Demystifying GDP

Gross Domestic Product (GDP) is one of the most widely used and cited economic indicators.  One cannot discuss the economy of a country or a region without talking about the national or regional GDP. However, many often misunderstand GDP. Specially, some may confuse GDP with the value of the total output (revenue) of an economy.

The reason GDP is misunderstood can be traced to its intended use. The origin of GDP is the need for an economic indicator to measure the overall size of a national or regional economy, so that people can compare which country has the largest or second largest economy in the world. When we think of a business such as a retail shop or a manufacturing plant, we typically use their total sales or revenue as an indicator of the size of their business. For example, Fortune magazine routinely publishes America’s 500 largest companies based on their total revenue. Similarly, when we need a measure of the size of a national or regional economy, it is natural for people to think of this measure as the sum of the revenue (output) of all businesses in a country or region.

While that thinking has its merit, total output (revenue) it is not a good indicator of a true size of the national or regional economy because it allows the possibility of double counting, which could inflate the size of an economy. Consider a business, which buys cotton from famers, and make shirts for the consumer. It has two plants—one turns cotton into fabric, and the other plant has sewing machines to stitch fabrics into shirts. Each shirt sells for $50 dollars. If the business makes only one shirt, the total revenue for the company is $50. 

What if the owner decides to split the two plants into two separate businesses: one produces fabric and the other purchases the fabric and produces shirts?  If the price of the fabric is $20, the total revenue of those two separate companies are $70, while the total sale of the company prior to split is $50. Even though only one shirt is produced in the process, the total output jumps from $50 to $70. One would think the economy represented by two companies is larger, even though only one shirt is produced. The difference is that the value of the fabric is included in both the revenue of the fabric and shirt companies.  This example shows that summing up total output (revenue) of all businesses in a country or region is not a good measure of the true size of the economy due to the fact that the value of the intermediary goods (in this case the fabric) is counted twice or multiple times.

Thus, the concept of GDP was born. GDP is the sum of all companies’ total sales minus the value of the intermediary inputs.  The difference between the total sales and the intermediary input is also defined as the value added of a business. Another commonly used definition of GDP is that it is the sum of consumer expenditures, business investment, government spending, and net exports. This definition is equivalent to the total value added of a country or region, because this definition counts only the value of final products and services; and not the value of intermediary products.

What types of values are added to the intermediary inputs and turned into another product? As the following diagram shows, the main components of value added are the labor income, business tax, and gross surplus.  In addition, gross surplus is made up of the consumption of capital (or depreciation), corporate profits, and other income such as rents, interest, and proprietors’ income. 

In 2014, U.S. GDP (or value added) was 54% of the total output of the country. Within GDP, more than half (53%) of it is labor income, with the rest making up gross surplus and business tax.

De-mystifying GDPDe-mystifying GDP

Recession on the Horizon?

Due in part to recent stock market volatility, fears of another recession have been growing. This despite a relatively healthy U.S. labor market and few indications that the economy is slowing with the exception of weakness in the manufacturing sector.

Nobel laureate Paul Samuelson famously said, “The stock market has called nine of the last five recessions.” That is, stock market declines often give us false positives.

The yield curve is one of the few predictors of recessions which does not send out false positives. An inverted yield curve (i.e., when short-term interest rates are higher than long-term interest rates) has preceded each of the last seven recessions.

The chart below shows the difference in basis points (i.e., one hundredth of a percentage point) between the yield on the 10-Year Treasury and the 3-Month Treasury going back to 1987. The spread turned negative before all three recessions over this period. Currently, the yield spread is 163 basis points.

Treasury Yield Spread: 10-Year Bond and 3-Month Bill (in basis points)Treasury Yield Spread: 10-Year Bond and 3-Month Bill (in basis points)

Chmura’s recession model uses the yield spread among other variables to forecast the probability of recession in the next six months. Based on January 2016 data, the model estimated the probability of recession at 10%, up from just 1% in December 2015; the increase was mainly due to the drop in the stock market. According to the most recent February data, the probability of recession is 6% through August 2016—suggesting the U.S economy will continue to expand.

Probability of Recession IndexProbability of Recession Index

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Hollowing Out of the Middle Class?

We’ve heard a lot about the hollowing out of the middle class.  That is, a trend of solid job growth for middle-class Americans which turned into contraction during the Great Recession. This contraction persisted after the recession ended as more of the jobs held by the middle class moved offshore, were consolidated into fewer jobs, or were lost to productivity gains resulting from technology and innovation.

Was this hollowing out driven by the recession or is it indicative of a new norm? Chmura economists looked at this issue in 2013 and verified a clear hollowing out of the middle class, as shown in the chart below.[1] During the period from 2001 through 2011, wages were mostly stagnant, with gains exceeding inflation for only those occupations on the high end of the wage scale. Also, job growth was mainly isolated to those jobs paying the least and those paying the most (see our related post Where the Jobs Are for more).


Now, with data available through 2014 and three additional years’ distance from the end of the recession, are the jobs in the middle faring any better?

Using the same methodology as in 2013, the results demonstrate a continuation of the trends identified in the 2011 data with modest improvement. Wages grew slower than the pace of inflation for all but the 7th, 9th and 10th deciles, with deciles 2, 3, and 6 showing the slowest growth. Specifically, inflation-adjusted wages declined 3.5%, 5.0%, and 3.3% in deciles 2, 3, and 6, respectively. Similar to our findings in 2013, job growth has been the fastest in the 10th, 9th, and 1st deciles. Also, the middle class—represented by deciles 4, 6, and 7—showed negative job growth between 2004 and 2014, albeit relatively smaller declines than reported in the previous blog. 


On a more positive note, employment grew in the 5th decile, which includes occupations such as dental assistants, medical secretaries, and customer service representatives. In addition, employment grew in a number of middle class occupations between 2004 and 2014, and many are expected to continue to grow, as demonstrated in the sample selection of occupations in the table below.   

  Avg Ann
Avg Ann
Empl Growth
Interpreters and Translators 7% 4% 7
Health Technologists and Technicians, All Other 7% 2% 7
Medical Equipment Repairers 6% 3% 7
Insulation Workers, Mechanical 5% 4% 7
Occupational Therapy Aides 5% 3% 4
Medical Assistants 4% 3% 4
Industrial Machinery Mechanics 4% 2% 7
Computer User Support Specialists 4% 1% 7
Pharmacy Technicians 4% 2% 4
Physical Therapist Assistants 3% 3% 7
Medical Appliance Technicians 3% 1% 6
Machinists 1% 1% 6
Source: Chmura Economics & Analytics and JobsEQ®

Growth in high-demand occupations such as these may lead to more competitive wages for the middle-deciles that could reverse current trends. For now, the data help explain the frustration that many have felt towards slow job recovery and wage growth post-recession. Stagnant wages have not been limited to the middle; spending power declined for seven of the ten deciles. Meanwhile, the middle-wage deciles in this analysis accounted for more than 40% of all jobs where job growth has been slow, at best, for those workers over the past decade.

Research assistance for this post was provided by Johnny Constable, Claire Brunner, and Leah Deskins.

[1] This analysis was created by using over 800 occupations identified by the Bureau of Labor Statistics. We broke the occupations into ten groups based on employment and wages earned and analyzed each deciles based on job and wage growth.

Much of the Nation Still Waiting to Grow Beyond Recovery

As of April 2014, employment in the U.S. economy exceeded the 138.35 million jobs that existed when the recession began in December 2007. Employment in more than a third of the U.S. metropolitan areas, however, has yet to reach the same levels of employment they experienced in December 2007.

Recent Industry Reclassifications Have Major Impact on Analysis in Health Care, Finance Sectors

In the first quarter of 2013, many establishments that provide home care for the elderly were reclassified from NAICS 814110 (private households) to 624120 (services for the elderly). This reclassification, while appropriate according to the BLS, may cause problems for anyone analyzing the health care industry, especially in the regions that were most affected.