Further thoughts on consumption and GDP
By Scott Sumner
I was surprised at the amount of resistance to my recent claim that consumption is not a part of GDP, i.e. that consumption is not production. Here I’ll respond to two claims that don’t mean what people think they mean:
1. The BEA measures consumption when it is computing GDP.
2. Without consumption there would be no production.
Both are true, but these facts have no bearing on the issue. Yes, the BEA does measure consumption, but consumption is not included in GDP. Here’s how it actually works:
The BEA measures the production of all consumer and investment goods, which is GDP. (Actually, they separate out private consumer (C) and investment (I) goods production from public C and I production, with the latter called “G”, but that minor point doesn’t change anything.) Basically, GDP is the total domestic production of consumer and investment goods in a given period. That’s the textbook definition, and that’s what the BEA measures.
In order to determine the production of consumer and investment goods, they look at domestic consumption and investment spending, and then adjust for inventory changes and trade imbalances. That converts domestic spending on C and I goods into domestic production of C and I goods. But make no mistake, GDP does not include consumption; it includes the domestic production of consumer goods plus the domestic production of investment goods.
The second point is also misleading. Yes, consumption is the primary motivation for production, indeed almost the only motivation. But that doesn’t make consumption a part of production. Some commenters tried to imagine what would happen to production if there were no consumption. Yes, it would likely decline. But it’s also true that production would decline if there were no oxygen in the atmosphere. That doesn’t mean oxygen is a part of GDP.
All this is true regardless of whether or not you accept my critique of Keynesian economics. But if we are going to discuss the merits of Keynesian economics, it’s important to start with some facts on which everyone should agree—such as that consumption is not a part of GDP. GDP measures production, not consumption.
Peter Navarro and Wilbur Ross made the opposite mistake when they claimed that imports are a negative part of GDP. Actually, imports are not a part of GDP at all, as GDP measures domestic production.
GDP = C + I + G + (X-M)
does more harm than good. It leads people into all sorts of fallacies, including protectionism and fiscal stimulus.
I much prefer this identity:
GDP = M*V
Neither identity has any causal implications, but at least the equation of exchange is less likely to lead to erroneous public policies.