Edward Lotterman
The Commerce Department’s Bureau of Economic Analysis last week released its “advance estimate” of U.S. Gross Domestic Product for the first quarter of 2025.
GDP measures the total market value of all final goods and services produced in the country over a period of time and is one of the key indicators of how an economy is performing. Despite acknowledged one-off data anomalies, it showed a very slight decline from the start of the year.
This is not good news, it means the nation’s economy contracted, but the response to it has been overwrought.
If instead of a 0.3% decline in output, it had been a 0.3% increase, the hubbub would be much less.
Of the four basic elements to GDP, consumption, investment, government spending and net exports, the three most closely related to domestic production were all positive. The decline came from a sharp increase in imports clearly driven by fear of President Donald Trump’s forthcoming tariffs. Companies that import supplies were stocking up before the higher prices kicked in. The anomaly is how the bureau factors in the impact of these imports into its estimate of overall GDP.
The quarter ended a month ago. The tariffs are now kicking in. This rise above usual import levels almost certainly has already flipped to a sharp drop that will worsen, and be reflected in the second-quarter estimate come July.
Let it be clear. Trump’s overall economic policies are bad. They will harm our nation. His trade policies are the worst of these. The odds that we are sliding into recession — defined generally as two consecutive quarters of negative growth — are high. Any recession is likely to be severe. But this most preliminary of three estimates of a quarter’s GDP shows little that is definite.
This coming Tuesday, May 6, will bring us a report on “U.S. International Trade in Goods and Services, March 2025.” The more reliable “second estimate” of January-to March GDP comes out May 29. April’s “U.S. International Trade in Goods and Services” will be out a week after that. These will all tell us more about where we are headed. However, we then need to wait until July 30 for the advance report on second-quarter GDP. That will give us even more certainty on how well our goose is being cooked.
In the meantime, if you want to understand events that are unfolding, begin by understanding GDP.
First, it is a measure of the value of output. That is important to remember. Don’t make it bigger than it is. Journalists have gushed, “Economists agree that GDP is by far the most important indicator of how an economy is doing.” Over 44 years in this field, I have never heard any economist say that nor seen it in any textbook. GDP is an important indicator, taken together with several others. Full stop.
Second, GDP has distinct limitations. Every 19-year-old taking intro macroeconomics at the U must memorize these by the second week. They are detailed in every textbook. Yet one constantly hears complaints like “but people don’t realize that GDP ignores ___________ !” The blank is filled with one of the limitations that are detailed in every macro textbook. Here are the important ones to remember:
GDP is a measure of the value of new things produced. It does not subtract things produced in previous periods that are thrown away. Do that and you get “net domestic product.”
GDP is a measure of flow, not a balance sheet of assets and liabilities. It measures new lumber, gasoline or steel cranked out, but is not adjusted for trees cut down, oil pumped or iron ore mined.
GDP is not adjusted for external effects, either positive or negative. If producing something harms health or the environment, that is bad, unless such damages can be measured in monetary terms, such as medical bills, they must be accounted for in other ways. If a product benefits people beyond those who bought it, that’s great. But again, this positive side effect must be measured some other way.
GDP makes no value judgement about the inherent goodness or badness of any good or service. You may think sports activities for disadvantaged teens do more for society than strip clubs, or that yoga classes are better than shooting ranges, or vice versa, but what goes into GDP is the money paid for each activity.
Some “goods” may reflect societal “bads.” If more people get drunk and drive and crash, then we will spend more money on tow trucks, body shops, ambulances, emergency rooms, orthopedic surgeons, undertakers and tombstones, all of which will add to GDP. A crime wave may force people to spend money on pepper spray, triple door locks, car and home alarms, safe rooms and self-defense classes. All will add to GDP.
Do these limitations mean that GDP is useless? No, not at all. It remains vital information. But again, it must be taken in context with other data.
Now understand what is counted.
Econ students memorize that “GDP equals consumption plus investment plus government spending on goods and services plus net exports.” All these involve “final goods,” ones that need no more handling before being used.
So purchases of food, clothing, shelter, medical care and so on make up consumption by households, the largest component of GDP. This includes “consumer durables,” things like appliances or vehicles that serve for years, but does not attempt to factor in the lifelong value these goods supply beyond the period in which they were purchased.
Purchases of expendable items, like parts, by businesses are different, since most go into goods or services ultimately bought by households. It is important to avoid double counting these. So most business spending falls into “investment.” These are “physical investments” by which economists refer to equipment, machines and infrastructure used in production that last a long time. Understand that this “investment” component of GDP does not refer to “financial investment,” such as putting money into stocks, bonds, mutual funds or bank accounts.
The government category includes all government spending on goods: patrol cars, aircraft carriers, locks and dams, school buildings and school supplies and compensation of government employees. Importantly, it does not include “transfer payments” of money to individuals via Social Security, SSI, SNAP or student aid grants.
For both consumption and physical investment, the value component used is the market price of the good or service in question. What did we pay for the underpants, yoga lessons or locomotives that we bought? But there is no market value for students educated or protection afforded by the USS Harry Truman. So government spending in GDP comes from the amount spent itself with no estimate of its value to society. This results in anomalies. In Nebraska, I-80 parallels the Union Pacific’s triple-tracked main line. The rail line produces millions in revenue each day for the UP, but I-80 supposedly produces no measurable monetary value to society beyond Nebraska DOT spending on maintenance.
“Net exports” or “exports minus imports” are the final category, and here’s where we get what happened in last week’s initial first-quarter estimate. If we produce bulldozers or airplanes sold abroad, that is part of our nation’s production. But when we import cars or toys, those are the production of some other nation. So we need to calculate the net amount. Whenever we import more goods and services than we export, we have a “trade deficit on goods and services.” That equals negative net exports.
Whenever imports climb, GDP shrinks. The new Kia car or LG TV produced abroad counts in household consumption, but it wasn’t produced here, so we need to subtract it off in the net exports category to get an accurate estimate of what we did produce.
Imports jumped in the past quarter in the weeks after Trump amped up his tariff talk. Importers rushed to get product here and through customs before the tariffs were actually charged. The big jump in imports made a big drop in net exports and hence the 0.3% drop in overall GDP.
Our nation and the world are in very troubled waters. And important data points to come out later will reflect this. People naturally want to know what is happening. But the information we use to justify our perceptions needs to be kept in context.
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St. Paul economist and writer Edward Lotterman can be reached at stpaul@edlotterman.com.
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