A carmaker buys tires so that the cars he sells can be driven off the lot. Maybe he buys 4000 tires and sells 1000 cars. The cost of the tires is included in the price of the cars, obviously. Let's say all 1000 cars are included in GDP. So now GDP already includes the cost of the 4000 tires the carmaker bought. So you don't want to add the separate purchase of 4000 tires to GDP, because then GDP would include 8000 tires. That would be double-counting: We know there were only 4000 tires involved. So economists say the purchase of the tires was a preliminary (they say "intermediate"; I say "preliminary") transaction, not a "final" transaction. And they do not add the preliminary purchase to GDP.
In our scenario, the manufacture and sale of those tires did happen. Yes, the value of all that work is included in GDP when the car sales are included in GDP. However, there are many transactions involved in the production and sale of the tires that are not separately added to GDP. That is because GDP is a measure of what we have produced. It is not a measure of the economic activity that was required for production.
GDP is a measure of what we have produced. It is not a measure of the economic activity that was required for production.
If you listen for it, you will often hear people say GDP is the size of our economy. You will hear them say GDP is a measure of all economic activity. The latter claim is most certainly incorrect. GDP is a measure of what we have produced. It is by no means a measure of all the economic activity required by the production process.
GDP is the cream floating on top, in a glass bottle of milk that's not homogenized... if you're old enough or bold enough ever to have seen such a thing.
|Source: Udder Farm Milk Cream & Cheese Company|
In order to describe where I'm going, let me begin by describing where I start. I start with GDP. GDP is "final" spending. The cream on the top. It includes most or all of consumer spending, most or all of business investment spending, and most or all of government spending. (And, yes, net exports.)
Wikipedia points out that the government component does not include transfer payments, and the business investment component does not include purchases of financial products. The former (I think) are counted in GDP as part of the consumer spending component; the latter (Wikipedia says) are saving, not investment.
But let me put it the way I put it the other day:
Back in the late 1970s when I got my three credits in macro, they said GDP equals consumer spending plus business investment plus government spending plus net exports.
See it? GDP includes business investment, but not all of business spending.
Almost missed that, didn't you, in the flurry of details about transfers and financial products. If you take all of business spending and put it in two piles, the pile of business investment spending would amount to about 18% of the cream floating at the top of the milk bottle. The other pile of business spending, the pile that's not investment, completely fills the bottle below the cream.
Got it now?
I want to take final spending -- GDP, the cream on the top -- and add to it the non-final spending that represents actual economic activity, but is written off as business expenses, filling the milk bottle in the process.
I have to do this by poke-and-hope, as I've never seen it done by someone who might actually know what they're doing. I'm thinking businesses write off their non-final expenses, but they also write off (or at least they depreciate) their final expenses. So I think if I look at total business tax deductions I will get both final and non-final spending all in one number. I can live with that.
But the final part of that number is already included in GDP. If I take GDP and add total business income tax deductions (as an estimate of total business spending) then I will be double-counting final business spending. So I need to start with GDP, subtract out the business investment component, and then add total business tax deductions. And this will give me a number that represents the dollar value of the economic activity that was required for the production of GDP.
In words it sounds complicated, but the arithmetic is simple:
where I is the business investment component of GDP.
In order to figure the numbers for economic activity required for the production of GDP, I need the numbers for GDP. That's simple enough; I can get them from FRED. I need the numbers for business investment. For this I can use Gross Private Domestic Investment, also available from FRED. The third thing I need is the series of numbers for business income tax deductions. For this I can turn to the Historical Statistics for data through 1970.
After 1970 I can use various editions of the Statistical Abstract. If I find the right table in the Abstract I can pull out numbers for four or five consecutive years. Then I need a later edition of the Abstract so I can grab another batch of numbers. I really want a one- or two-year overlap so I can see that there is continuity in the data. I sure don't want my graphs to show data revisions that I don't know about.
Gathering these numbers is the "inconvenient" thing, in case you were wondering.
Actually, I had this all done in time for the post of 26 June. But at the last minute I noticed a problem. I was using numbers for corporate business instead of all U.S. business. Hey, you know, corporations dominate; so if I only count corps I get the dominant effect.
Yeah, but if I only count corps, I may misinterpret the growth of the corporate economy as the growth of business. I think non-corporate business faded as corporates rose, so that the growth of business spending would be less than the growth of corporate spending, and less than my first series of numbers were showing. But I'm not sure, and I can't be sure until I get a second batch of numbers completed, numbers that include proprietorships and partnerships as well as corporate businesses.
That's what I'm doing now.
Man! That takes hours.
I got numbers for 1959 thru 2008. That's decent.
Okay, here's what I got:
|Graph #1: Federal Spending relative to Final Spending (blue)|
Federal Spending relative to Final + NonFinal Spending (red)