Consumption is normally the largest component of the GDP (Bureau of Economic Analysis, 2007), defined as the value of household spending on durable goods, non-durable goods, and services (Mankiw, 2012). Consumption affects households and individuals insofar as it is reflective of the standard of living; meaning that higher consumption generally is indicative of a higher standard of living and vice versa. The major determinants of consumption are income, savings, and expectations of the future and the resulting use of available credit. Of major concern to many critics of the nation’s myopic focus on GDP as the primary measure of national progress, is the focus on consumption has helped create an era of hyper consumption, where many live far beyond their means by most measures, including economically, socially, or environmentally (Cobb, Halstead, & Rowe, 1995). Indeed, the latest financial crisis and subsequent global recession can be laid at the doorstep of hyper consumption as lending institutions made cheap credit available to millions of Americans irrespective of credit worthiness; where the subsequent defaults plunged the nation and the globe into crisis (Nanto, 2009). The focus on consumption distorts the decision-making of households, businesses, and government alike, obfuscating unsustainable practices by not including their impact in the equation, resulting in hyper consumption.
“Investment is the purchase of goods that will be used in the future to produce more goods and services” (Mankiw, 2012, p. 201), including capital equipment, inventories, and structures. Increasingly, businesses pursue lean manufacturing techniques to minimize inventories, because high inventory impacts a firm’s profitability and ability to compete. In addition, high inventories can be a boon to consumers, as prices tend to drop as businesses seek to unload excess inventory.
In 2009, government purchases were nearly three trillion dollars or more than 20% of the nation’s GDP, a significant portion of the economy (Mankiw, 2012). Government purchases are the money the government spends on goods and services, rather than transfer payments that redistribute income (Mankiw, 2012). Government spending is part of governmental fiscal policy and is used as an instrument to improve market outcomes. For example, after the latest global financial crisis, government spending was increased as part of the American Recovery and Reinvestment Act of 2009, where more than $840B in federal stimulus spending was spent in the form of tax breaks, grants, and entitlements (The Recovery Accountability and Transparency Board, 2012). The impact for households and businesses was twofold; first, the economy was injected with money, improving access to credit and lowering expenses, as a strategy to fuel consumption. Second, the spending focused on job creation, awarding grants to projects that created employment for more than 200,000 new job recipients (The Recovery Accountability and Transparency Board, 2012). Government purchases make up a significant portion of the GDP and impact the daily lives of consumers when wielded as an instrument of fiscal policy to improve market outcomes.
Net exports are the final component of the GDP and is “the foreign purchase of domestic goods minus the domestic purchases of foreign goods” (Mankiw, 2012, p. 202); or put more simply, exports less imports. Net exports are removed from the GDP, because imports are counted in the components of consumption, inventories, or government purchases (Mankiw, 2012). Net exports are most commonly discussed as the trade deficit in the media and often in a negative light, as many consider the trade deficit to be the result of poor trade policy, while bemoaning the loss of U.S. manufacturing jobs. Rather, the trade deficit is the result of inflows of foreign capital because of the steep decline in personal and government savings over the last twenty years (Arnold, 2000). In other words, increased consumption and government purchases resulted in historically low savings, increasing foreign capital inflows. Arnold (2000) finds that the trade deficit is both harmful in some respects and helpful in others, but benefitting the U.S. economy in small but important ways; suggesting Congress should not alter trade policies, rather allow the trade deficit to recover naturally, or alternatively, improve incentives to encourage savings. The impact of net exports on consumers and businesses are complicated, but can be considered beneficial on the whole, while both harmful and helpful in specific instances; helpful in the sense that consumers can increase their standard of living by consuming goods at lower costs than domestically purchased products, and harmful insofar as cheaper imports result in manufacturing job loss domestically.
The GDP is the primary measure of a country’s economic growth. Very often, and specifically in the U.S., there is a myopic focus on the GDP as the primary measure of economic well-being. Indeed, Mankiw (2012) indicates that “GDP does not directly measure those things that make life worthwhile, but it does maintain our ability to obtain many of the inputs into a worthwhile life” (p. 209). In business, there is an oft-cited mantra, “if you can measure it, you can manage it”. While the GDP is useful allowing individuals, businesses, and policymakers to manage economic growth, it ignores other critical measures of well-being like sustainability, social health, and national progress.
Arnold, B. (2000). Cause and consequences of the trade deficit: An overview. Washington DC: Congressional Budget Office Retrieved from http://www.cbo.gov/ftpdocs/18xx/doc1897/tradedef.pdf.
Bureau of Economic Analysis. (2007). Measuring the economy: A primer on the GDP and national income and product accounts. Washington DC: BEA Retrieved from http://www.bea.gov/national/pdf/nipa_primer.pdf.
Cobb, C., Halstead, T., & Rowe, J. (1995, October 1995). If the GDP is Up, Why is America Down? Retrieved February 5, 2012, from http://www.glaserfoundation.org/program_areas/pdf/If_the_GDP_is_Up_Why_is_America_Down.pdf
Mankiw, N. G. (2012). Principles of macroeconomics (6th ed.). Mason, OH: South-Western Cengage Learning.
Nanto, D. K. (2009). The Global financial crisis: Analysis and policy implications. Washington, D.C.: Retrieved from http://www.fas.org/sgp/crs/misc/RL34742.pdf.
The Recovery Accountability and Transparency Board. (2012). Recovery.gov: Tracking the money Retrieved February 5,, 2012, from http://www.recovery.gov/Pages/default.aspx