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Over the last couple of months we raised the question of who is “responsible” for recessions and looked at the role Consumer and Business Spending plays.  We concluded that business was to blame for recessions as the “business cycle” is the only major variable in contribution to GDP[1] over time.

Now that we have some data which seems to fit, we now need to see if there’s a logical reason for this observation.  Why?  Well, because correlation is not causality[2].  More importantly we need to know which is the cause and which is the effect.

Fortunately, because this is simple mathematics we can be confident that business spending is the cause since GDP as measure is the sum of a number of other numbers, including the business spending number.

Warning – “simple” math lesson[3]

In other words, if A+B=C, then we know variations in A will cause variations in C, even without looking at B.  In fact unless B always moves counter to A, then A will always make a difference to C.  Given that we’ve seen B (consumer spending) is pretty constant, then we know A (business spending) must account for most of the movement in C (GDP)

Does this fit logically?

We know that there’s a business cycle and that companies tend to go a bit far from time to time.  They spend too much money on the wrong things, take on too much debt or develop products that don’t work and then have to

pull back, maybe sack a few people and consolidate.  Once the accounts have been repaired though, shareholders begin to demand more and off we go again in search of more growth.

But is this a bad thing?  Sure it may appear nicer if things were a little more predictable and cycles a little less boom or bust but then what would we miss out on?  Many companies manage to navigate these cycles quite well and take advantage of the opportunities they present.  Importantly, the opportunity to “boom” provides incentive which drives innovation and in turn higher living standards through more productivity.

Therefore before we come down too hard on the small business owner (I’m one and you may be too!)  let’s not forget that the reason business drives recessions is precisely because business ultimately drives the economy.

Business is the source of everything

Before upsetting large sectors of the community (particularly in Canberra), let me preface these comments with a clear declaration that business is NOT the only valuable contributor to our economy or society.  Both the Public and Social sector provide invaluable benefits in many ways, no question.

However with respect to the issue at hand (ie economic growth) it is business that provides the engine.  Quite simply Governments get their revenue from business either through direct taxation of the business itself or on behalf of employees.  Regardless of who pays the taxes, the money came from a business in the first place.  In the interests of brevity, I won’t outline the process here but I’m happy to address in future articles if it’s not clear.

The role of Public and Social sectors is to assist in keeping balance, which is essentially a cost rather than production.  This doesn’t mean they are less important by any means, without balance businesses will ultimately fail.  Therefore ultimately they are as important, they just don’t significantly contribute mathematically to the variation the measure of GDP.

This is similar to looking at a business.  Ultimately it’s all about sales – sell, more to more customers is the only way to grow a business.  Therefore sales staff are critical, whereas admin staff are a cost.  Without good admin and systems the business can’t grow very well or may even fail, but can succeed even with average admin performance.  Without customers (sales) however there simply isn’t a business.  Therefore in measuring growth, it’s nearly all about sales.

The importance of GDP?

Perhaps the lesson in all this is the importance of the measure in the first place.  Sure it’s important, particularly in the longer-term but there are many other factors which are equally or perhaps more important.  GDP is not a measure of happiness and I’m sure most of us would prefer to increase happiness over wealth.

Therefore let’s focus not just what’s actually most important, but the actual factors which drive these.  Based on the experience of hundreds of clients, the happiest are those who focus on the things they can control which actually make a difference.  Everything else (like GDP[4]), whilst not necessarily unimportant, is either not critical or beyond their control so occupies little headspace.

Next Month I was going to look at the RBA’s obsession with unemployment as a driver of inflation. However given the change in rhetoric since November’s rate rise it seems they realise enough is enough, so we might leave them alone for a while.  Instead we’ll look at the importance of economic growth in investment returns and what drives valuations.  Unless of course I get a more interesting topic – suggestions always welcome.

 

[1] GDP – Gross
[2] Just because two things happen to the same group at the same time (correlation) doesn’t mean they are the cause and effect of each other (causality).
[3] Apologies if you find this a bit basic but a good friend of mine once told me there’s no such thing as simple math – to some people (like him), all math remains a mystery.  Therefore never assume it’s simple.  It’s a bit like saying simple music or simple art – again some people don’t get it no matter how “basic”.
[4] GDP contributions and trends is important to us because it drives long-term investment decisions.  Otherwise I wouldn’t both with it at all.
Matt Battye

Matt Battye

CEO, Financial Adviser

Analysing what can seem to be like complex issues, Matt is effective in using analogies to better explain scenarios and truths to the rest of us. This is what Matt enjoys – educating clients on the truths and debunking the commonly held (wrong) view.

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