Economic Statistics

Podcast Transcript

Every month, or sometimes every quarter, governments around the world release economic statistics.

Markets will often wait for the release of these statistics, and billions of dollars of investments will often hang on what these statistics reveal.

While the announcement of economic data will often make the news, many people aren’t aware of what these statistics actually mean. Often times they reflect something totally different than what their name might imply.

Learn more about economic statistics, how they are calculated and what they mean on this episode of Everything Everywhere Daily.

If you pay attention to the news, it will only be a matter of time before you come across some economic statistics. Data on unemployment, inflation, and economic growth is published on a regular basis by countries around the world.

This data is used to make extremely important decisions in both the private and public sectors. It is not an exaggeration to say that trillions of dollars globally are spent and invested on the basis of this data.

This data, however, doesn’t come out of nowhere. It has to be calculated and there needs to be a definition of exactly what it is that is being measured, which is actually more tricky than you might realize.

Each country has one or more agencies that are tasked with gathering and producing economic data. While there might be some differences in how the data is gathered and calculated, for the most part, it is largely similar.

There are many, many different economic statistics that exist, many of which are different ways to view economic activity.

For the purpose of this episode, I’m going to focus on economic data collection for the United States just because its the world’s largest economy and it isn’t radically different from other countries.

Let’s start with the statistic that is probably the most important and widely used: Gross Domestic Product or GDP.

GDP is intended to show the overall amount of economic activity in a country.

There are two ways that economists can calculate GDP, both of which should, in theory, arrive at the same number.

The first looks at total expenditures. In this method, GDP equals total consumer spending, plus total business investment, plus total government spending, plus the difference between exports minus imports.

The second method involves income. This way, GDP equals wages plus rents, plus interest, plus profits, plus taxes.

Growing up, the statistic that was always used was GNP or gross national product. The two numbers are actually very similar.

GDP measures the total value of goods and services produced within a country’s borders, while GNP includes the value of goods and services produced by a country’s residents, regardless of whether the production occurs domestically or abroad.

For example, if you are an Australian working in the US, your income would be part of the Australian GNP and the United States GDP.

The difference between GNP and GDP is pretty minor, usually within a single percent.

In 1993, the System of National Accounts, which is the international organization that creates the standard for national economic accounting, switched from GNP to GDP as GDP was a better reflection of economic activity within the borders of a country.

GDP, especially historical or comparison figures, can be reported two ways. There is nominal GDP and real GDP.

Nominal GDP measures the total value of goods and services using current prices, while real GDP adjusts for inflation to reflect the true value of economic output over time.

More on inflation in a bit.

GDP doeesn’t measure informal or black market activity. That means it can’t capture the economic activity of the illegal drug trade for example, but it also doesn’t capture much economic activity which is conducted in barter or cash.

This is a much bigger problem in developing countries where enormous sectors of the economy are conducted informally. Estimates put the unrecorded informal economy in some developing countries as high as 25 to 40 percent of GDP.

By the same token, some things are counted which do very little to raise standards of living. Disaster reccovery spending, needless construction projects, or large infrastructure projects paid for with foreign debt can show up as GDP.

The next economic statistic which gets a lot of attention is the unemployment rate.

The unemployment rate seems pretty straightforward. It measures the number of people who do not have a job. However, it isn’t quite so simple.

Children don’t have jobs, but it would be silly to count them as unemployed. The same goes for people who are retired, college students, or those who are disabled and can’t work.

Likewise, there are some people, like homemakers, who are not actively part of the counted labor force. There are also some people who just have rich parents and play video games all day.

The unemployment rate is calculated as the number of unemployed people divided by the total labor force, multiplied by 100 to make a percent.

Unemployed is defined to be people who are actively looking for work but cannot find a job. The total labor force is just the number of unemployed by this definition plus the number of employed.

The big problem with the unemployment rate is what is known as discouraged workers. People who have been looking for a job for a long time without success and eventually just give up.

This can become especially pronounced when times are very bad, which means the higher the unemployment rate is, the greater the odds that it is actually underreporting…..because it doesn’t count discouraged workers.

There are also always going to be people who are between jobs or people who lose jobs for cause or something that was out of their control. For that reason, full employment is not considered to be zero percent unemployment. Most economists will put full employment at around four to five percent unemployment.

Inflation is an important measurement and is probably one of the most difficult to measure. The traditional measure given for inflation is the Consumer Price Index or CPI.

Everyone knows that prices go up over time, and sometimes prices rise faster than others. However, measuring the overall increase in prices across the entire economy is very difficult to do.

The CPI is the change in the price of a basket of goods that is tracked as a proxy for the overall economy.

There are a host of problems with the CPI as a measurement. For starters, there is no way to know just how representative the basket of goods selected is.

Second, they are changing what is measured in the CPI all the time. Over the last 20 years, there have been 30 changes to the CPI, and since 1919, there have been no fewer than six major changes to how the CPI is calculated and weighted.

That means if you go back in time to make price comparisons, you are going to be using a metric that is measuring fundamentally different things.

Another problem is that some things, like technology, get better over time. Personal computers and mobile phones are much more powerful than they were 20 years ago. Even if the price for a device were to go up, and they usually go down, how do you compare a modern computer with something decades old?

There is also a problem with substitution. If beef gets expensive, for example, people might switch to pork or chicken, which would then throw off the importance of beef in the index. If you replace beef with chicken in the index, then it would reflect lower prices when, in fact, prices have gone up, which is why the substitution took place.

One of the most important expenses for most people is their rent or mortgage. However, the CPI doesn’t actually measure that directly. Instead, it measures “Owners’ Equivalent Rent,” which estimates what a homeowner could get if they rented out their house rather than what they actually pay.

Then of course, there is the problem that different places have different prices. A hamburger at McDonald’s in New York City will cost much more than the exact same thing in Des Moines, Iowa.

Because the CPI is so opaque compared to other economic statistics, it is more prone to manipulation. Many countries will adjust what is in the package of goods to make inflation appear lower so they can spend less on pension and welfare payments that are adjusted for inflation.

Many people look to the money supply as an alternative to CPI. The primary measure of the money supply is known as M2.

M1 is a measure of all the money that is in cash and checking accounts. Basically. any money that is very liquid and can be spent immediately.

M2 is just M1 plus money in savings accounts and other short-term investments like CDs.

The reason why M2 is considered a measure of inflation is because inflation is usually considered to be a reflection of the growth in the money supply.

The final statistic I want to discuss isn’t actually a government-issued statistic, but it is often used as a proxy for the overall economy, the stock market.

Various stock market indices are used as a proxy for the overall economy. The most popular of which is the Dow Jones Industrial Average.

I previously did an episode on the subject, but to summarize, the Dow Jones is a collection of 30 popular and successful stocks.

The thing to know about the Dow Jones is that it is not a measure of overall economic activity or even of all stocks. It is just 30 stocks.

The stocks that are represented change every few years. Over a long enough time, the stocks in the Dow Jones are entirely different.

The Dow Jones is not the only measure of the stock market. There are several others that include more stocks, including the Standard and Poors 500, the NASDAQ composite, the NASDAQ 500, the Russel 500, and the Wilshire 5000.

Oddly enough, the broader the index with more stocks, the more accurately it represents the state of the economy. However, the smaller indexes, like the Dow Joines, are almost always the most popular ones.

However, there are some things you always have to keep in mind. The first of which is, of course that the Down Jones is only 30 stocks.

Second is that the stocks that are listed in the Down Jones are selected because they are good, profitable companies. That means that by definition, you should expect the index to probably outperform the general economy.

However, there is more to it than that. Neither the Dow Jones nor any of the other stock indexes are adjusted for inflation. That means that when you look at the increase in the index, you need to manually adjust it for inflation to get a true sense of how much it really increased.

There is another thing that most people don’t realize. It has to do with index funds. Index funds have become a very popular way of investing. Basically, you invest in a fund that mirrors the composition of the index.

I’m not saying it’s a bad way to invest, as index funds have done quite well. However, once a stock is added to an index, all the index funds are obligated to buy it simply because it is now in the index.

That means that any stock that is listed on an index will have, at least at some level, some artificial demand for the stock compared to other stocks that are not in the index.

The point of all of this is that any stock index is going to have factors that do not necessarily reflect the underlying economy.

There is one other thing about economic statistics that you have to consider. In some cases, the government that produces them could just outright be lying.

When the Soviet Union was around, they were notorious for just fabricating their economic data. They announced growth rates that were more about propaganda than they were about any sort of fundamental reality.

A country doesn’t even have to make outrageous claims in their data to cause huge problems. Even exaggerating growth by one percent every year will have compounding effects over just a few years that will make the economy out to be something that it isn’t.

Economic statistics are very important. They are necessary for both policymakers and investors to make decisions. However, calculating them can be extremely difficult.

When you encounter them in the news, it’s just important to know what they are actually measuring and what their potential flaws are.

The Executive Producer of Everything Everywhere Daily is Charles Daniel. The Associate Producers are Austin Oetken and Cameron Kieffer.

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