When the growth number is worse than it looks: reading the composition instead

A headline growth figure is an aggregate of several components that can move in opposite directions. Two economies reporting the same number can be in entirely different conditions, and the composition is where the information is.

The components and what each indicates

Household consumption is the largest component in most economies and the most stable. It tells you about incomes, employment and consumer confidence, and it moves slowly.

Fixed investment is the forward-looking component. Companies invest when they expect demand; they stop when they do not. A falling investment figure alongside flat consumption means firms are more pessimistic than households, and firms are usually right first.

Inventory change is the component that most often distorts the headline. Goods produced and not sold count as output. An economy where production continued while sales fell will report growth that consists of unsold stock, and that growth reverses in the following period when production is cut to clear it.

Net exports can flatter a weak economy. If imports fall faster than exports — usually because domestic demand collapsed — the arithmetic contribution to growth is positive while the underlying situation is deteriorating.

What the 2013 composition showed

Output was roughly flat. Underneath, the picture was worse than flat.

Fixed investment was falling, which is the clearest single signal a business can read about how other businesses assess the future.

Industrial output was declining, concentrated in the export-facing heavy industry that had driven the previous decade's expansion.

Consumption was holding up, supported by wage and pension increases that were not matched by productivity — which meant the support was fiscal rather than earned, and therefore temporary.

And the external accounts were deteriorating, with the current account deficit widening while reserves fell.

An economy with falling investment, declining industry, fiscally supported consumption and a widening external deficit is not a flat economy. It is a contracting one that has not yet registered the contraction.

The general method

Three questions answer most of it.

Is investment rising or falling? This is the single most informative series, because it aggregates the forward expectations of everyone who has money at stake.

Is consumption supported by earned income or by transfers and credit? The first is durable and the second is not.

Is the trade balance improving because exports rose or because imports fell? The first is strength and the second is weakness wearing the same arithmetic sign.

Why it matters commercially

A company reading a flat growth number might conclude that conditions are stable. A company reading the composition would have concluded that demand for capital goods was about to fall sharply, that consumer demand was being held up artificially and would correct, and that the currency was under pressure.

All three of those conclusions were available in 2013 from published data, and all three turned out to be right. The headline number gave none of them.

Related in this archive

• An economy that stopped growing, and the three reasons why
• The last year of the old model: a review written at the end of one era
• An old balance-of-payments problem, and why it kept coming back
• Ukraine Annual Review 2013: the year the model ran out

A growth figure near zero is like a company's break-even point: the same result can come out of two entirely different situations. You cannot decide without reading the composition — is investment falling, or consumption, or are stocks being run down. When my own turnover is flat the first thing I look at is not the number but which line replaced which.