What is Gross Output?

In economics, gross output (GO) is the measure of total economic activity in the production of new goods and services in an accounting period. It is a much broader measure of the economy than gross domestic product (GDP), which is limited mainly to final output (finished goods and services). In 2016, the Bureau of Economic Analysis estimated gross output in the United States to be $32.4 trillion, compared to $18.7 trillion for GDP.

GO is defined by the Bureau of Economic Analysis (BEA) as “a measure of an industry’s sales or receipts, which can include sales to final users in the economy (GDP) or sales to other industries (intermediate inputs). Gross output can also be measured as the sum of an industry’s value added and intermediate inputs.”

It is equal to the value of net output or GDP (also known as gross value addedplus intermediate consumption.

Gross output represents, roughly speaking, the total value of sales by producing enterprises (their turnover) in an accounting period (e.g. a quarter or a year), before subtracting the value of intermediate goods used up in production.

Starting in April, 2014, the BEA began publishing gross output and gross output-by-industry on a quarterly basis, along with GDP.

Economists regard GO and GDP as complementary aggregate measures of the economy. Many analysts view GO as a more comprehensive way to analyze the economy and the business cycle. “Gross output [GO] is the natural measure of the production sector, while net output [GDP] is appropriate as a measure of welfare. Both are required in a complete system of accounts.”

 

Origin of GO – Historical background

In his work, The Purchasing Power of Money: Its Determination and Relation to Credit, Interest, and Crises (1911, 1920), Yale professor Irving Fisher introduced a theoretical measure of “volume of trade” with his Equation of Exchange: MV = PT, where PT measured the “volume of trade” in the economy at a specified time.

In 1931, Friedrich A. Hayek, the Austrian economist at the London School of Economics, created a diagram known as Hayek’s triangles as a theoretical measure of the stages of production. Hayek’s triangles formed the basis of gross output, before GNP or GDP were invented. However, Hayek’s work was strictly theoretical, and no attempt was developed to statistically measure gross output.

Simon Kuznets, a Russian American economist at the University of Pennsylvania, did breakthrough work in the 1930s in measuring national income, “the size of the final net product.” He defined net product as follows: “If all the commodities produced and all the direct services rendered during the year are added to their market value, and from the resulting total we subtract the value of that part of the nation’s stock of goods that was expended (both as raw materials and as capital equipment) in producing this total, then the remainder constitutes the net product of the national economy of the year.” Thus, net product focused on final output only, and excluded business-to-business (B2B) transactions in the supply chain. He expanded his “net output” data to measure Gross National Product (GNP) starting in 1942.

Following the Bretton Woods Agreement in 1946, GNP became the standard measure of economic growth. Wassily Leontief, a Russian America economist at Harvard University, followed with the development of the first input-output tables, which he regarded as a better survey of the whole economy. I-O accounts require examining the “intervening steps” between inputs and outputs in the production process, “a complex series of transactions…among real people”

I-O data created the first estimates of gross output. However, Leontief did not emphasize GO as an important macroeconomic tool. He focused on gross output-by-industry, i.e., the inner-workings between industries, not the aggregate GO. The BEA began publishing GO data on an annual basis in the early 1990s, and was not updated on a quarterly basis until 2014. BEA director J. Steven Landefeld spearheaded the effort to bring gross output and gross output-by-industry up to date and released quarterly.

Mark Skousen introduced gross output as an essential macroeconomic tool in his work, The Structure of Production in 1990; see also Mark Skousen, “At Last, a Better Economic Measure,” Wall Street Journal (April 23, 2014)[10] According to Skousen, GO demonstrates that business spending is significantly larger than consumer spending in the economy, and tends to be more volatile than GDP. Earlier-stage and intermediate inputs in GO may also be helpful in forecasting the direction of economic growth. He contends that gross output should be the starting point of national income accounting, and offers a more complete picture of the macro economy. GO can be integrated into macroeconomic analysis and textbook economics, and is more consistent with leading indicators and other macroeconomic data. He makes the case that GO and GDP complement each other as macroeconomic tools and that both should play a vital role in national accounting statistics, much like top line and bottom line accounting are employed to providing a complete picture of quarterly earnings reports of publicly-traded companies.

 

What is missing from GDP?

When it comes to national income accounting, economists have traditionally taken a narrower approach, one which has led to much mischief.  They focused solely on the “bottom line” — the end product of final goods and services produced in a country in one year, known as Gross Domestic Product (GDP).

GDP has been criticized on a number of counts, but from an accountant’s point of view, it has a major drawback.  It leaves out the value the supply chain; all the business-to-business (B2B) transactions in the production process.  GDP only measures the end product, and not how we got there.  Let me explain why this is a mistake.

Let’s start with what GDP is, and what it isn’t.  Economic analysts, government officials, and the financial media refer to GDP as “the” measure of the economy.  As Diane Coyle states in her book GDP, A Brief But Affectionate History, it is treated as the “single most important benchmark measure of how an economy is doing.”  They report and analyze its components when it’s released four times a year by the federal government (the Bureau of Economic Analysis at the U. S. Commerce Department).  Here’s one way an economist explains in layman terms what GDP is:

“Total output (GDP) is the sum of everything spent by consumers on consumption goods (C), plus everything spent by business when investing in capital goods (I), plus everything spent by government in buying whatever it is that governments buy (G).”

Ignoring for now the foreign trade sector (exports and imports), this brings us to the standard textbook formula for GDP (Y):

       Y = C + I + G

Notice that this definition leaves out a critical component of spending by business: financing the production process, the supply chain, or the goods-in-process from the resource stage to finished goods and services.

I’ve created the following four-stage model of the economy to demonstrate what is  included and what is not included in GDP.  This diagram represents how all goods and services are produced.  They start out as raw commodities or resources, go through a production or manufacturing process, are then distributed through wholesale and retail outlets, and finally are sold to final users – to consumers in the form of consumer goods, to businesses in the form of capital goods (tools, equipment, machines, etc.), and to governments in the form of goods and services purchases (military, buildings, supplies, etc.).

 

Gross Output

Figure 1. Universal four-stage model of the economy.

As you can see from the above figure 1, GDP accounts only for the final stage (#4).  It ignores the value of the supply chain, stages #1 through #3.

What Consumer Spending Drives the Economy?

Why is this a problem?  Because GDP, by focusing on final output only, overemphasizes consumer spending and vastly underplays the necessary role of business financing the production process of the economy.  According to the GDP model, the breakdown of the economy is as follows (using the latest data in 2016):

 

   C =

$13,307

    I =

3,178

   G =

3,332

  NX =

-567

GDP =

$19,250

Data from The Bureau of Economic Analysis; bea.gov, for Q3 2017 [in $ billions]

Using the GDP model, consumers are the biggest players in the economy.  Based on the Q3 2017 data above, consumer spending accounts for 69.1%, or more than two thirds of the economy; government represents 17.3%; and business comes in a poor third at less than 16.5%. The percentages for these three line items add up to more than 100 because the net exports account for -2.9%

Using GDP as “the” indicator of economic performance, the financial media constantly focuses on consumer spending as the driver of economic growth, with such frequent statements as:

“Consumer spending is the lifeblood of the U. S. economy…”  Barron’s, August 15, 2016, p. M1.

“Household spending generates more than two-thirds of total economic output, so sturdy [consumer] spending gains should translate into economic growth.” – “Spending Rises, Inflation Stays Low,” Wall Street Journal, September 30, 2014, p. A2.

 “Consumer spending makes up more than 70% of the economy, and it usually drives growth during economic recoveries.” — “Consumers Give Boost to Economy,” New York Times, May 1, 2010, p. B1.

Or as the Wall Street Journal stated a few years ago, “Consumers are the engine of the U. S. economy, accounting for about 70% of economic demand…” — “Consumers Stepped Up Spending in March,” Wall Street Journal, April 17, 2012, p. A7.

These examples demonstrate how the media depends on GDP as a summary statistic for the economy.  But while GDP is a reasonable estimate of national living standards and economic growth, it vastly underestimates the full contributions of business in the “make” economy, that is, the full value of business-to-business (B2B) transactions that move the supply chain along the intermediate stages of production toward the final production of finished goods and services.  As we shall see, the value of the supply chain in the United States alone exceeded $21 trillion dollars in 2015.  In reality, business spending is considerably larger; almost double the size of consumer spending.  As we shall see below, business is the real driver of economic growth.

 

GO vs GDP

What does GO tell us?  First, GO is a more complete and full measure of economic activity, and complements GDP.  GO represents the top line (total revenues/sales at all stages) in national income accounting, and GDP is the bottom line (sales of final products only).  However, it is important to note that GDP is not the same as the bottom line (earnings, net income) in corporate financial statements.  GDP measures final output, or value added by the factors of production.  In national income accounting, value added is gross sales minus the cost of goods, and therefore includes wages, salaries, rents, interest, taxes and profit.  Thus, GDP can be compared to “gross profit” rather than “net income” in a corporate financial statement.  (I thank David Colander at Middlebury College for making this point.)

Second, it reveals the size and significance of business (B2B) spending in the supply chain.  In 2015, it amounted to $21.2 trillion, which is substantially larger than GDP itself and almost twice the size of consumer spending.  See figure 2 below.

Gross output

Figure 2.  US Business Spending (B2B) vs Consumer Spending, 2007-2016

Using GO as a more appropriate measure of total economic activity, we now get the proper perspective on what drives the economy.  When we add in the value of the supply chain (II in the equation below), we get a very different picture.

II* = $22,014
   C = 13,307
    I = 3,178
   G = 3,332
  NX = -567
GDP =  $41,264

[in $ billions]

Using GO*[1] as a measure of total economic activity, it turns out that consumer spending is actually only about one third of the economy, not two-thirds as typically reported.  Business spending (combining II and I, or $25.2 trillion) is over 60% of economic activity.  The GO model comes to a very different conclusion than the GDP model about what drives the economy.  Business is considerably more important than consumer spending.  The GO model is more consistent with economic growth theory and the Conference Board of Leading Indicators.

Third, GO tends to be more volatile than GDP and better reflects the ups and downs of the business cycle.  For example, during the 2008-09 financial crisis, nominal GDP decreased only 3%, thus vastly underestimating the gravity of the Great Recession.  At the same time, GO fell 11% from its peak in the 2nd quarter 2008 to its trough in the 2nd quarter 2009.

During the recovery and expansion phase, GO tends to rise faster than GDP.  For example, from the trough of the 2009 recession until the 1st quarter 2016, nominal GDP grew nearly 27.5% while nominal GO advanced 30%.  The results are similar in real terms.  During the 2008-09 recession, real GDP fell 4%; while real GO fell over 8%.  In the recovery stage from 2009 until 2016, real GDP rose slightly more than 10%, and real GO climbed over 18%.

The data indicates a systematic trend in the relationship between GO and GDP over the length of the business cycle.  During the expansion phase, GO tends to grow faster than GDP; during the contraction, GO declines more sharply than GDP; and during the recovery stage, GO tends to accelerate at a faster rate than GDP.

 

Conclusion

Top-line GO is a true snapshot of the total economy, because it includes both the entire production process and the final product (GDP).  It demonstrates that the business sector (B2B) is much larger than reported in the media, and is the main driver of economic growth.  GO is more sensitive to the business cycle and a better indicator of the ups and downs of the economy.  It is now being added to major economics textbooks, and more of the financial media is covering it on a quarterly basis.

In the recent past, the economics profession has become an imperial science, invading political science, sociology, history, religion, and even sports.  In finance, it launched the efficient market theory of investing and modern portfolio theory.  In accounting, it introduced economic value added (EVA) as a measure of the opportunity cost of capital, now considered the fourth financial statement.

But with gross output, the accountants and finance analysts have returned the favor.  In the 21st century, the economists have finally caught up with the accounting and finance professions by adding a top line to national income accounting.  By doing so, it has filled in a major piece of the macroeconomic puzzle.

 


[1] Unfortunately, the BEA currently uses a limited measure of total sales of goods and services in the production process. Once products are fabricated and packaged at the manufacturing stage, the BEA’s GO only adds “net” sales at the wholesale and retail level. Its official GO for the 2017 3rd quarter is $33.8 trillion. By including gross sales at the wholesale and retail level, the adjusted GO is $41.7 trillion in Q3 2017. Thus, the BEA omits nearly $8 trillion in business-to-business (B2B) transactions in its GO statistics. We include them as a legitimate economic activity that should be accounted for in GO, which we call Adjusted GO.