Why Consumer Spending is Not the Most Important Measure of the Economy

Posted: Dec 01, 2015 12:01 AM
Why Consumer Spending is Not the Most Important Measure of the Economy

Alex Green, the chief investment strategist of the Oxford Club, recently wrote an article on the importance of Christmas in the economy and googled the question, “How much of the economy is consumer spending?” The responses came up as 70%.

This is a common response based on a fallacy in the media — that the economy is consumer-driven because 70% of gross domestic product (GDP) is made up of consumer spending. Based on this myth, reporters are always worried that consumers will stop or reduce their spending during the holidays, leading to a massive recession.

It’s a false notion, based on a misconception of what GDP is. It does not measure all economic activity. The reality is that GDP measures only the value of finished or final goods and services and leaves out all the business-to-business (B2B) transactions necessary to bring unfinished intermediate products to final use. Consequently, GDP way overestimates consumer spending and vastly undervalues business investment and spending in the so-called “make” economy.

Fortunately, the federal government (Bureau of Economic Analysis in the U.S. Commerce Department) now produces a broader, more accurate measure of economic activity called gross output (GO). I’ve been the biggest advocate of GO since writing my book, “The Structure of Production,” in 1990. The book is now in its 3rd edition.

Adjusted GO amounted to $39.0 trillion in 2015, and only $12.2 trillion of it is linked to personal consumption expenditures. That means that consumer spending makes up only 30% — not 70% — of the economy. As much as 60% of economic activity is business spending and investment. See the chart below comparing business and consumer spending.

What drives the economy? As CNBC commentary Larry Kudlow concludes, “Though not one in a thousand recognizes it, it is business, not consumers, that is the heart of the economy. When businesses produce profitably, they create income-paying jobs and then consumers spend. Profitable firms also purchase new equipment because they need to modernize and update all their tools, structures and software.”

Remember that the next time you hear that consumer spending drives the economy.

Thank you, Subscribers!

I end this Skousen CAFÉ with a big thank you to all my subscribers for another profitable year at Forecasts & Strategies. It has not been easy to stay fully invested in the face of a Chinese stock market crash, the slump in oil prices, terrorist attacks around the globe and constant doom-and-gloom predictions. Bull markets climb a wall of worry. But if you have held on, you are ahead of the game.