Academic journal article Economic Perspectives

How the U.S. Economy Resembles a (Very) Big Business

Academic journal article Economic Perspectives

How the U.S. Economy Resembles a (Very) Big Business

Article excerpt

Introduction and summary

This article offers a perspective on analyzing the growth of the U.S. economy by treating the economy as a very large firm. A well-functioning economy maximizes households' well-being rather than firms' profits, so policymakers' objectives and motivations are not as clear-cut as those of company chief executives. Still, as in any business, identifying areas of weakness and relative strength in the economy is inherently valuable in guiding decision-making.

I present basic tools for measuring different business lines' contributions to the U.S. economy's growth. Then, I extend the economy-as-business analogy by using the same tools to measure the exposure of a large conglomerate to macroeconomic risks. While these tools are often used to evaluate the strengths and weaknesses of the economy with the goal of recommending appropriate monetary policy, they can also he used by profit-maximizing firm managers to better understand macroeconomic risks to firm performance.

If we consider the U.S. economy to be a large enterprise, how do we measure its performance? First, what does our company look like? This very fictional national firm employs all of the workers in the U.S. economy; owns all machinery, structures, and other productive assets; and returns its profits to its shareholders (the American public). The national firm also makes machinery, structures, and materials for its own account to add to its productive capacity. The national firm has two customers: the national family (to which every U.S. resident belongs) and a conglomerate government that encompasses local, state, and federal governments.

The following two key macroeconomic concepts allow assessment of a particular sector's contribution to overall economic growth as well as its sustainability: the fundamental national product accounting identity and the contributions to growth formula.

These concepts can provide similar insights into a firm's performance, capturing the contribution of a particular product line (or group of product lines) to the firm's growth and the likely sustainability of that contribution.

Applying these concepts to the U.S. economy reveals that macroeconomic risks arise primarily from sectors such as nonresidential fixed investment (business investment) that change substantially from quarter to quarter and also account for a moderately large fraction of economic activity. Sectors of the economy that are responsible for a large fraction of national income, such as expenditures on nondurable goods and services, and whose growth changes relatively little from quarter to quarter represent small risks to overall economic activity. Other sectors, such as new home construction, with unstable but relatively small sales also represent small risks to growth. With these results in hand, I can assess an individual firm's growth, and the macroeconomic risks to it, by measuring what fraction of the firm's sales corresponds to particular sectors of the overall economy.

After developing this methodology, I go on to apply it. The first application is to a fictional hair salon that has exposure to only one sector of the U.S. economy, personal consumption expenditures on services. The second application is to a real conglomerate, General Electric Company (GE). This application makes use of publicly available data and is purely for illustrative purposes. A serious evaluation of any particular company would require much more data than employed here.

In the next section, I present basic concepts from national income and product accounting, which divides the U.S. economy's production into different business lines. (Readers already familiar with the definitions of gross domestic product, or GDP, and its major components might wish to skip this section.) in the following section, I develop the contributions to growth formula and use it to understand business cycle risks to the U. …

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