Why You Should Care

Until the Great Recession hit, most Americans fell into a trap of increased consumption, the prioritization of “now” over the future. We felt the “wealth effect” (see #15) of higher house prices, cheaper goods mainly from China, stable incomes, and strong marketing messages. Saving took a back seat, despite dire warnings about the future of Social Security and retirement. The combination of weak income growth, unemployment, and asset price declines brought a sudden end to the party. The message, of course: prudent Americans should choose the path of sustained wealth, placing savings as first priority and buying only what we can afford. You should invest those savings for returns in the future, as should society as a whole.

4. GROSS DOMESTIC PRODUCT (GDP)

Gross domestic product is the sum total of all goods and services produced in an economy. As it measures the market value of all final goods and services produced by a nation, it is a fundamental indicator of an economy’s performance. It is highly correlated with personal incomes and standard of living. It can be looked at as a true measure of the value added by an economy.

What You Should Know

The calculation of GDP boils down to a sum of four items: Personal consumption plus total personal and business investment plus public or government consumption plus net exports (exports minus imports). It is thus a measure of what is consumed today (consumption) plus what is put aside for tomorrow (investment) plus our net sales to others around the world. That combined figure in turn roughly represents the income we as a nation produce from all of those activities.

Economists track both the size and the change in GDP. The U.S. GDP in 2012 was just over $14.5 trillion, but with the effects of the Great Recession, the average annual growth rate dropped from 3.2 percent (1997–2007) to an average of 0.7 percent from 2005 to 2010. More recently, it has returned to a still rather anemic 1.5 to 2 percent. GDP dropped 6.3 percent in the fourth quarter of 2008, one of the sharpest declines on record, and a true measure of the severity of the Great Recession. At that time it should be noted that other economies fared worse—Germany’s GDP went down 14.4 percent, Japan’s 15.2 percent, and Mexico’s declined by 21.5 percent in the same period. However, their base GDPs are much smaller, so the value lost in the decline was less.

The breakdown of U.S. GDP components (from 2012) is also interesting:

Personal consumption

71%

Personal and business investment

15%

Public, or government, consumption

17%

Exports

13%

Imports

−16%

The good news is that exports have increased about 2 percent since 2008, while imports dropped about 1 percent (influenced in a large measure by reduced dependence on foreign oil). Also, the public/government consumption share has declined about 2 percent, signaling less reliance on that sector. But dependence on consumption still remains high, as the following figures for China will show:

Personal consumption

35%

Personal and business investment

48%

Public, or government consumption

13%

Exports

30%

Imports

−26%

China, in contrast to the United States, is foregoing current consumption to build for the future, although the trade balance has shifted about 5 percent away from exports and toward imports—perhaps bad for China, but good for the rest of the world.

The GDP is also an important measure of standard of living. Economists measure GDP per capita—that is, per person in a nation. Here, the U.S. at $47,150 (World Bank figure from 2012) is on solid footing, although not at the top of the pack (twelve nations, including Norway, Denmark, Australia, and Qatar, are ahead on this measure). As well, economic wealth isn’t the only component of standard of living; the less measurable safety, health, leisure time, and climate go beyond GDP per capita as components of true living standards (though these are sometimes separated out as components of quality of living).

Why You Should Care

The GDP is the broadest measure of the country’s overall economic health, and it defines the economic “pie” you ultimately enjoy a slice of. If it is healthy and growing, times are good; if it is stagnant or declining, it will most likely affect your standard of living, sooner or later.

5. UNEMPLOYMENT AND UNEMPLOYMENT RATES

Most of you have a good idea of what unemployment is—especially when you don’t have a job! Economists take the same view, but add the conditions that unemployed people are not only without a job but are also available to work and are actively seeking employment. The unemployment rate is the percentage of the work force that is currently out of a job and is unable to find one, but is actively looking.

What You Should Know

Economists closely watch the unemployment rate as a signal of overall economic health. High unemployment is a sign that an economy is weak currently and will remain so. Why? Obviously, if people are losing jobs, demand is most likely falling, as are incomes and purchasing power. When people lose jobs, they can afford less, home foreclosures rise, they can save less for retirement, and their future becomes more grim in general.

Economists also recognize that there is no such thing as a true, 100 percent, full-employment economy. Some unemployment is structural; that is, created by changing job requirements—there simply aren’t as many jobs for autoworkers or office clerks these days. Some is frictional, caused by the natural changes businesses make and that people make to their lives, moving from one place to another. Some is seasonal, the result of a decline in certain jobs that are tied to particular times of the year (for example, sales clerks in retail stores during the Christmas holidays). As a result, economists suggest that an unemployment rate of about 4 percent represents “full employment.”

As you can see from Figure 2.1, unemployment rates reached an all-time low during World War II and a substantial all-time high in 1933. The numbers for that year were astounding: 25 percent overall for the work force; 37 percent for nonfarm workers (see #6 Recessions and #7 Depressions). Aside from those periods, the unemployment rate in good times decreases to about 4 percent and surges toward 10 percent in recessions, including 1982 and the most recent in 2009. More recently, unemployment rates have ticked back downward to the mid-7 percent range. Typically, when unemployment rates exceed 7 percent or so, governments go into action to stimulate the economy (see #58 Chicago or Monetarist School, and #57 Keynesian School).

Figure 2.1 U.S. Unemployment Rates, 1890–2011

Source: Bureau of Labor Statistics

Why You Should Care

Obviously, when unemployment is on the rise, it suggests a reduction in business activity, which means you should be more fearful for your job as well. You should do whatever you can to make yourself more employable, including building new skills or becoming more indispensable on your job, by building expertise and credibility within your own organization. You should also develop contingency plans, including savings cushions and prospects for perhaps doing your job as an independent contractor. Long-term employment with big companies still happens, but is less the norm than ten or twenty years ago; it has become more of a “free agent” economy, and you should hold nothing back in becoming part of it. Aside from keeping an eye on the unemployment rate in order to protect your job, it’s a smart way to monitor the pulse of the economy, which will affect your investments, your company if you’re a small-business owner, and your tax revenues if you’re in the public sector.