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The sky is blue …

… news at eleven.

The National Bureau of Economic Research (NBER), the official business-cycle dating body for the U.S., has declared that the United States is in a recession and that it started in December 2007.

The data were a little confusing in calling the timing.  Gross Domestic Product (GDP) and Gross Domestic Income (GDI) are two sides of the same coin.  Figures regarding their levels and growth rates ought to be the same and differ only because of statistical (i.e. counting) errors.  From the formal release:

The committee believes that the two most reliable comprehensive estimates of aggregate domestic production are normally the quarterly estimate of real Gross Domestic Product and the quarterly estimate of real Gross Domestic Income, both produced by the Bureau of Economic Analysis. In concept, the two should be the same, because sales of products generate income for producers and workers equal to the value of the sales. However, because the measurement on the product and income sides proceeds somewhat independently, the two actual measures differ by a statistical discrepancy. The product-side estimates fell slightly in 2007Q4, rose slightly in 2008Q1, rose again in 2008Q2, and fell slightly in 2008Q3. The income-side estimates reached their peak in 2007Q3, fell slightly in 2007Q4 and 2008Q1, rose slightly in 2008Q2 to a level below its peak in 2007Q3, and fell again in 2008Q3. Thus, the currently available estimates of quarterly aggregate real domestic production do not speak clearly about the date of a peak in activity.

The brief respite in the middle of 2008 appears to be the result of the first fiscal stimulus package.  Nevertheless, it seems quite clear that the overall trend has been downward.

The committee declared December 2007 as the peak after looking at payroll (i.e. employment) data:

Payroll employment, the number of filled jobs in the economy based on the Bureau of Labor Statistics’ large survey of employers, reached a peak in December 2007 and has declined in every month since then. An alternative measure of employment, measured by the BLS’s household survey, reached a peak in November 2007, declined early in 2008, expanded temporarily in April to a level below its November 2007 peak, and has declined in every month since April 2008.

… and personal income (less transfer payments):

Our measure of real personal income less transfers peaked in December 2007, displayed a zig-zag pattern from then until June 2008 at levels slightly below the December 2007 peak, and has generally declined since June.

… and real manufacturing and wholesale-retail trade sales:

Real manufacturing and wholesale-retail trade sales reached a well-defined peak in June 2008.

… and the Federal Reserve Board’s index of industrial production:

This measure has quite restricted coverage—it includes manufacturing, mining, and utilities but excludes all services and government. Industrial production peaked in January 2008, fell through May 2008, rose slightly in June and July, and then fell substantially from July to September. It rose somewhat in October with the resumption of oil production disturbed by hurricanes in the previous month. The October value of the industrial production index remained a substantial 4.7 percent below its value in January 2008.

The only really interesting thing in all of this to me is to observe that the first fiscal stimulus and the corresponding positive growth in 2008:Q2 saved some embarrassment for the Republican Party.  The negative 2008:Q3 figures were only released on the 25th of November, three weeks after the U.S. election.  Had the 2008:Q2 figures been even faintly negative, there may have been considerable (and, I think, reasonable) pressure for the recession to have been formally recognised in the middle of the campaign.

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Australia, you’re not as rich as you think you are

We’re covering this in my EC102 classes this week and I thought it interesting enough to share with a wider audience:

Looking at what goes into GDP is usually a pretty tedious affair, but the simplest way to think of it is like this: GDP is meant to represent the total value added. It is new work done; new stuff produced.

One upshot of this is that new houses are counted in GDP, while sales of existing houses are not. This is because sales of existing houses are just value transferred – an exchange of assets – and so don’t represent new effort. That’s not quite true. The real-estate agent fees and legal fees associated with the sale count, since they are new work done: they add new value by facilitating the trade.

Here’s a trick in looking at value added: we only need to look at the prices of final goods. This is because the price of the final good will represent the total value added along the entire production chain. The typical example of this used in introductory textbooks is bread:

Who Sells Price Value added
Farmer Wheat $0.10 $0.10
Miller Flour $0.20 $0.10
Baker Bread $0.45 $0.15
Supermarket Packaged and convenient bread $1.00 $0.55


The price of the final good – packaged, convenient bread – is $1.00, which exactly equal to the sum of all the value added. So when the statisticians want to calculate a country’s GDP, they can ignore all the intermediate levels and just add up all the final goods that were produced.So what counts as a final good? Anything that gets sold to someone for consumption or investment. That might be to an individual, or to a private firm, or the government, or someone overseas. (Of course, since I buy both bread and flour from my supermarket, flour is sometimes an intermediate good and sometimes a final good; but it’s easy to tell which is which – flour sold by the supermarket is final, while flour sold by the miller is intermediate.)

Now consider a country that has a large natural resource sector. Australia is a great example. So are all the oil exporting countries. We’ll pick the mining of iron ore in Australia as an example. Just like with the wheat above, there is a whole range of production possibilities based on the iron ore. However, when it’s exported, the final good that gets counted from the point of view of the Australian economy is the iron ore in the ship as it sails off to another country.The mining companies are definitely adding value. They’ve got to find the stuff in the first place, dig it up, clean it a bit to get rid of the dirt, transport it to the coast and then ship it overseas. They’ve also got to maintain all their equipment and allow for the fact that they wear out over time. All of that is new effort. But the price that India or China pays for the ore is more than cost of doing all of that. A large fraction of the price they pay represents the market value of the underlying asset – the ore – itself. But since the mining company didn’t actually produce the ore, that part of the price shouldn’t really count in GDP, for the same reason that when existing houses are sold, only the agent and legal fees are counted. None of this is really news.

When natural-resource-based industries are only a small part of a country’s economy, there’s not too much distortion, so we tend not to worry about it. But when those industries represent a large share of the national income, then the overestimates can be significant. In Australia, mining represents about 6.7% of the national economy. A fair chunk of that will be “true” value added, but a large share of it is really just the transfer of assets. How much? Well, BHP currently has a Return on Equity of 49%, while the long-run, risk-free return on capital is more like 8-10%. So as a very rough guess, assuming that BHP is representative of the mining industry as a whole and that the mining industry is competitive, we might suggest that Australia’s “true” GDP is at least 39% * 6.7% = 2.6% smaller than we think it is.

Some people might at this point wonder about the farmer back in the bread example. What if the farmer who, like BHP, is taking something from the land, is actually only adding 60% of the value that we think she is? The answer lies in the fact that there is a large production chain that builds up from the farmer’s wheat. Even if we remove a large fraction of the farmer’s value-added, that is only a small share of the total value added that we see in the final good’s price. So we would expect this overestimate to be very small overall. The point about mining is that we are only adding a small amount of value relative to that of the asset we are trading away, so as a percentage of the final good, the asset itself is quite large.