NEW OFFICIAL STAT IS "SUPPLY--SIDE" VICTORY / SPROTT ASSET MANAGEMENT

Mark Skousen: New Official Stat Is ‘Supply-Side’ Victory

By Henry Bonner (HBonner@sprottglobal.com)


Mark Skousen authored The Structure of Production, a best-seller about economics. A Presidential Fellow at Chapman University, he is also a long-time friend of Rick Rule, who has recommended his book to many of his clients and friends. In Structure, Skousen makes the case that modern economists downplay the importance of the business sector in the economy, and overstate the importance of consumer spending. In particular, he believes that the GDP should not be used as a sole measure of economic activity.

In his book, Mark argues that a more accurate picture of the economy is provided by another statistic, gross output. Gross output includes investments made by businesses in order to produce their goods, such as capital outlays on new equipment, raw materials, or other business-to-business transactions.

Over two decades after The Structure of Production was published, The Bureau of Economic Research recently announced it would calculate and publish official numbers for gross output on a quarterly basis, on the same level as GDP.

In a recent phone conversation, Mark described this event as “probably the greatest personal triumph of my lifetime,” adding, “This will have a very big effect on our current understanding of economics and investing.”

In a lead editorial in the Wall Street Journal Online1, Mark explains why he argued for the admission of GO as an official measure of the economy alongside GDP:

Why pay attention to gross output? For starters, research I published in 1990 shows it does a better job of measuring total economic activity. GDP is a useful measure of a country's standard of living and economic growth. But its focus on final output omits intermediate production and as a result creates much mischief in our understanding of how the economy works.

In particular, it has led to the misguided Keynesian notion that consumer and government spending drive the economy rather than saving, business investment, technology and entrepreneurship. GDP data at the end of 2013 put consumer spending first in importance (68% of GDP), followed by government expenditures (18%), and business investment third (16%). Net exports (-2%) makes up the difference.

Thus journalists and many economic analysts report that "consumer spending drives the economy." And they focus on retail spending or consumer confidence as the critical factors in driving the economy and stock market. There is an underlying anti-saving mentality in this analysis, as evidenced by statements frequently made during debates on tax cuts or tax rebates that if consumers save their tax refund instead of spending it, it will do no good for the economy. Presidents including George W. Bush and Barack Obama have echoed this sentiment when they encouraged consumers to spend rather than save and invest their tax refunds.

Although consumer spending accounts for about 70% of GDP, if you use gross output as a broader measure of total sales or spending, it represents less than 40% of the economy. The reality is that business outlays—adding capital investment and all business spending in intermediate stages of the supply chain—are substantially larger than consumer spending in the economy. They make up more than 50% of economic activity.

Mark also points out a second advantage to using gross output in an opinion piece in Forbes Online2: it is more volatile and shows recessions and economics booms more distinctly:

GO is significantly more sensitive to the business cycle. During the 2008-09 Great Recession, nominal GDP fell only 2% (due largely to countercyclical increases in government), but GO collapsed by over 7%, and intermediate inputs by 10%. Since 2009, nominal GDP has increased 3-4% a year, but GO has climbed more than 5% a year.

As Mark points out, when you look at GDP numbers, consumer spending occupies the biggest slice of economic activity. In contrast, looking at total spending within the economy measured by gross output, businesses take up the biggest portion of economic activity.

On the phone recently, Mark explained why the inclusion of gross output was a victory for “supply-side” economics:

“To properly understand the economy, we need to know how much businesses are spending to create goods, but that number is not included in the GDP, which only counts how much money is spent to buy goods and services that have been through all the stages of production – like hammers, books, dishwashers, or a cleaning service.

“The dispute over what matters more – consumer spending or business outlays, which is to say spending and consuming or saving and investing – has gone on for decades. Figureheads of the intellectual debate include John Maynard Keynes on the one side, advocating that growth is driven by demand, against the Austrian school, featuring Friedrich Hayek, who argued that production drove economic booms, not consumer demand.

“GDP tells you that consumer spending drives economic growth, but it doesn’t. Higher consumer spending is the effect of economic growth, not the cause. The true source of growth is investments in the stages of production to improve the quality and quantity of goods and services being produced.

“Because gross output gives a better overall view of the economy, I believe this will usher in a whole new era of economic research, and I believe it will help to restore the importance of savings and investments over consumption and spending.”


1 At Last, a Better Economic Measure. The Wall Street Journal Online. April 22, 2014

2 Beyond GDP: Get Ready For A New Way To Measure The Economy. Forbes Online. November 29, 2013.