Multiple choice guess-tion: On an annualized basis, the nation's gross
domestic product in the fourth quarter of 2001 went up: (a) 0.2 percent,
(b) 1.4 percent, (c) 1.7 percent, (d) still to be determined.
Technically, all of the answers are correct or were correct at one
point. The best answer right now is 1.7 percentthat's the most
recent figure released in late March by the Bureau of Economic Analysis
(BEA), the federal agency responsible for calculating growth of the
nation's gross domestic product, or GDP. But the BEA makes three estimates
for every economic quarter, and it just so happened that each estimate
came up with a different number in the fourth quarter. Same thing
happened in third quarter 2001.
In fact, GDP estimates are similarly restless over time. In a 1999
comprehensive review, the BEA remeasured 34 quarters of the economic
expansion up to that point, and not a single quarter came in at the
previously published figure. It also revised annual GDP from 1990
to 1998 an average of almost one-half of a percentage point. It came
close to revising away the negative annual growth of 1991, shaving
a -0.9 percent annual growth rate to just -0.2 percent.
Someone asleep at the national abacus? Not really. Much of the seeming
fickleness is part of the inherent difficulty of getting a tape measure
around the country's $10 trillion economywhich is more than
twice any other single economy and one-third of the planet's GDP.
In that context, subsequent revisions to GDP seem pretty minorakin
to hitting a bull's eye from a great distance, and then being disappointed
that the arrow wasn't dead center.
GDP revisions come from two main sources. The first is the time-lag
nature of data collection in such a large, complex economy, which
mainly affects the three estimates (advance, preliminary and final)
made for each quarter (which are released one, two and three months,
respectively, after the end of a quarter).
The second major source of revisionswhich mostly affect historical
GDP figures, rather than recent estimatesis a change in the
definition of what GDP actually counts or how it is counted. These
definitional changes must then be applied to past GDP estimates so
historical figures are comparable over time.
Though small in percentage, both types of revisions can produce changes
in GDP equal to the output of not-so-small countries. For example,
the cumulative increase of 1.5 percentage points from the first to
last GDP estimate for the fourth quarter of last year (the result
mostly of data lags) meant that the nation's measuring stick initially
missed $33 billion in outputthe equivalent of Morocco's entire
Brent Moulton, BEA associate director for national economic accounts,
called the fourth quarter revision "fairly dramatic"compared
with the average revisions of one-half a percentage point, but said
GDP watchers "should be aware" that significant revisions
can and do happen.
"If our typical revision were that large, it would be cause for
concern," Moulton said, but revisions of such magnitude are "relatively
rare," he said, estimating that only 10 percent of quarterly
revisions are that large.
A + B = C(omplex)
The task of measuring GDP is both fairly simple and very complex.
On the simple side, it is a basic, aggregate measure of the market
value of new production in the United States. It measures only the
value of final goods and services, and does not "double count"
items as they are bought and sold among, say, manufacturers, distributors
and retailers on their way to consumers. Nor does it count the resale
of used merchandise. It counts only the final sale of new items.
GDP measures final purchases by summing consumption, investment
and net exports of households, business and government. It considers
only those goods produced in the United States, regardless of whether
production is owned by foreign interests. Similarly, it does not
count production by U.S. nationals abroad. (The precursor to GDP,
gross national product, or GNP, did the opposite, excluding U.S.
production by foreign-owned companies but counting production abroad
by U.S. nationals. The shift to GDP was made in 1991.)
Even the building blocks of GDPso-called national income and
product accounts, or NIPAsare fairly straightforward. One
measures income, the other product, or output. NIPAs trace basic
economic flows through the country's major industrial sectors and
give GDP a useful
cross-referenceincome should equal the value of output.
Sounds simple, right? Well, it ain't. Peek behind GDPif you
dareand things get complicated quickly. Not only is the measurement
task itself Herculean, but quarterly and annual GDP estimates entail
innumerable factors, many of which are subject to change or interpretation.
For example, GDP is itself something of a proxy measure and is several
interpretive steps removed from what we're actually after, which
is national outputthe "new stuff"produced in a year:
cars, apples, shoes, lawyer consults, restaurant meals and innumerable
other final goods and services. But moving from "national output"
to GDP requires a little mental gymnastics, particularly if the
goal is to be able to compare one year's output with another.
One can't simply count the number of new things produced because
cars and apples are fundamentally different economic units. So rather
than a numerical count of items produced, we substitute the cumulative
sales of all newly produced final items, which also establishes
the relative importance of cars and apples to the nation's output.
This valuewhat people actually paid for all final goodsis
called current, or "nominal," gross domestic product.
But your math homework isn't quite finished. Such simple arithmetic
does not actually tell us much. Most importantly, it does not allow
us to compare one year's output with another because the value and
quality of goods changes regularly, and new goods are constantly
being introduced. To compensate, the BEA uses different tools to
transform nominal GDP into something more useful.
For example, the agency uses what's called the "implicit GDP
deflator." This measure adjusts the value of nominal GDP for
price inflation and provides a better apple-to-apple comparison
of GDP over time. This adjusted measure is called "real GDP,"
and is the figure typically reported by the media. (Unless otherwise
noted, all subsequent references to GDP in this article will mean
That's merely the tip of the GDP iceberg. The BEA also uses sophisticated
measuring techniques that adjust output for relative price changes
over timelike the dramatic fall of computer pricesas well
as changes in product quality. It is this complexityboth in
the size of the economy and the methods employed to measure itthat
gives birth to revisions in quarterly and annual GDP reports.
Anyone seen Indonesia?
As the fourth quarter of last year demonstrates, the advance, preliminary
and final estimates of quarterly GDP can differ rather significantly.
But most of the change stems from the lack of timely, comprehensive
data. The BEA gathers GDP information mostly from government and
private surveys, censuses and administrative records, but not all
data sources are available on a timely basis. Rather than wait until
all information is availablesome of which is only available
annuallythe BEA fills data gaps by substituting judgmental
estimates about the likely value of missing data until it receives
"harder"information. Later, revised estimates often reveal
more up-to-date information.
For example, the BEA said that much of the revision between the
advance and final estimate of fourth quarter GDP last year was the
result of "newly available" Census Bureau data on imports,
exports, retail sales and manufacturers' shipments of complete aircraft,
along with better data on federal spending from the Treasury Department.
In other words, given the information the BEA had at the timeand
no one had betterthe three different estimates for fourth
quarter 2001 were simply the best possible at the time.
Data lags even affect annual estimates. Every summer the BEA crunches
GDP numbers for the previous three years. Last year's review downgraded
2000 GDP growth from 5 percent to 4.1 percentequal to $90
billion, or Singapore's annual GDPbased mostly on lower investments
in inventory and software, and lower personal consumption expenditures.
Because new and better information trickles in constantly from a
variety of sources, quarterly and annual GDP estimates can see small
changes years later. But most historical revisions are the result
of definitional changes to the GDP formulawhat "counts"and
how it is countedby the BEA to account for a changing economy
and to take advantage of better theoretical models and improved
For example, in 1999 the BEA introduced nine definitional and classification
changes, the biggest of which was a change in how software was counted.
Previously, software purchases by business and government were considered
"intermediate" inputsin other words, they only contributed
to the final good and were not the final good itself. The reclassification
shifted software to a fixed investment, meaning it had residual
value beyond the year of purchase that would be counted toward GDP
(specifically, the BEA established depreciation schedules of three
years for prepackaged software, and five years for both custom and
own-account, or internally created, software).
This simple change had a significant effect on GDP, particularly
in the 1990s when software became a bigger part of the economy.
In a 1999 comprehensive review, the software change boosted GDP
in 1998 alone by $150 billion (the GDP equivalent of Indonesia).
Smaller definitional changes, along with $80 billion in statistical
revisions meant that 1998 saw a one-year, upward revision of $250
billion (think combined GDP of Ireland, Egypt and Peru).
In fact, it's hard to say we ever have the "final" answer
for almost any year. The 1999 study revised GDP back to 1959 to account
for the definitional changes. GDP remained unchanged for only five
years, all of them in the 1960s. Most years were revised up; only
seven were revised down (all in the 1970s).
1.7 percent = picking up speed
So what, if anything, does a "moving GDP" mean for policy-
decision-makers whose job it is to have their thumb on the economic
pulse of the nation? Is it wise to put so much weight on a figure
that is sure to change?
That depends on which estimate you pay the most attention to, and
how much weight you put on it. Of the three estimates made each
quarter, the advance estimate receives by far the most attention,
the BEA's Moulton said, because such people are trying to get the
earliest glimpse of new information on the economy, and the advance
notice "is by far the most timely" of the estimates. But
he acknowledged it is also "the least reliable by nature"
because it depends more on data estimates than the subsequent preliminary
and final estimates.
Mark Zandi, chief economist at Economy.com, said the private market
normally does not pay all that much attention to GDP announcements,
but he acknowledged that GDP estimates "do garner more attention"
at economic turning points like the third and fourth quarter of
When the advance report for the fourth quarter 2001 came in at a positive
0.2 percent, Zandi said there was a "sigh of relief ... [but]
everyone took it with a grain of salt" because revisions in the
third quarter saw the advance estimate of -0.3 percent drop to -1.3
percent by the final report. Sure enough, fourth-quarter estimates
changed as well, but for the better, moving to 1.4 percent and finally
to 1.7 percent.
And despite such revisions, research has shown repeatedly that quarterly
GDP estimateswhether the advance, preliminary or finalare
all useful indicators of the economy's general direction. A January
2002 BEA study on reliability found, as have previous studies, that
the early estimates of GDP and their components "are reliable
and present a useful picture of economic activity."
The report looked at final quarterly estimates from the first quarter
of 1983 to the fourth quarter of 2000. They found that this estimate
successfully indicated the direction of change 97 percent of time
and GDP acceleration or deceleration about three-fourths of the
time. It accurately predicted whether real GDP was high relative
to trend about three-fourths of the time, and low relative to trend
two-thirds of the time. It was also useful in finding cyclical peaks
and troughs. As Moulton noted, advance estimates are generally less
reliable than final estimates but are still useful barometers.
So, it seems, the real skill in reading GDP is being able to see general
trends in the forest, rather than exact numbers in the trees. For
instance, despite the fairly large revision from the advance to the
final GDP report for the fourth quarter, the estimates "are telling
us there was some growth in the last quarter, but less than average,"
Couple of inches short of a yardstick
Whatever the final figure, some say that any tally of GDP is a poor
national yardstick because it ignores vital parts of society. For
example, GDP fails to measure any household output done without
pay: cleaning clothes, preparing food and, particularly, raising
children. GDP goes up, however, when we pay someone to do these
things for us.
GDP also can rise because of a response to man-made events or natural
disasters. For example, part of the surprise in fourth quarter 2001
numbers came from strong government spending, which grew at an annual
rate of 10 percent, much of it the consequence of Sept. 11. Hurricanes,
tornadoes and floods also "contribute" to GDP growth because
they ruin the old stuff (buildings, cars) and people replace it
with new stuff.
Moulton acknowledged that "sometimes there's some confusion"
about the nature of GDP. Some people "misinterpret it as a
measure of [social] well-being or welfare. ... It is specifically
an output measure."
But the output model itself has its critics. For example, economists
point out that GDP gives equal weight to expenditure regardless of
its contribution to future prosperitycounting research and development
spending as no different than expenditure for soda.
GDP, we love thee
Acknowledging the criticisms, it appears no one else has been able to
build a better output yardstick than the BEA. A December 2000 paper to
the Federal Reserve Board of Governors found that GDP revisions were highly
predictable in the United Kingdom, Italy and Japan, and about half of
the variability in revisions was due to data available at the time of
the announcementstatistical noise that can be fixed, but isn't.
For other G-7 countries, including the United States, "it seems that
revisions primarily reflect news not available at the time"inherent
noise that has no volume-control knob.
So the BEA and others will continue to build better economic listening
devices. But the current model was good enough that the Department of
Commerce (which houses BEA) dubbed the development of the national income
and product accountsthe component parts of GDPthe department's
"achievement of the century."
Before NIPAs and GDP, presidents as recent as Franklin Roosevelt were
forced to design policies to combat major economic upheaval like the Great
Depression on such meager data as stock price indices, freight car loadings
and other crumbs of industrial output. In the 1930s, economist Simon Kuznets
was commissioned by Commerce to develop a set of national economic accounts.
He presented the original set of accounts in a report to Congress in 1937,
and Kuznets would later receive the Nobel Memorial Prize in economics
for his work in this area.
What we recognize today as GDP was formalized in the 1940s, when World
War II necessitated a better understanding of the nation's output capacity,
and national income accounts developed by Kuznets were adapted and expanded
to include national output (or product) measures. The rest is history
(though it's being revised).
In testimonials on the achievement, renowned economists have gushed. Nobel
Laureate James Tobin called GDP "the centerpiece of an elaborate
and indispensable system of social accounting," and added that these
innovations "deserve much credit for the improved performance of
the economy in the second half of the century."
At a commemoration event, Federal Reserve Chairman Alan Greenspan said
GDP "is a crucially important statistic to get a sense of where the
overall economy is and where it has been." One of the "most
significant ... and least heralded" contributions of the national
accounts has forced structure and consistency onto an otherwise chaotic
"I'm aware that we've got a statistical discrepancy which creates
all sorts of havoc, especially in the short run," Greenspan said.
"But what is really quite extraordinary is how small that number
is in a [$10] trillion economy."