On the evening of the 26th of February, the Nobel Prize in Economics that had been awarded in 1971 to Simon Kuznets was offered by Nate D. Sanders Auctions and found a buyer at $390,848.
Statistically, it is likely that very few households are familiar with Kuznets’ name — but his work appears in headlines and is discussed on the evening news and in coffee shops in the U.S. and around the world. Simon Kuznets was the father of a system of national accounting, the process that comes up with our gross domestic product and allows us to assess how the economy is doing.
As you might expect, it is a very tedious process, and was especially so in the days before computers were available to assist with tabulating data. Kuznets labored on this in the 1930s but like many scientific research projects his work received little attention until World War II. Suddenly, it was very important to know about the nation’s total output of goods and services.
It was also very important that our enemies not know anything about our output capabilities and production, so Kuznets’ efforts were classified as secret. That added a cache to national accounting of course, but after the war it was no longer necessary. Besides, with the Employment Act of 1946, national accounting had become an integral part of American domestic and foreign policy. It became, in fact, the standard measuring tool used to evaluate the effectiveness of economic policies — and its newly acquired prominence in national thought dragged the rest of economics along with it.
One of the things that Kuznets’ national accounting system allowed was a systematic calculation of economic growth. Over time, growth measurements have come to dominate public thought on the economy. In fact, the Commerce Department releases on GDP and its components are expressed, analyzed, and discussed mostly in terms of in growth rates.
The most recent data available is the “second estimate” for the fourth quarter of 2014 and it shows that real GDP grew at an annualized rate of 2.2 percent. That is a substantial reduction from the initial estimate, which was 2.6 percent, and both show a significant slowdown from third quarter, which came in at 5.0 percent.
Within that slowdown, though, there are some encouraging signs. Personal consumption expenditures grew, indicating continued consumer confidence — although this is tempered by subsequent information on consumers’ banking, not spending, their bounty from lower oil prices. Business investment grew slowly but at least at a rate consistent with overall growth of the economy.
There are two elements of the GDP accounts which, for different reasons, are almost always difficult to interpret: federal government spending; and inventories.
Federal government expenditures are a net addition to GDP, but their level in any given quarter is determined by factors unrelated to the economy. This is particularly noticeable in defense spending, where global or national emergencies can dramatically impact expenditures, but other areas of federal operations are subject to similar effects.
Increases in inventories are considered positive in the national accounting system, but inventory levels also contain portions of what economists call “unintended investment” — often due to overestimated demand or a downward slide in consumer expenditures. An increase in inventory levels, then, might reflect growing confidence in the economy or it could reflect other, less positive causes.
Because both federal expenditures and business inventories require analysis and interpretation a case can be made for looking at the GDP data without them, in the same way that corporate earnings in accounting reports are often looked at “pre-tax,” “pre-tax and pre-interest” (EBIT), or even EBITDA (Earnings-Before-Interest-Taxes-Depreciation-Amortization).
In the private sector world, these modified accounting reports are used by investors and analysts to strip away the effects of long-term financing decisions and of tax payments that reflect legal structure or even may reflect prior time periods. The goal is to look at the strength of the business as an operating entity.
In a similar way, we could look at our GDP accounting report and strip away the impact of changes in government expenditures and inventories. The goal is to look at the strength of the economy and its ability to grow at a rate that will increase employment and income.
If we were to look at the fourth quarter of 2014 in that light, for example, our economy appears a bit stronger than the total report suggests — because federal expenditures declined enough in that quarter to have a negative impact.
We owe a debt to Simon Kuznets, for his imagination and his efforts. We cannot repay it, but we can acknowledge it by appreciating our national accounts system for the achievement it is and putting it to the best use possible.
James McCusker is a Bothell economist, educator and consultant. He also writes a column for the monthly Herald Business Journal.
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