Gross Domestic Product, GDP, is a measure of what economists call the output of the nation. It measures all the money that we as a society spend in a period of time (normally on an annual basis.) GDP includes the total monies spent by consumers, businesses and the government. It records how much food we bought, how many cars and refrigerators, how much college education we purchased, how many machines industry acquired, and how much our government services cost. Last year U.S. GDP was nearly $16 trillion.
GDP is a good way to measure of the elusive idea of standard of living. Economists presume that the more BMWs and pairs of skis we own, the better off we are. (They do distinguish between “better off” and “happy.” GDP is not a measure of happiness.) A common way to measure standard of living is the ratio of GDP to the total population, or GDP per capita.
Economists look at the change in GDP over time to gauge our economic progress. Since 1970, GDP has grown an average of 3% each year. Increasing GDP defines an economic expansion, decreasing GDP a recession. As a result, much is made of the change in GDP from one three-month period (a quarter of a year) to the next, and the amount by which this quarter’s figure is greater than, or less than, the comparable quarter last year.
How should one think about the figures one hears in the news? What does a 2% increase in GDP really mean? A first cut is the fact that it is below the average of 3%. Beyond that, it is well below the growth we normally experience right after a recession, which is in the 4-6% range.
GDP growth has been around 2% since 2008. How much should it be? Think of GDP like a birthday cake. The more people you invite to your party, the less cake there is for each person. It is reasonable, therefore, to think that GDP should grow at least as fast as the population is growing, around 1% per year, in order for us to be able to consume at least as much stuff as the year before. But really, we should liken GDP to the cake and the oven we used to bake it in. Eventually, that oven is going to wear out and need to be replaced. Likewise, the capital equipment required to make all the stuff we buy needs to be replaced. This requires a higher GDP. And if we want to be able to buy more stuff this year than last, even more GDP is required to make that new stuff.
So, for the economy to be able to satisfy today’s needs and continue to create new and better products and services, we need to get GDP above 3%, the higher the better. A growing economy also produces more tax revenue for the government without raising tax rates. This is the only good solution to our debt problem.