New GDP numbers are out, and already causing negative judgments on the new administration. But how seriously should we take them and what other forces might be at work here?
Some background.
Back in the 1930s, governments were fired up to use science to prove that their new tools and schemes for industrial planning were working. They were also interested in competing with each other to score propaganda points. It was Russia vs. the United States vs. Italy vs. Germany and so on, each regime excited to cite science to show that their policy schemes would boost output.
The result was national income accounting in the form of Gross National Product (later GDP), a formula to assess output and signal the greatness of this nation’s plan over that one.
Eventually, there was a settled formula: consumption plus investment plus government plus exports minus imports. These are gigantic categories that make no distinction between public and private while crushing all complexities inherent in production structures and the international division of labor.
In the bucket went a variety of data inputs, from sales to manufacturing profits to trade exports to fiscal stimulus. Some were fine, others not, but the theory connecting them all was cobbled together by John Maynard Keynes. His scheme imagined huge aggregates of supply and demand that characterized an entire nation, and in each category he pushed forces together in buckets to make the math work.
Since then, we’ve mostly been stuck with that exact model. The theory has come under fire since the 1950s if not earlier, and has been savaged in the technical literature repeatedly. It’s hard to find anyone alive who will rally around the original theoretical apparatus, and the journals have long made sport of poking holes in the models. Even with that, the GDP remains the same, despite known distortions, confusions, missteps, and overall nonsense.
Even bad formulas kind of work so long as the mistakes are carried over from one reporting period to another, under the assumption that errors get factored in and ultimately discounted. Let’s say you have a 13” ruler and are sewing clothes for yourself that keep not fitting. Eventually, you adapt to the wrong tool because it is at least consistently wrong. You can work with that.
It’s this way with the GDP. It is consistently wrong in consistent ways that at least render it insightful in what might have changed from that period to this one. In any case, it is all we really have by which to measure national output.
This works until it doesn’t. What causes it not to work is when one feature of the model suddenly explodes out of historical proportion (an exogenous shock). This happened during World War II when government spending exploded. Government spending is on the plus side of output, so suddenly it looked like the nation was producing like crazy, even as people’s groceries were rationed and life felt poorer than ever. Clearly something was not right.
It happened again during the pandemic response with multiple trillions flooding the economy during stay-at-home orders. Implausibly GDP did not crash over the months and years but rather trucked along at a normal pace. This was not believable. Once you subtract the government component, and adjust it for a more accurate reading of price increases through inflation, the GDP didn’t look so hot.
The lesson is that output data in the form of GDP can be instructive in normal times but when there is some big data shock, the entire thing goes kablooey and generates implausible results that defy good sense.
That is exactly where we are today. The first quarter GDP is said to have reported down again, not as much as expected but down 0.3 percent. What drove the change? There was one major factor: imports. And there was one minor factor: declining government spending that otherwise sustained GDP.
Let’s examine the import data.
Why did imports explode in valuation in the first quarter? There is a simple answer. Retailers and wholesalers both loaded up on purchases as fast and as voluminously as possible in anticipation of coming tariffs from the Trump administration. This was anticipatory buying, something that was easily expected.
The irony screams out, of course, because the whole point of the new trade policy is to reduce the trade deficit. But the law of unintended consequences kicked in. The result is a remarkable increase in the trade deficit.
The question is whether this is really a sign of recession. It seems obvious that the answer is no. Real resources had to exist in order for these import purchases, many of which pertain to intermediate goods, which are certainly going to be converted to sales throughout the remainder of this year.
We can argue about the meaning of trade deficits, but it is in no way indicative of slowing economic growth that businesses and consumers made new purchases from abroad in anticipation of tariffs. To claim otherwise is just theoretically uncomprehending.
Another factor concerns government purchases. When government takes money from you and me and spends it, it should not be classified as output but it is. The reverse is also true. When government purchases decline, leaving more money in our pockets, that surely does not represent a decline in output but it is recorded as that.
The first quarter registered bad news that is actually very good news: consumer spending outpaced government purchases.
There is a final factor that concerns the inflation adjustment. The consumer price index (CPI) for the quarter includes the January inflation report under Biden. That accounts for nearly the whole of the adjustment. Inflation fell following the inauguration of Trump. We can argue if that was a coincidence or not. But there is no disputing that it is true.
That alone accounts for the inflation adjustment that turned from positive to negative.
So we have three factors at work here that have distorted the results. But of course it makes for great propaganda that Trump has kicked off recession along with declining financial markets. This is made-for-media data reporting, perfect for the press hounds desperate to see the administration fail.
All of this was not only predictable. I and many others have predicted this for months. It is likely too that this will be repeated in the second quarter. The same voices will be screaming recession even though last time when we had two declining quarters of falling GDP, the media said it was not a recession because the labor markets were strong (they were not).
There’s another piece of actual great news in the new GDP report: the Treasury’s interest payments on the national debt actually declined for the first time since Trump was last in charge. Why is no one celebrating this achievement?
There is plenty of evidence that the lockdown recession never really went away. That puts us in the strange position of having overestimated past economic growth while underestimating current economic growth.
All told, it seems like our economic data is no better than our infectious disease data, numbers tossed around for political purposes and having not much to do with on-the-ground reality.
If the Trump administration could focus a bit, it would benefit us all to have entirely new methods and data packages to make these assessments. The current ones are not working.
