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What Are the Components of GDP?

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new-car.jpg

Buying a new car contributes to GDP.

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health worker exam

Services, such as healthcare, drive nearly half of the U.S. economy.

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A Marine stands guard as another searches an Iraqi man on February 8, 2006 in Ramadi. People forget that nearly 20% of GDP is government spending, and more than half of that is for defense.

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Question: What Are the Components of GDP?

Answer: The components of Gross Domestic Product (GDP) tell you what a country is good at producing. That's because GDP is the country's total economic output for each year.

The BEA (Bureau of Economic Analysis) has subcategorized U.S. GDP into four major components:

1. Personal Consumption Expenditures

Nearly 70% of what the U.S. produces is for personal consumption. In 2013, $10.832 trillion of the $15.942 trillion produced went toward household purchases. The BEA sub-divides personal consumption expenditures into goods and services.

Goods contributed $3.706 trillion in 2013, almost 1/4 of total GDP. Goods are further sub-divided into two even smaller components. The first is durable goods, such as autos and furniture. This is the smallest sub-component, at only $1.358 trillion. The second is non-durable goods, such as food, clothing and fuel. This contributed $2.366 trillion. 

Services are a much larger sub-component of personal consumption expenditures. In 2013, $7.125 trillion in services was produced, nearly half (44.7%) of GDP. This is much larger than in the 1960s, when services contributed less than 30% to the economy. A large driver of this growth has been the dramatic increase of the financial services and health care industries. Most of these services are consumed here at home, as they 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 very good at knowing what consumers want.

2. Business Investment

Business investment includes purchases that companies make to produce consumer goods. However, not every purchase is counted. If a purchase only replaces an existing item, then it doesn't add to GDP and so isn't counted.

Total business investment in 2013 was $2.643 trillion, beating its pre-recession peak of $2.327 trillion in 2006, and nearly double its post-recession low of $1.549 trillion in 2009. The BEA divides business investment into two sub-components: Fixed Investment and Change in Private Inventory. 

Most of Fixed Investment is non-residential investment, contributing $2.022 trillion in 2013. This consists primarily of of business equipment, such as software, capital goods, and manufacturing.

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, since these structures were counted as contributing to the GDP in the year they were built. Commercial real estate's contribution to GDP went from a high of $586.3 billion in 2008 to its low of $376.3 billion in 2010. This represents a decline from 4.1% to 2.6% of GDP. In 2013, it rebounded a bit to $436 billion or 2.7% of GDP.

You might wonder why so much commercial real estate was still being built during the recession. That's because the commercial real estate pipeline can take years from initiation, getting financing and zoning approvals, to final construction. Once a building gets into the pipeline, it will be completed, even if tenants can't be found or pull out, and the building is left vacant.

Fixed investment also includes residential construction, which includes new single-family homes, condos and townhouses. Just like in commercial real estate, the BEA doesn't count housing resales as contributing to GDP. New home building reached its peak in 2005, when it added $775 billion to GDP. It didn't hit bottom until 2011, when only $338.7 billion was added. Housing's contribution to GDP plummeted from 6.1% to 2.2% during this time. Residential construction rebounded to $489 billion or 3.1% of GDP in 2013.

Combined commercial and residential real estate construction contributed $1.195 trillion, or 8.9% of GDP, at its peak in 2006. It fell to a low of $716.9 billion, or 4.9% of GDP, in 2010. In 2013, it was $925.4 billion, or 5.8% of GDP.

The second sub-component of business investment is Change in Private Inventory. The BEA measures how much businesses order to increase the inventories of the goods they are planning to sell. When orders for inventories increase, it usually means that companies are receiving orders for goods they don't have in stock, and so are ordering 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. These customers may find what they need elsewhere, and never return. Therefore, a business would rather have just a little too much on hand, than not enough. Therefore, an increase in private inventories is a contribution 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. Therefore, the change in private inventories is an important leading indicator, even though it contributes less than 1% of GDP. In 2006, companies added $60 billion to inventories. In 2007, they only added $29 billion. After the 2008 financial crisis hit, businesses subtracted $41 billion from their inventories, and withdrew another $160 billion in 2009. Economists knew the recession was really over in 2010, when businesses added $66.9 billion to inventory. In 2013, inventories rose $111.7 billion, nearly double the prior year. This was to prepare for the holiday shopping season.

However, this caused a problem in 2014, since growth didn't continue. That's because companies, once again, drew down from this high inventory level since demand wasn't there. In fact, slow retail sales in the latter half of 2013 kept businesses from adding to inventories, and the fierce winter storms further depressed demand, leading to an economic contraction in the first quarter of 2014.

3. Government Spending

Government spending added $2.939  trillion to the economy in 2013, 18.4% of total GDP. This was up from 17% in 2000, but less than the 19% it contributed in 2006. In other words, the government was spending more when the economy was booming, 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 added $1.125 trillion. Nearly two-thirds of this, or $694 billion, was military spendingOn the other hand, state and local governments can't spend more during a recession. They are usually mandated to balance their budgets, and so must cut spending when tax revenues drop. Now that the recession is over, state and local government contributed $1.743 billion.

4. Net Exports of Goods and Services

Imports and exports have opposite effects on GDP. Exports add, while imports subtract, from GDP. The U.S. imports more than it exports, which creates a trade deficit. That's because the U.S. imports a lot of petroleum, and its service-based economy is difficult to export. For more, see Import and Export Components.

 In 2013, imports were $2.446 trillion, while exports were $2.064 trillion. As a result, international trade subtracted $383 billion from GDP. (Source: U.S. Bureau of Economic Analysis, National Income and Product Accounts Tables, Table 1.1.5., Gross Domestic Product  Note: The figures reported are real GDP, and are rounded to the nearest billion. For the latest revisions and more detail, please use the BEA tables.) Article updated July 15, 2014

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