A headline gross domestic product (GDP) gives a reading of basic economic health – or sickness. But you need to press and prod in the right places to get a full picture of what’s working and what’s failing.
Like the human body, there are hundreds of different moving parts to an economy. Not all tell the truth all the time.
1. Gross Domestic Product (GDP)
GDP is three dull words or letters attached to a number to show wealth, poverty or something between the two.
The problem is it’s like measuring a patient’s heart rate, pulse and temperature and each suggesting a different disease. There’s a bunch of ways to interpret GDP because it is always only an estimate and the estimate is constantly being revised.
GDP is estimated in three ways:
- Production – an estimate of how much value each stage in the manufacturing or service process has added, tallied up and called gross value added (GVA)
- Expenditure – an estimate of how much the country (companies, consumers, government) has spent buying goods and services, based on surveys and government figures
- Income – an estimate of how much individuals have earned and companies have profited
The best GDP figures take all three of these and put them together. In theory, the three methods should all produce the same number, but they rarely do. That means judging which figure is the fairest estimate. It might be an average of all three or the best of two of them.
GDP is also estimated at least five times after the close of an economic quarter:
- 25 days – with just 44% of output data and no input data is ready at this stage this GDP is based on surveys of turnover and government data
- 55 days – using the most up to date data available and published alongside and ‘alignment adjustment’ showing how the new data changed the estimate
- 85 days – with even more facts available another ‘alignment adjustment’ is made
- Quarterly – Each new quarter can provide a further revision of the previous quarters’ GDP
- Blue Book - the UK government’s annual publication of National Accounts Statistics. More detailed annual data sources are incorporated and changes to methodology or new international standards may be included. Revisions can go back several years and impact annual and quarterly figures
Basically, GDP is just the best guess we have at any given time. That makes producing an accurate diagnosis and then prescribing the correct medicine a challenge.
2. Energy level check
Let’s perhaps look at GDP another way. In essence GDP is about energy. As your GP might advise, exercise is good. If cash is spent, loads of people and businesses benefit:
- Your local supermarket and cinema
- The bike shop around the corner
- An architect company and a building merchant if you’re planning a new extension
- Even the local cattery or dry cleaner
GDP is connected to spending. Preferably lots of it. This can be worked out by looking at pure expenditure. That’s the amount of investment, consumption and government spending less the costs of any imports. Even then, you need to allow for inflation. But this can help the medics decide if the patient needs a glucose injection.
If the heart of the economy is racing too fast it might also be time to tell it to slow down.
3. Heal thyself?
Most modern economies self-regulate, much in the way the human body fends off a cold or minor infection. When this happens, economists say you get a ‘natural’ level of GDP.
Salaries and prices climb and fall as shortages and surpluses chug through the economic cycle. That compares with potential GDP: the value of what an economy could produce at the top end of a business cycle – full use of labour and capital.
However, in all this, don’t forget so-called self-regulating economies remain exposed to interventionist moves from central banks, such as quantitative easing – but these painkillers and their effectiveness at fighting viruses, reduce over time.
4. A true pulse?
Getting your hands on an accurate GDP reading isn’t always possible. GDP official data can take time to align or appear up-to-date.
There’s also a tension between GDP and ‘real’ GDP. ‘Real’ GDP includes the effect of inflation or deflation. Otherwise you’re left with just rising prices – but no more economic output.
GDP metrics can stumble when trying to measure industries such as financial services, of which the UK relies on, because of the complexity on profits, margin and output, not to mention obfuscation about costs being defrayed.
Many industries produce technology that has massive depreciation/obsolesce built in, such as software, despite huge R&D expense. Some digital or information businesses operate in an environment where services or products that were once chargeable are now free, or significantly cheaper than they were.
There’s also the peer-to-peer activity in the economy to consider, such as Airbnb. That’s all hard to measure.
5. Country-by-country scan.
Comparing country-by-country GDP statistics is riddled with issues, such as cost of living differences. The purchasing power of a basket of goods and services can differ considerably as energy, housing and food costs all vary.
Currency differences – especially so given the high (early 2017) US dollar – may well also distort the picture further. Some care is needed when calculating local purchasing power.
6. Shadows on the economy
What of country corruption and GDP? It’s tricky to measure the so-called ‘shadow economy’. Even back in 2013 the UK’s Institute of Economic Affairs claimed the UK’s shadow economy was worth 10% of GDP [Link https://iea.org.uk/publications/research/the-shadow-economy].
The dilemma for any government is how much of this data it should absorb when formulating policy based on GDP information (there are also ethical and moral issues about attempting it).
There are also dangers with simplistic country-by-country comparisons. Russia, for example, has a far bigger ‘informal’ economy than the UK.
At the edges of this are contrast-and-compare concern on tax law: how it is read by large multinationals, potentially skewing the numbers due to profit shifting strategies, sometimes known as transfer pricing.
7. A more complete diagnosis?
While a GDP reading will measure the productive performance of an economy it doesn’t measure happiness or well being. There are lots of different measures for that too though so it is equally confusing.
And a huge negative, a tsunami, war or humanitarian disaster can lift as rebuilding programmes kick off. GDP So GDP can tell the opposite of how people feel.
Traditional GDP measurements may start to look a story of diminishing returns: does quality of life meaningfully increase if your salary rises from £35,000 to £37,500? Higher growth may mean more hours worked, giving less time to enjoy spending.
8. Or simply a better dashboard
In contrast to a standard GDP read-out, imagine the physician able to glance quickly at several economic and health read-out dials. Not only do they get a goods and services valuation, but information on how the data is being collected.
- Where in the country do the numbers appear most stressed?
- What about unpaid labour (carers, a lot of domestic at-home work)?
- How does the balance look between GDP growth and the environment (profit might be judged not just as income but also as an environmental expense)?
A shift in attitude is already underway. Back in 2010 Lord Adair Turner, the former chairman of the Financial Services Authority (replaced in 2013), said growth already achieved in the UK, “does not automatically translate into human welfare and happiness”.
So, official confirmation from the top: GDP is just one measure of economic activity and not of standard of living. But traditional economic indicators are hard-wired into the system. For the moment, at least.