Components of GDP Explained
Four Critical Drivers of America's Economy
The four components of gross domestic product are personal consumption, business investment, government spending, and net exports. That tells you what a country is good at producing. GDP is the country's total economic output for each year. It's equivalent to what is being spent in that economy. The only exception is the shadow or black economy.
The formula to calculate the components of GDP is Y = C + I + G + NX. That stands for: GDP = Consumption + Investment + Government + Net Exports, which are imports minus exports. In 2018, U.S. GDP was 69% personal consumption, 18% business investment, 17% government spending, and negative 5% net exports.
Here's how the Bureau of Economic Analysis divides U.S. GDP into the four components.
Consumer spending contributes 69% of total United States production. In 2018, that was $12.89 trillion. Note that the figures reported are real GDP. It's the best way to compare different years. They are rounded to the nearest billion. The BEA sub-divides personal consumption expenditures into goods and services.
Goods are further sub-divided into two even smaller components. The first is durable goods, such as autos and furniture. These are items that have a useful life of three years or more. The second is non-durable goods, such as fuel, food, and clothing. The retailing industry is a critical component of the economy since it delivers all these goods to the consumer. The BEA uses the latest retail sales statistics as its data source. Since this report comes out monthly, it gives you a preview of this component of the quarterly GDP report.
Services are almost half of U.S. GDP. These include commodities that cannot be stored and are consumed when purchased. It contributes 45% of GDP. That's a big increase since the 1960s when services contributed 30% to GDP. Thank the expansion in banking and health care. Most services are consumed in the United States. These are difficult to export.
Why does personal consumption make up such a large part of the U.S. economy? America is fortunate to have a large domestic population within an easily accessible geographic location. It's almost like a huge test market for new products. That advantage means that U.S. businesses have become excellent at knowing what consumers want.
2. Business Investment
The business investment includes purchases that companies make to produce consumer goods. But, not every purchase is counted. If a purchase only replaces an existing item, then it doesn't add to GDP and isn't counted. Purchases must go toward creating new consumer goods to be counted.
In 2018, business investments were $3.39 trillion. That's 18% of U.S. GDP. It's double its recession low of $1.5 trillion in 2009. In 2014, it beat its 2006 peak of $2.3 trillion. The BEA divides business investment into two sub-components: Fixed Investment and Change in Private Inventory.
Most of Fixed Investment is non-residential investment. That consists primarily of business equipment, such as software, capital goods, and manufacturing equipment. The BEA bases this component on shipment data from the monthly durable goods order report. It’s a good leading economic indicator.
A small but important part of non-residential investment is commercial real estate construction. The BEA only counts the new construction that adds to total commercial inventory. Resales aren't included. The BEA adds them to GDP in the year they were built.
Fixed investment also includes residential construction, which includes new single-family homes, condos, and townhouses. Just like commercial real estate, the BEA doesn't count housing resales as fixed investments. New home building was $610 billion in 2018. That was 3% of GDP. Combined, commercial and residential construction was $1.15 trillion or 6% of GDP.
The 2008 financial crisis burst the bubble in housing. Residential construction reached its peak in 2005 when it added $872 billion to GDP. Comparisons over time are always adjusted for inflation. It didn't hit bottom until 2010 when only $382 billion was added. Housing's contribution to GDP plummeted from 6.1% to 2.6% during this time. At its peak in 2005, combined commercial and residential construction contributed $1.3 trillion or 9.1% of GDP. In 2010, it fell to a low of $748.7 billion or 5.1% of GDP.
Change in Private Inventory is how much companies add to the inventories of the goods they plan to sell. When orders for inventories increase, it means companies receive orders for goods they don't have in stock. They order more to have enough on hand. It's important for companies to have enough inventory so they don't disappoint and turn away potential customers. An increase in private inventories contributes to GDP.
A decrease in inventory orders usually means that businesses are seeing demand slack off. As inventories build, companies will cut back production. If it continues long enough, then layoffs are next. So, the change in private inventories is an important leading indicator, even though it contributed less than 1% of GDP in 2018.
3. Government Spending
Government spending was $3.18 trillion in 2018. That's 17% of total GDP. It's less than the 19% it contributed in 2006. In other words, the government was spending more when the economy was booming before the recession. That's exactly when it should have been spending less to cool things off. Slower spending now is a result of sequestration, which was also timed poorly. Austerity measures shouldn't be used when the economy is struggling to recover.
The federal government spent $1.23 trillion in 2018. More than 60% was military spending. State and local government contributions fell a bit to 10%. Although this spending rose a bit since 2017, other sectors of the economy grew faster.
4. Net Exports of Goods and Services
The United States imports more than it exports, creating a trade deficit. America still imports a lot of petroleum, despite gains in domestic shale oil production. The U.S. economy is based on services, which are difficult to export. In 2018, imports subtracted $3.45 trillion a little more than in 2017. Exports added $2.55 trillion, about the same as 2017. As a result, international trade subtracted $90 billion from GDP, more than the $859 billion it subtracted in 2017.
Components of Real GDP (2018)
|Commercial Real Estate||$0.54||3%|
|Change in Inventories||$0.05||0%|
|State and Local||$1.95||10%|
(Source: "Table 1.1.6. Real GDP," Bureau of Economic Analysis. "Concepts and Methods of the U.S. National Income and Product Accounts," Bureau of Economic Analysis, October 2016.)