished goods?

They are semi-finished goods or producer goods. GDP would include a hammer sold in a retail store, but not steel or iron ore. GO includes spending at all stages of production or goods-in-process. It is a full measure of spending in the economy. Over 60% of [this] spending is by business, compared to 31% for consumers, and the rest by government.

Considering what GDP leaves out, why the obsessive devotion to that measure?

Unfortunately, when economists such as Simon Kuznets were deciding how to measure the economy, they settled on one number, GDP, because they were under the influence of Keynesian economics, which stresses "final effective demand" as the most important factor in the economy. They ignored GO and the supply chain that are necessary to generate GDP. This focus on GDP as "the" measure of the economy has led to much mischief -- primarily the false notion that "consumer spending drives the economy."

What role does consumer spending actually play?

Consumption is actually around 67% of GDP. But if you use GO as the true measure of total spending in the economy, consumption is really only about 31% of the US economy, and business spending is over 60%.

What’s the final takeaway?

GO is the best way to view total spending in the economy, and it proves that business investment, productive savings, entrepreneurship and technology -- the supply chain -- drives economic growth, and that consumer spending is the effect, not the cause, of prosperity.

How do GDP and GO account for government spending?

Government spending is the most controversial part of GDP and GO. Simon Kuznets, the Harvard economist who created GDP, seriously considered not including government spending during World War II, because the funds were being spent on war material.

GO and GDP count government purchases of goods and services, but they do not include welfare payments of food stamps and Medicaid, so these two statistics underestimate the size of government. Currently government spending is 18% of GDP, but the actually size of government is over 35% of GDP when you include welfare payments.

But isn’t government spending often a drag on the broader economy?

Libertarian economist Murray Rothbard always thought GDP should be C + I - G! [Consumer Spending + Investment - Government Spending] But under the rules, if the government builds a bridge to nowhere, it increases GDP.

What some of the other problems with GDP?

GDP vastly underestimates the importance of trade in the US because it subtracts imports from exports. The reason it does this is to avoid double counting, since imports are already included in consumer spending. However, trade -- adding exports and imports -- actually amounts to over 18% of the US GDP.

On the other side, what are the criticisms of Gross Output?

One argument is that GO is simply double counting, that it counts the iron ore over and over again as it moves through various stages of production toward the final product of a hammer or a car. But what economists ignore is that each commodity is being transformed as it moves along the production process: Iron ore becomes steel, coffee beans are roasted and crushed, etc. Business is actually writing checks and funding the supply chain all along the way toward final use. Double and triple accounting are essential to the whole economic process.

Another complaint by academic economists is that GO makes national income accounting too complex. As a Harvard professor told, "Mark, students have enough trouble understanding GDP." My response: "Come on, professor, they are Harvard students! If they can understand a financial statement, they can understand the top line and bottom line of national income accounting."

What about that resistance to GO’s underlying assumption that business activity and not consumer spending drive the economy? Didn’t we see the same thinking in the debate over corporate tax cuts? The media and politicians ignored the impact of tax cuts on hiring and investment, as though these activities had little to do with the economy. It was all about “the rich.”

The media and many politicians, both Republicans and Democrats, still live under the illusion perpetuated by GDP that consumers are the most important sector of the economy, and that the key to prosperity is for consumers to "spend" their tax cut rather than "save and invest" it or expand/start a business.

Let’s talk some numbers. You have real Gross Output in Q3 GO up 2.7% (a nominal increase of 4.3%).

Real Q3 gross output was up substantially higher than the 2nd quarter, so that indicates accelerated growth. However, for the first time in several years, GO is growing slower than GDP, which is not a good sign.

GO anticipates changes in GDP. I was not surprised that 4th quarter GDP slowed down to 2.6% rate — just as GO predicted. But I think it's temporary, as the business tax cuts should encourage faster growth in 2018.

Why does GO anticipate changes in GDP?

Because consumers tend to continue buying during a recession, or cut back only slightly, while business cuts back much more sharply, depending on inventories, not new production, to fulfill new demand. During the 2008-09 Great Recession, business spending dropped much more sharply than GDP.

You’ve also noted that Gross Output grows faster than GDP in a recovery. Why?

GO typically grows faster during a recovery because businesses not only look at current demand for their products, but future demand. During a recovery, businesses start hiring more workers, ordering more supplies and increasing production in anticipation of more demand in the future.

Let’s talk a bit about FreedomFest. For those who don’t know, tell us a little about it and what you have planned for this year.

FreedomFest is billed as "the world's largest gathering of free minds," held every July in Las Vegas. The Washington Post calls FreedomFest "the greatest libertarian show on earth." It's an intellectual feast in the entertainment capital of the world. Our co-ambassadors are Steve Forbes and John Mackey, CEO of Whole Foods Market. We have over 200 speakers and exhibitors, and over 2,000 attendees each year. Both Steve and John attend all 3 days. Past keynote speakers have included William Shatner, George Foreman and, yes, even Donald J. Trump (in 2015). We have lots of debates, panels and breakout sessions on philosophy, history, science & technology, health living, geo-politics and finance. We have the Anthem Film Festival, and a mock trial, with major media coverage. This is a great place to meet authors, professors, and experts in every topic of interest.

What’s on the agenda this year?

This year our theme is "Where is the Voice of Reason?" and George Will, Judge Andrew Napolitano, Rich Lowry, Robert Kiyosaki, and many others are keynote speakers. We are also joining forces with Reason magazine in celebrating their 50th anniversary. For more information and to sign up, go to www.freedomfest.com.

To conclude, do you have any thoughts on what’s ahead for the economy in 2018?

I expect both GO and GDP to increase in 2018, barring protectionist measures by the Trump administration or the Fed aggressively raising rates. Both could hurt economic growth if enacted. Given the huge run-up in January, the current sell-off is to be expected, though unpredictable when it happens. I still expect the stock market to do well in 2018, though not likely to outperform 2017.

Where do we go to find out more about Gross Output?

The Bureau of Economic Analysis or BEA, puts out GO and GDP. Unfortunately, they release these two statistics at different times, and the media is simply not paying attention to GO. However, I've been told by Brian Moyer, the director of the BEA, that within two years they will be releasing GO and GDP at the same time, similar to what publicly-traded companies do when they release earnings every quarter.

I appear monthly on CNBC with Rick Santelli extolling the virtues of this supply-side "Austrian" statistic (after all, GO is a measure of Hayek's triangle). GO has been endorsed and written up in Forbes, the Wall Street Journal, Barron's, and other publications. You can get more information from my website, www.grossoutput.com.

Not to mention our home page at Free Market Central, where we feature your quarterly numbers. Thank you for taking the time to talk to us today.