Growth in gross domestic product or GDP—governments’ main measure of economic output—is often seen as a positive indicator. In business and investing, GDP is frequently depicted as an all-encompassing economic indicator. However, despite its ubiquity, GDP can also be poorly understood and misinterpreted. In Fisher Investments' ('FIE') review, it helps to know what GDP is—and isn’t—to evaluate claims about what it can reasonably show regarding a country’s economic health.
The nature of GDP
GDP is a flow—the flow of economic transactions taking place in a country annually or quarterly. Some statistics agencies, like Statistics Canada or the UK’s Office for National Statistics, even tabulate monthly GDP. If there are more transactions by value on an inflation-adjusted basis in one period over the last, GDP—theoretically the economy—grew.
GDP and natural disasters
Consider what this means. If a natural disaster strikes and causes billions of dollars of damage, those headline figures don’t immediately subtract from GDP per se. This is because GDP doesn’t measure accumulated wealth and therefore doesn’t take into account any property destruction, as those don’t constitute transactions. However, damage does show up as spending on construction, repairs and replacement goods.
Indirect impact of disasters on GDP
There is another indirect way natural disasters could affect GDP: in the loss of transactions that would normally have occurred. To the extent disaster—or, say, a pandemic lockdown—prevents transactions, GDP could decline if there isn’t enough growth elsewhere in the country to offset the impact. But if they are made up later as households and businesses unleash pent-up demand, GDP would then rebound. This impact to activity, however, is far harder to actually account for in Fisher Investments' ('FIE') review, as there are no counterfactuals showing what growth would have been otherwise.
Classifying economic transactions in GDP
GDP classifies economic transactions into various categories: consumer spending, business investment, government expenditures and trade. Note that GDP uses net exports (exports minus imports) when accounting for how trade impacts overall economic activity within countries’ borders. Whilst imports detract from GDP, those same imports are already counted in other non-trade categories—mostly in consumer spending. But businesses and governments also buy imported goods and services. Imports’ subtraction just nets their overall GDP contribution to zero. So we don’t consider imports as a negative. They represent demand, in Fisher Investments' ('FIE') review. That is why our research shows imports mostly rise and fall with GDP—when households are buying more stuff, it usually means they are also buying more stuff from abroad.
Government's role in GDP
Government’s GDP component is also open to interpretation. GDP’s accounting treats all public spending and investment as positive, but sometimes government can displace private activity, creating winners and losers. This can negatively affect businesses, in Fisher Investments' ('FIE') review, despite counting as growth in GDP maths.
Calculating GDP growth
How is GDP growth calculated? Here we think an important distinction to make is whether it is for real GDP, which adjusts for inflation (economy-wide price increases), or nominal GDP, which doesn’t. Real GDP tends to headline most reports we see. But we find looking at unadjusted GDP can be helpful sometimes, too. For example, charging more for the same good or service constitutes inflation—it wouldn’t add to real GDP. From a business perspective, though, that would imply firms are able to recoup rising costs.
Understanding GDP reports
GDP reports we see also tend to feature the change from one period to the next. This can be year-over-year, quarter-over-quarter or month-over-month. If the latter two, we think it is important for the GDP series to be seasonally adjusted, which removes the influence of predictable seasonal patterns—e.g., Christmas spending—to get a better sense of underlying economic trends. In Fisher Investments' ('FIE') experience, many Emerging Market countries without a long historical GDP record report year-over-year numbers because they don’t have a reliable seasonal-adjustment baseline to filter out those effects.
Annualized GDP figures
Notably, some countries—namely the US and Japan—report their headline GDP figures on an annualised basis: the rate at which GDP would grow over a full year if the quarter-over-quarter growth rate repeated for four quarters. Before comparing countries’ GDP growth rates, we suggest checking to make sure they are like-for-like on all counts.
Looking at GDP levels
Then, too, looking at GDP levels rather than rates can sometimes offer useful perspective, in Fisher Investments' ('FIE') review. For instance, during and immediately after 2020’s pandemic lockdowns, we observed GDP growth rates for many countries plunged and then surged. We found comparing GDP levels with their pre-pandemic ones more helpful at gauging the extent of the downturn—and recovery—than growth rates by themselves.
The importance of understanding GDP
The economy may seem big and complicated. But to us, given its importance in our lives, understanding how it works, its measurement—and its limitations—can improve how we make business and investment decisions. We don’t think it is always necessary for economists to explain the economy, when a little digging can demystify what experts sometimes take for granted, in our experience.
Investing in stock markets involves the risk of loss and there is no guarantee that all or any capital invested will be repaid. Past performance is no guarantee of future returns. International currency fluctuations may result in a higher or lower investment return. This document constitutes the general views of Fisher Investments ('FIE') and should not be regarded as personalized investment or tax advice or as a representation of its performance or that of its clients. No assurances are made that Fisher Investments ('FIE') will continue to hold these views, which may change at any time based on new information, analysis or reconsideration. In addition, no assurances are made regarding the accuracy of any forecast made herein. Not all past forecasts have been, nor future forecasts will be, as accurate as any contained herein.
