GDP Decreases, But Is That Bad?

Contrary to most analysts’ predictions GDP actually declined last quarter by 0.1 percent, according to the BLS estimates. A decline in GDP generally indicates a contraction in the economy, but is that what’s really going on?

One of the main reasons GDP declined was a 22 percent decrease in defense spending. This is not a bad thing. Simply put, far too much of our revenue is spent on defense spending. In fact, government spending overall declined 1.33 percent from the third quarter, also contributing to the decrease in GDP growth. This highlights another problem with GDP: it doesn't distinguish between "good" spending and "bad" spending. We see that overall government spending is down. In this case, it happens to be that a decrease in defense spending is responsible. Again, not a bad thing. However, when government spending is down due to austerity measures, that threatens our already fragile economic recovery. During the current period of high unemployment, spending cuts threaten unemployment benefits, increase public sector job losses, gut higher education budgets, and so on.

When we critique the use of GDP, we often focus on how its growth does not show overall societal and economic progress. The same is also true for GDP decline. The fourth quarter decline illustrates this well. Last quarter, personal consumption expenditures increased by 2.2 percent. Residential investment grew by 15.3 percent and business investment in equipment and software grew by 12.4 percent, the fastest pace in over a year. These are all positive economic trends and indicate that our economy continues to recover from the Great Recession.

As we highlighted in our last Explainer, if GDP was used just as a gross measure of raw economic activity, it would be fine. The problem is that decisionmakers rely on GDP for policy priorities and decisions. This reliance means the solution to increasing GDP is to increase defense spending, which is not the right decision. At the same time, positive private sector trends are ignored because overall GDP growth is down. We need to start measuring what is important and not only what makes GDP grow.