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The US government could soon reshape how we measure the economy

How much does that giant cupcake add to the economy? It's complicated.
How much does that giant cupcake add to the economy? It's complicated.
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Even if you don't know what gross domestic product is, chances are you still sort of know what it is. GDP is the most common way to measure the size of the economy. It's released on a quarterly basis and updated regularly, and those readings always make news. They can also heavily influence stock markets, not to mention policymakers like Fed Chair Janet Yellen.

But tomorrow the Commerce Department will start releasing quarterly updates on a different measure of the economy's size: gross output. This has a few people in the economics community very excited.

Why does it matter? Here's a primer on a different way to measure the size of the US economy.

What is gross output?

The best way to explain is by starting with how gross output differs from GDP, as the two together both try to measure the level of activity in the economy.

Imagine you own a bakery and you sell a dozen cupcakes. GDP measures how the economy is doing by tallying up the value of finished goods, in econspeak. That means it would count the money a customer pays you when you sell a dozen cupcakes. It would also count the new Kitchenaid mixer you bought to make those cupcakes — another finished product. However, it wouldn't count the flour or butter you bought to make the cupcakes — in econspeak, the flour and butter are intermediate goods.

Unlike GDP, GO includes those intermediate goods. So the flour and butter and baking powder and confectioner's sugar and so on would be counted, as well as the mixer and the cupcake. (And for Kitchenaid, it would count all of the steel and plastic that went into making that mixer, and so on.)

How does this play out on a bigger level?

It means that the quarterly total gross output reading will be much bigger than GDP, since it will include all of that flour and sugar, as well as the steel that goes into cars and the lumber that goes into houses. For example, the Bureau of Economic Analysis (which releases GDP and GO figures) found that in 2012, GDP totaled around $16 trillion, while gross output totaled nearly $29 trillion. The two also won't necessarily move in tandem; one could climb while the other holds steady.

It also will show a totally reconfigured picture of what drives the economy. GDP is the total of consumer, business, and government purchases of finished goods, plus the balance of exports minus imports. Including intermediate goods like lumber and flour will mean the consumer share of the economy will shrink considerably in comparison to other areas — businesses buy all sorts of intermediate goods, but by definition consumers don't.

So what's the big deal?

How you measure the economy can shape how people think about the economy, say GDP's critics.

"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," writes Mark Skousen, an economist and presidential fellow at Chapman University, in an op-ed for the Wall Street Journal. Measure GDP and consumer spending is almost 70 percent of the economy, he says, Use GO and it's less than 40 percent.

The logical conclusion of that is that if you were a lawmaker looking at GO, you might conclude that supply-side policies are really important, since this measure shows a big amount of activity in the business area. GDP, meanwhile, shows that consumer spending is a bigger share of the economy. Skousen, who has been promoting gross output since the 1990s, says this promotes the "fallacy" that consumers drive the economy.

"Consumer spending is largely the effect, not the cause, of prosperity," he wrote on Forbes.com in 2013.

It's no surprise, then, that conservatives are among the biggest proponents of GO. Steve Forbes, former Republican presidential candidate, CEO of Forbes, Inc., and editor in chief of Forbes magazine, is also really excited, as evidenced by an April 14 column titled: "New, Revolutionary Way To Measure The Economy Is Coming — Believe Me, This Is A Big Deal." In that column, he says Skousen deserves a Nobel for his efforts.

How new is gross output?

Proponents like Skousen have trumpeted that this is a new development for the Bureau of Economic Analysis, the Commerce Department office that releases these statistics, but that's not entirely true. The BEA has released gross output data annually for a while, but now it's going to be measured on a quarterly basis. Because it will be released quarterly, like GDP, it could now be used as a more constant way to keep an eye on the pulse of the economy. BEA Director Steven Landefeld has himself framed the new figures as a major shift, though the concept of GO is in fact decades old.

"Gross Output provides an important new perspective on the economy; and one that is closer to the way many businesses see themselves," he has said (as reported by Skousen).

Is this a better measure than GDP?

That depends on whom you ask. Forbes and Skousen, for example, say it is a better measure because it keeps an eye on all of the transactions in the economy, not just final transactions.

But Steven Landefeld, the head of the Bureau of Economic Analysis, disagrees.

"In the aggregate it's not a good measure," he says. "This is the kind of accounting that got Enron in trouble."

The issue is that gross output double-counts lots of things. Using GDP, the consumer purchase of that $2 cupcake would add $2 to the economy. Using gross output, that cupcake would add $2, plus a share of the butter and flour and sugar and so on. In other words, the flour and sugar and butter would all be sold twice — once to the baker and once to the customer.

That would mean some industries that have lots of inputs would register disproportionately high measures of output, says Landefeld.

"Manufacturing has a lot more of this double-counting going on, if you will, in the sense that a manufacturing firm buys parts from all these different people," he says. "[Manufacturing] has longer and more complex supply chains than, say, a lawyer." That means goods-producing industries would probably look much larger, while the service side of the economy could shrink considerably in comparison.

Wait. Why release an indicator that isn't helpful?

Gross output will be helpful, just not so much as a broad measure of how big the US economy is. Landefeld says gross output will be really useful by packaging together information on individual industries that wasn't available before.

"What's cool about it is currently, yes, you have employment by industry; yes, you have profits by industry; yes, you have shipments and sales ... but none of them are pulled into one picture of what happens in an industry," says Landefeld. "This number will quarterly give you a comprehensive and consistent snapshot of how industries are doing."

That means tracking all of the activity in an industry over time could get much easier. The BEA expects that gross output will get plenty of attention.

"I think that, yes, this will be closely watched as well, because it's, one, on a quarterly basis, and now you have a way of seeing in real time how these industries are performing," says a BEA spokeswoman.

Corrected: This piece originally got imports and exports flipped around in the GDP definition, and has been corrected.