A New Measure of Real Economic Growth

I have spent some time with historical economic data over the last several days to try and establish a new measure of real economic growth.  The work, which I will be sharing below, is something that, philosophically, I have been working on for many years.

Back in my undergraduate economics education I would hear about gross domestic product (GDP) as a measure of a nation’s economic growth.  Shortly thereafter you learn that GDP figures are always adjusted for inflation so as to better measure actual growth, not just growth on an absolute basis.

But it always seemed to me that there was another component that should be stripped out of even the “real gross domestic product” measurement.  Here I am talking about the growth of the population.  After all, more mouths to feed means a need for a larger economy, and hence, more economic growth.  Yet, feeding more mouths is not economic growth as far as I am concerned.

As I have written about on the What My Intuition Tells Me Now blog continuously is what I call “real economic growth,” that is, getting more output from the same set of resource inputs, or getting the same output from a smaller set of resource inputs.  In other words, “real economic growth” is a reflection of innovation; or great ideas that actually create something new, or save something current.

So you would think that this would be a fairly easy thing to calculate, annual gross domestic product – annual inflation – annual population growth = real economic growth, but it just isn’t easy.  Why?

Most importantly, while the number of babies born this year certainly leads to an increased need for economic output, babies just don’t produce anything that economists elect to measure.  No, not until people are much older do they start to positively contribute to gross domestic product in a meaningful fashion.

In the early years of life the primary contribution is a demand for more resources, like food, clothes, shelter and education.  But once folks enter the workforce they can add to the preceding list the output created by their actual, paid work.

So, in other words, there is a long lag between birth and economic potency.  How can you measure this?  The easiest answer is to look at economic growth 15-25 years after a population group is born.  Before looking at the data for this, let’s look at some of the very straightforward data.  Since 1933:

• the U.S. has averaged gross domestic product growth of: 7.5%
• the Consumer Price Index (CPI), standard inflation measure, has averaged: 3.8%
• the real gross domestic product has averaged: 3.6% [Note: this is not the 3.7% derived by 7.5% – 3.8% because of individual differences in certain years of economic data.]
• the U.S. population growth has averaged: 1.2%
• the raw, un-lagged, “real economic growth” for the U.S. is:  GDP – CPI – Population growth = 7.5% – 3.8% – 1.2% = 2.5%

Sources: U.S. Department of Commerce, Bureau of Labor Statistics, What My Intuition Tells Me Now Blog and Jason Apollo Voss

That last figure is the most interesting one because it says that, on average, ex-inflation and population growth, that citizens of the United States find a way of increasing the worth of their resources by 2.5% per year.  Are you surprised that the number is so low?  Don’t be.  In fact, it is often the case that productivity measures show a similar magnitude of economic efficiency.

While the above data are interesting, remember I said that there is a lag between birth and a true contribution to the economy.  So what if we deducted the population growth of 15 years prior from a real GDP figure?  What about deducting the population growth of 20 years prior?  Or even 25 years prior?  Here’s what you would get:

Average Real GDP – Population Growth of x Years Prior = Real Economic Growth (1934-2010)

• 15 years: 1.7%
• 16 years: 1.8%
• 17 years: 1.7%
• 18 years: 1.6%
• 19 years: 1.5%
• 20 years: 1.6%
• 21 years: 1.5%
• 22 years: 1.4%
• 23 years: 1.4%
• 24 years: 1.5%
• 25 years: 1.4%

Source: U.S. Department of Commerce, Department of Labor, What My Intuition Tells Me Now Blog and Jason Apollo Voss

The average of the above figures, which would include lots of overlap in the data, is: 1.6%.  For me this is a very informative result and it demonstrates just how hard it is to create something completely new.

Other interesting information from the data set include:

• The maximum real economic growth from 1934-2010 was 8.6% in 1951 using the 15 year population lag figure
• The minimum real economic growth from 1934-2010 was -7.2% in 1980 using the 24 and 25 year population lag figure

Source: What My Intuition Tells Me Now blog and Jason Apollo Voss

By the new “real economic growth” measurement you can see that 1980 was the worst year for the U.S. economy since 1934.  But interestingly enough, gross domestic product was up 8.1% that year.  However, CPI was up 13.5%.  And the population growth had been a very high 1.8% 25 years earlier.

So the “real economic growth” measurement seems to have presaged the deep 1982 recession by two years.  What about in other recessions, was there some sort of predictive ability?  Let’s look:

Recession     Real GDP     Year Prior’s Real Economic Growth (15-year lag) Declined

1958               -0.3%            -5.3%

1974              -1.9%             +4.1%

1975              -0.1%             -7.7%

1980              -5.4%             -4.3%

1982              -0.4%             +8.1%

1991              -2.0%             -1.3%

2009             -1.1%              -1.5%

Source: U.S. Department of Commerce, Department of Labor, What My Intuition Tells Me Now blog and Jason Apollo Voss

While not a perfect correlation, what is fascinating to see is that in 5 of 7 of the recessions since 1958, that the year prior’s “real economic growth” showed a marked decline from trend.  Not only that, but the failure of this measure to call the “double-dip” recession of 1982 can be forgiven.  Why?  Because the between year of 1981 was a year of rapid real GDP growth so this measure would not have predicted the recession.

Effectively then, we have a new measure of real economic growth that has called 5 of the 6 preceding recessions.  This makes sense.  What the measure is recognizing is that the economy can’t just grow on an absolute basis, it must also grow enough to exceed inflation and also to accommodate bubbles of population growth.  Those population bubbles have a way of catching up to a growing economy and sucking the juice out of it even before it is measured as a recession.  Interesting.

So what is the measure saying now?

The “real economic growth” measure, using the 15-year population lag, grew in 2010 by 1.6%, from -2.1% in 2009 to -0.5% in 2010.  This measure is communicating that there won’t be a double-dip recession.  Unfortunately, there is no quarterly data for population growth, otherwise I could compare the rolling population growth figures to gross domestic product and the consumer price index to see if the “real economic growth” measure is predicting a 2012 recession.

I hope that you enjoyed this!

Jason