Is GDP Wildly Underestimating GDP?

Steve Roth | January 23, 2015 9:26 am

US/Global Economics

The markets have been showing a rather particular schizophrenia over the last dozen or so years — but not, perhaps, the one you may be thinking of. This schizo-disconnect is between the goods markets and the asset markets, and their valuations of U.S. production.

In short, the existing-asset markets think we’re producing and saving far more than we see being sold and accumulated in the newly-produced-goods markets. Take a look:

Screen shot 2015-01-23 at 6.17.38 AM

(See here for some ways to think about these measures. The spreadsheet cumulating saving is here. You can find all the data series on Fred here.)

A huge gap has emerged between what we’ve saved and what we’re worth.

Household Net Worth is the asset markets’ best estimate of what all our privately-held real assets are worth. It’s our best or perhaps only proxy for that value. (Household net worth includes all firms’ net worth, since households are firms’ ultimate shareholders. Firms, by contrast, don’t own households. Yet.) This is not just about assets like drill presses and buildings, but also skills, techniques, knowledge, organizational systems, etc. — all the tangible and intangible stuff that allows us to produce more stuff in the future. Household Net Worth at least provides us with an index of the change in that total value, as estimated by the asset markets.

As we increase our stock of real assets (“save,” by producing more than we consume), household net worth (wealth, or claims on those real assets) increases. The valuation jumps up and down as asset markets re-evaluate what all those real assets are worth — how much output and income they’ll produce in the future — but the two measures generally (should) move together.

Except: Since about ’98, and especially since ’02, that hasn’t been true. And no: zooming in on earlier periods doesn’t reveal the kind of anomaly we’ve seen since 2002.

There are two oddities here:

First, the flattening of cumulative savings: this measure was increasing exponentially for decades. Then it slowed significantly starting in the late 90s, and has gone flat to negative since The Great Whatever.

Second, the continued exponential growth of household net worth, and the resulting divergence of the two measures.

But bottom line: Net Worth and the cumulative stock of savings used to move pretty much together. They don’t anymore. What in the heck is going on?

There are three possibilities:

The asset markets are wrong. They’re wildly overestimating the value of our existing stock of real assets, and the output/income they’ll deliver in the future. See: “Irrational exuberance.”

The goods markets are wrong. The market for newly-produced goods and services is setting the prices for newly produced goods below the production’s actual value.

GDP is wrong. We’re producing something that’s not being measured by the BEA methods (tallying up what people spend on produced goods). There’s production the GDP methods can’t see in sales, so it doesn’t show up in saving (production minus consumption). But the asset markets can see it (or…sense it), and they deliver it to households in later periods, through the mechanism of market asset revaluation/capital gains.

Techno-optimists will like this last one. You’ve heard it before: The BEA has no sales-based method for estimating the produced value of free digital goods like Wikipedia, or the utility people derive from using them. They’re not purchased, so the BEA can’t “see” them. They could look at ad dollars spent on Facebook as a proxy for the value of browsing Facebook, but…that’s a pretty shaky estimation method, especially when many of those ad dollars would have been spent anyway, in other media. GDP simply doesn’t, can’t, measure that value, because nobody purchases it.

The timing sure supports this invisible-digital-goods story. The divergence takes off four to eight years after the release of the first mainstream web browser, and the global mainstreaming of the internet in general.

But it’s worth pausing before swallowing that explanation wholesale. You have to ask, for instance:

How does the internet/digital-goods story explain the flatlining of cumulative savings? Shouldn’t that continue to rise, though perhaps not as fast as net worth? Has the internet killed off sales (and accumulation) of traditionally measurable, purchased, goods to the extraordinary extent we see over the last dozen-plus years?

Are the asset markets seeing something else that GDP can’t see? Improved supply-chain management? More-efficient corporate extraction of profits from other other (less-developed?) countries? More-effective suppression of low-end wages? The rising costs of education and health care? (Which the BEA counts as consumption, extracted from saving, even though they’re arguably investment at least in part; they produce very real though intangible and difficult-to-measure long-term value/assets.) Or — here’s a flier — does it have something to do with the Commodities Futures Modernization Act and other financial “liberalizations” passed in the waning days of the Clinton administration? Something else entirely? In particular: would any of these explain the striking trend change in the cumulative savings measure?

Whatever the causes, the divergence of these two measures suggests a rather profound and singular economic shift of late — a shift that is not being widely discussed, even amidst the recent spate of commentary on Piketty’s Capital. (Piketty, by the way, defines wealth and capital synonymously — though his usages are not always consistent.) Prominent exceptions include the economists Joseph Stiglitz and Branko Milanovic, who are actively interrogating the troublesome theoretical intersection of wealth and real capital. The recent divergence of these two national accounting measures suggests that they’re tilling fertile ground for our understanding of how monetary economies work, and how we measure those workings.

Note: Technically one might add (negative) government net worth to the household measure to arrive at national net worth. But: 1. government net-worth estimates are inevitably dicey to meaningless. Government assets (and services) aren’t generally sold in the marketplace, so we have no observable sales information to base our estimates on. Liabilities are also very tricky: estimates vary massively based on your chosen time horizon and (necessarily) arbitrarily chosen discount and economic-growth rates. And 2. It barely changes the picture drawn above. Feel free to add government to the spreadsheet if you want; you’ll find estimates of net worth for the federal, and state/local, government sectors here. Net worth is — as it should be — the bottom line for each sector.

Cross-posted at Asymptosis.

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