Tuesday, June 10, 2008

GDP not negative, but GDP per capita is

Lately there has been a lot of banter about the state of the US economy. Many (including Warren Buffett) have argued that for all intents and purposes, we're in a recession. Officially, however, a recession is defined as two consecutive quarters of negative, real (i.e. inflation adjusted) GDP growth. When you consider the fact that GDP is not adjusted for population growth, you realize this definition is pretty meaningless.

Consider country Happy, with a population of 1 million and GDP of $1 billion. If next year their GDP grows by 2.5%, pundits in the media will proclaim the economy is strong. During that same year, if the population increases by 5%, GDP per capita will have actually dropped from $1000 to $976. The standard of living of the average Happonian drop as a result, while the official numbers tell them growth is strong!

What is it we're trying to measure when it comes to GDP? Currently, the government and media seem most interested in how much the country as a whole produces (see some arguments here about why we're not in a recession). I would argue that what we should be interested in is how the people within that country are doing, to truly understand what is occurring in a given economy.

In the US, population growth is expected to be 1.2% in 2008. This suggests that if GDP growth for the country as a whole is below this, the standard of living of the average American will be lower this year. Real US GDP for the last two quarters has been (annualized) .6% and .9%. This IS a recession for all intents and purposes. The GDP for the entire country as a whole is useless without thinking about it and applying it to the population within that country.

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