Value Investing – Gross Domestic Product (Lesson 21)
Gross Domestic Product is defined as the total production for the country. It is measured by including all the dollars spent to purchase products/services from all the various sellers of goods. The largest purchaser of products/services is consumers. Coming in behind consumers are businesses, remember they are buying goods too. This includes everything from office supplies to the raw materials to make the products the consumers ultimately purchase. Finally, the government spends money on materials too. Of course, they purchase items that many of us cannot afford such as aircraft carriers.
One of the problems with the formula is where the product is manufactured. It turns out the sneaker (Converse All-Star, the old Chuck Taylors, you have to be at least 45 to appreciate them) used to be made in the United States, but it is now made in China and shipped here. In reality, the product is an import. But at the same time, the United States makes products and ships them to other buyers throughout the world. Thus, the Gross Domestic Product formula makes an adjustment for exports and imports. Over the last 30 years or so, the United States imports more than it exports thus the Gross Domestic Product formula is adjusted downward to reflect the net value of the total imports in excess of the exports.
The following sections describe the four main areas of the formula and how the value is derived.
Consumer Spending
In 2013, the 290 million Americans living in the continental United States spent over 11.5 trillion dollars for goods and services. The Bureau of Economic Analysis provides a quarterly report updating the Gross Domestic Product. The consumer spending section is divided into two broad categories. They include goods and services. Goods are further divided into durable (autos, appliances, & electronics) and nondurable (traditional consumer items such as food, clothing etc.). Services are traditional expenditures for a typical family. This includes transportation, utilities, education, entertainment, insurance, health care, and many others.
Industry Investment
The US Bureau of Economics refers to this section as the Gross Private Domestic Investment and it is comprised of three groupings. The first is the non-residential group comprising purchases of new tools, equipment, and manufacturing facilities. This includes the traditional consumables the company’s use on a day to day process. The second grouping is the residential investment. This is basically the landlord investments into additional properties available for rent (apartment complexes, resort facilities and single family homes). The final grouping is the inventory volume. This comprises the increase or decrease in overall volume of inventory available for sale to the consumers. Imagine General Motors having inventory from raw materials to the final product. If their overall inventory on the books increases, they believe the consumers desire to purchase more and this grouping acts as a leading indicator of economic change. During 2013, the industry investment totaled 2.7 trillion dollars.
Government Spending
When most people talk about government spending, they automatically think of the federal government. But in reality the local and state governments (combined) spend about 1.5 times as much as the federal government. Altogether the federal government spends around 1.25 trillion dollars and the state/local governments spend around 1.88 trillion dollars. Think of all the products they purchase; from expenditures for defense down to the staples used in the local government offices. Altogether, the governments spent 3.1 trillion dollars in 2013.
Exports/Imports
For the last 33 years, the United States buys more products from foreign nations than it exports. The driving force of purchases relates to oil. The U.S. imported nearly $390 billion in 2013 followed closely behind by machines, engines and pumps at $311 billion. The next closest type of imported good was electronics at $303 billion. On the export side of the equation, the number one export for the United States is machines and engines at $213 billion. The second largest export is electronic equipment at $165 billion followed closely by oil at $148 billion. Since imports exceed exports, the net combined number is generally negative (has been for 33 years and there is no foreseeable change) and during 2013 it reached a negative 500 billion dollars.
20 Private Industry Sectors
The gross domestic product comprises 20 private industry sectors and two government groups. All together 22 distinct sectors contribute to the gross domestic product (GDP). The governmental sectors consist of the federal and state/local governments. This article will identify the 20 private industry sectors and their corresponding annual production in dollars and percentage of the total GDP.
Here is a basic table taken from a news release dated February 21, 2019 from the Bureau of Economic Analysis, Department of Commerce. See pages 9 and 10.
Take note of a couple interesting items from the above table.
- The largest industry sector is real estate at 13.3%. This makes sense as the customary number one cost for the typical family unit is housing.
- The third largest industry is finance and insurance. Again, this ties to the traditional family unit related to financing of housing and transportation.
- The fourth biggest contributor to the private side of the GDP formula is health care at 7.4%.
The governmental side of the equation contributes 12.2 percent of the total economy.
Summary – Gross Domestic Product
Based on the equation used to calculate Gross Domestic Product, the following is the result for 2013:
- Consumer Spending $11,500,000,000,000 Plus
- Industry Investment 2,700,000,000,000 Plus
- Government Spending 3,100,000,000,000 Minus
- Exports/Imports (500,000,000,000) (Remember, we import more than we export)
Gross Domestic Product for 2013 $16,800,000,000,000
Notice the number of zeroes involved? 16.8 Trillion dollars is a big number. In 2022, it is estimated the GDP will approximate $24 Trillion dollars. Act on Knowledge.