The Japanese revised GDP accounts for the 2013 4-6 period has gone pretty much the way of the export-import data. It reveals not only the lack of depth in understanding the numbers on the part of the media (and most economists), it is actually a useful example of some of the primary flaws in the expenditure approach itself.

The Wall Street Journal outlined the mainstream view,

“Following a revised solid 4.1% rise in the January-March quarter, the second-quarter GDP data make it clear that Japan’s economy is now leading global growth, outshining the U.S. and the euro zone, picking up the slack left by slowing emerging economies.

“’There is no doubt that the upward revision … will boost the case for the consumption tax increase next year,’ said Takeshi Minami, chief economist at Norinchukin Research Institute.”

The New York Times zeroed in on the primary source of the upward revision,

“Preliminary G.D.P. data for April-June fell short of market forecasts because of weaker-than-expected capital spending, casting doubt on whether the tax increase would proceed as scheduled.

“But capital expenditure was revised up to a 1.3 percent increase from the preliminary 0.1 percent decline, suggesting that improving business sentiment is prompting companies to spend more on plants and equipment.”

Finally, Reuters quotes an economist to put the numbers into some “relatable” context,

“Companies are replacing old equipment, which led to the large upward revision to GDP,” said Hiroaki Muto, senior economist at Sumitomo Mitsui Asset Management. “This means the government can raise the sales tax as scheduled.”

There are a couple of problems with these interpretations, first encapsulated in the rhetoric of certainty that is wholly unearned, as GDP accounts on a quarter-to-quarter basis measure second derivatives. Once the second derivative is established, the measurement for “inflation” yields these figures that are universally lauded.

Since the primary focus has been on business investment, that is the best place to start. Sure enough, in the nominal, seasonally adjusted Q/Q revisions, “private non-residential investment” was re-estimated from +0.2% to +1.6%. In real terms, the revisions went from -0.1% to +1.3%, the figure quoted by the New York Times above, increasing GDP as a whole by slightly more than +0.2% Q/Q (the vast majority of the upward revision).

If you start at the beginning, however, you can see how much the rules of the calculation system impact these final interpretations. In the “original series”, without any seasonal or inflation adjustments, “private non-residential investment” declined 2.6% Y/Y. In real terms it was a 3.0% decline, meaning there was some positive inflation in this segment.

But a 3% Y/Y real decline was a bit better than the 5.1% real decline in the preceding quarter. Since GDP measures second derivatives to gauge Q/Q performance, a -3.1% rate is a positive second derivative from -5.1% rate. Thus, Q/Q in the adjusted series is a positive rate regardless of that overall context. In other words, because business investment is shrinking less quickly it is a sign that “companies are replacing older equipment”, regardless of whether that is actually the case.

You really have to wonder if these economists are simply looking at the positive number and making these kinds of ad hoc statements without any depth of analysis. So much of conventional economics is taken without question, on full faith, that there is no critical inquiry beyond the headline.

The same approach yields the same flaws in the export data, which is supposed to be the primary expression of monetary stimulus. Here we at least see a positive Y/Y change in the nominal original series, +8.6%. On a “real” basis, however, we get -0.3% as the yen’s devaluation shows the media’s prior interpretations of export “health” as nothing more than wishful thinking and bad analysis. But here again, since -0.3% is “better” than -3.3%, on a Q/Q basis it leads to an astounding +4.7% figure that “proves” monetary stimulus works.

So Japanese businesses are both investing less and exporting less, but at less negative rates, so Abenomics is clearly working and Japan is now “leading global growth”? I cannot think of a better interpretation or slogan for this sentiment; Japan is leading the way in the global economy by shrinking the slowest.

There were some positive aspects to the GDP calculations, but even here they get overstated by convention. Private consumption was +1.1% on a nominal basis Y/Y, much better than the 0.2% Y/Y in the prior quarter. On a “real” basis, factoring “inflation”, private consumption actually looks better. Since the GDP deflator for the segment was believed to be -0.7%, that +1.1% becomes +1.8%.

Residential investment also increased, but since housing and real estate are such a small part of the Japanese economy a 7.1% Y/Y growth rate only adds 0.2% to the GDP growth rate. Overall investment would actually be negative absent the huge and ongoing fiscal/government “investment” programs. That too would contradict the narrative of the business turnaround.

Japan is in a near-unique predicament that skews too many of these factors against making conventional interpretations. Second derivatives that change signs are always problematic in that mainstream calculus. It may mean an improvement is beginning, or that a bottom has been reached, but it may also just be an artifact of the calculation rules. Separate data sources bear that out – Japanese wages have declined for 14 straight months despite all the changes in sign for these important second derivatives. I suppose if wages were shrinking less quickly, it would be taken as a sign of robustness in this age of diminished and still diminishing standards of economic success.


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