What is real economic growth?

Happy Saturday to all of you out there!

Today’s post is a missive as to what qualifies as real economic growth. This may sound like a very dry topic, but having a handle on this actually then gives you a powerful tool for evaluating the health of any country’s gross domestic product (GDP) – alias, an economy.

This, in turn, allows you to accurately assess the quality of investments that exist in any nation and for any company. I have tangentially hit this topic in a couple of other postings, but here I felt it was time to address the topic specifically.

Real economic growth is not simply the inflation-adjusted gross domestic product of a country. Yes, this is what most economists use when they are evaluating “growth in the economy.” GDP represents all of the goods and services that the economy has produced domestically that have been bought and sold for dollars (or the home currency of whatever country you are evaluating).

Note: the word “domestically.” This means that a multinational corporation that is operating in India does not necessarily have its output included in the number.

Economists define GDP as being made up of four major components:

Consumer Spending + Investments + Government + Net eXports = GDP

You will almost always see this abbreviated as: C + I + G + X.

Net exports is the only “weird” number as it is really made up of two numbers: a nation’s exports – imports. For our country, imports have exceeded exports for decades.

That means that we are actually subtracting from our own economy as net importers. But big deal, that really is not that critically important except that it means we borrow other countries currency in order to purchase their goods as a net importer…meaning that they are our creditors.

Consumer spending makes up the bulk of this number and usually it is around 65-70% of the total. That’s why you see consumer spending numbers reported so prominently in the business news as it is an insight into the health of a big chunk of the economy.

OK, so here is my problem with the way GDP is evaluated as “economic growth.” The fact that consumers have found a way to spend more money on goods and services is not real economic growth.

In our economy for the last 25+ years the growth in consumer spending has come only a wee little bit from increased wages and salaries – I am guessing about half. The real growth in consumer spending has come from borrowing. That borrowing has taken the form of credit cards, mortgages with cash back features, home-equity loans, 401(k) borrowings, etc.

Let’s compare that with what I consider real economic growth to be.

Real economic growth is when an individual or group of individuals (e.g. a business) finds a way to get more output from the same set of resources.  Or, alternatively, they get the same output from a smaller set of resources.

In other words, real economic growth is when folks find a way to do something more efficiently.

Economic growth is not simply people buying more stuff. Economic growth is not simply Public Storage building more storage units for people’s stuff.

No, real economic growth is you switching from dial up modem access of the Internet to high-speed Internet access. Why? Because now you have just found a way to save time. With that banked time you can find a way to contribute to the economy.  Real economic growth is Barack Obama wanting to digitize the Nation’s healthcare records.  Real economic growth is “pay at the pump” at the gas station.  And so forth.  Does all of this make sense?

Real economic growth does not have to be about electronic technology. For example, if you find a better, faster way of getting to and from work, say a new route, that qualifies as economic growth, too.

So the troubling thing about the U.S. economy is that for too long, our economic growth has been simply an increase in consumer spending, without necessarily that figure representing an increase in efficiency in the economy.

Compare all of this with what has been happening in China or India. These countries were/are so Third World that paving a road between two cities is a boost to economic growth. Whereas, in the U.S. most of the major roads (I hope) have been paved and for 60-70 years.

Ultimately, the health of a nation’s economy should be a direct reflection of its efficient use of its resources and its ability to increase the efficiency of its assets, including human resources.

Let’s do a gut check for a second…based on the above criteria, do you feel that the U.S. has a healthy economy?  My own opinion is that, “yes” we do have a healthy economy.

The U.S. is still the engine for technological change for the world’s economies. It may be true that electronic goods are manufactured in China, but often the technology invention was created here.

However, and this is a big “however,” a goodly portion of U.S. economic growth has really just been a measure of the frequency with which U.S. cash registers have been ringing.

So when evaluating the health of the U.S. economy, or a Barack Obama stimulus package, or your route to work, or your personal use of electricity at home, or your General Practitioner’s paperwork system, or the crowdedness of your local mall, or the country’s obsession with flat panel TVs, or the increased vacation time received at work, or whatever, you now have a basis for evaluating it economically.

Now let’s evaluate a news item from yesterday’s business news as a form of a test case.

Circuit City, after having had itself on the business auction block for a goodly portion of 2008, has removed itself and has said that it will instead close all of its stores and shut down as a business. Whoa! This sort of thing hardly ever happens. Almost always a business of Circuit City’s caliber will be purchased by a competitor.

So what does it say about the state of the U.S. economy that Circuit City couldn’t find a buyer? Take a minute with this one. Ideally you come up with your own answer. Your answer is just as good as mine as I will be speculating, just like you will be speculating. Yes, I used to get paid for this stuff, but now you can, too. Have I killed enough time? Have you stopped reading, sat down with this and figured it out for yourself? Go ahead and do that right now…

I think that Circuit City’s inability to find a buyer is a strong sign that the winds of Consumer Spending have changed quite dramatically. It is a sign that consumers are starting to save money, not spend it.

What are they saving for? A rainy day, yes, but also many of us have all started to realize that we need to invest for our futures, not just spend for our present moments.

In other words, no prospective buyer of Circuit City could imagine there being enough consumer demand for what Circuit City had to offer, for anyone to bid high enough to buy it. This means that consumer glut will be taken out of the economy. Presumably, those “lost” Circuit City revenue dollars will turn into consumer savings.

I believe this is a tremendously healthy thing. Much more importantly, what do you think?

Have a great weekend!

Jason