In the past I have written about how the structure of GDP has changed over the years, with consumption becoming a bigger share over time. For a fuller discussion see: “The Changing Composition of GDP.”
The first graph shows that in 1960, Consumption was 62% of GDP, which means that the combination of Government expenditures (excluding transfer payments like Social Security and Medicare, which get counted as Consumption), Investment and Net Exports was 38% of the economy. Back then, Net exports were generally positive; in other words, we ran a trade surplus rather than a trade deficit.
Since then, Consumption has climbed as a share of GDP, meaning that those other parts of the economy have shrunk relative to the overall size of the economy. Net exports are now deeply negative, although at the current rate of about 3% of GDP, they are not as bad as they were a few years ago when they were over 6% of GDP. So now Government and Investment make up 32% of GDP combined.
Since transfer payments are excluded, the part of government we are talking about is the part that pays the salaries of government workers, and government investments. Those investments include aircraft carriers, but also include things like roads and sewage plants. Both public and private investment are needed to growth the economy over the long term (I’m not going to address the correct mix in this post, but will point out that we need both, and that the growth of Consumption has been causing the other sectors of the economy to shrink relatively).
The flip side of the trade deficit is a capital surplus. In other words, when we buy more from abroad than we sell, we are either selling off assets to pay for them, or going into debt abroad. Capital from abroad — either direct as in, say, Honda (HMC) building a factory in Ohio, or indirect as in China buying T-notes — has actually provided a large percentage of the investment in the country over the last few decades.
Consumption Consuming GDP
By the fourth quarter of 2009, Consumption had climbed to a record 71% of GDP. So have we turned into a nation of grasshoppers, consuming everything and putting nothing aside for a rainy day? In a word, yes.
But why? The answer is that what we have really been consuming a lot more of is health care. Note how the rise in the second chart (from this source) which shows health care spending as a share of GDP. It climbed from 5.2% of the economy in 1960 to 16.0% in 2004 (Consumption was 70.25% of GDP in the fourth quarter of 2004). In other words, health care had climbed by 9.8% of GDP over that time frame, while Consumption had increased by 8.25% of GDP over the same period.
Health care spending is overwhelmingly counted as Consumption. If you go to a doctor’s office hospital owned by Tenet Health Care (THC) it is counted as Consumption, regardless if you pay directly or if the insurance company (or Medicare) pays. However if the hospital buys a new MRI machine from General Electric (GE), that is counted as investment.
Note that the Consumption chart goes through the end of 2009, while the health care chart only goes through the end of 2004. Thus, it is not that we are as a country all going on a spending splurge and blowing our inheritance. We are spending it, but it is being spent on health care, which has risen much faster as a share of the economy here than abroad.
OK, so correlation does not equal causality, but this seems to be more than a coincidence to me. The just-passed health care reform should slow down the growth in health care expenditures as a share of the economy, but due to the slow phase-in, it will not happen over night (most of the provisions do not take effect until 2014).
However, to the extent the reform is successful at slowing the growth rate of health care expenditures, it means that we will have more resources that can go into investments for our future, and perhaps can even do that investing ourselves, rather than have it all done by capital from abroad. This should make the economy healthier in the long run.
Dirk van Dijk, CFA is the Chief Equity Strategist for Zacks.com. With more than 25 years investment experience he has become a popular commentator appearing in the Wall Street Journal and on CNBC. Dirk is also the Editor in charge of the market beating Zacks Strategic Investor service.
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