Today sees the publication of the UK figures -Gross Domestic Product or GDP- for economic growth in the third quarter of 2012. This particularly matters because of the state of the UK economy which has shrunk in the previous three quarters on the same measure and has an overall level which is still around 4% below the peak reached before the credit crunch hit. On the political side there was a ratcheting up of tension when the Prime Minister announced this yesterday at Prime Minister’s Questions.
The good news will keep on coming
As you can see this was not specific. Also if we look at the latest result from the NIESR (National Institute for Economic and Social Research) then good news was expected anyway.
Our monthly estimates of GDP suggest that output grew by 0.8 per cent in the three months ending in September after growth of 0.1 per cent in the three months ending in August 2012.
What does headline GDP tell us?
This is treated as a number which tells us all manner of things which it is not designed for. It does not for example give us any real clue as to national well-being and as a blunt number is not even especially accurate. It is also often used as a type of national balance sheet indicator when at best it tells us something about income. Also the use of a single number hides the fact that there are three ways of measuring GDP (income,output and expenditure) and they regularly tell a different story. It is not easy to get a grip on the size of this problem as some years ago the then Chancellor Nigel Lawson thought that such differences might disturb people and instructed the Office for National Statistics to “merge” them into the same number. This is the output number and it is something of a shame as for example in the United States there has been research suggesting that it has been the income measure which has been a superior guide and measure in the credit crunch era.
For those wondering about the size of such disparities I was looking at Portugal’s numbers earlier this year and they were 4% of output at their maximum which gives some perspective to discussions about 0.1% or 0.2% movements in GDP does it not?
What is Gross Domestic Product?
Gross Domestic Product is the market value of goods and services produced by workers and property in the country concerned, regardless of their nationality. So it is defined with geographical boundaries.
Gross Domestic Product = consumption (personal) + government spending + business investment + net exports (exports – imports)
Should we not use GDP per capita?
One obvious problem with using overall GDP numbers is that they make no allowance for population changes. If we look at countries where there is net emigration right now such as Portugal and Greece this means that headline GDP numbers are likely to make the declines look worse than they are. For the UK we have been experiencing inflows to our population so in terms of the individual or per capita the overall number has been flattering the numbers. We were given some insight into the effect of this since the credit crunch began earlier this week.
Given that the UK’s population increased steadily throughout the period and is the denominator used in the per head calculation, the falls on a per head basis are even greater …………a fall of 7.0 per cent for GDP.
As this number which takes us to the end of the second quarter of 2012 compares to an overall GDP fall of 4.1% we can see that individually we are on average worse off than the headline figure would tell us.
In fact the number which is considered to be a better measure of national well-being tells us an even grimmer story.
In the second quarter of 2012 net national income per head in real terms was 13.2 per cent below its level in the first quarter of 2008; a sharper fall in economic well-being than the GDP data alone indicate
I wish to make it clear here that I am differentiating between the individual and the government as for it the overall measure of GDP is important as it reviews debt and deficit sustainability although even it must have concerns about the impact of falling numbers per capita or head.
Today’s GDP numbers
Here we have some good news released by the Office for National Statistics.
GDP was estimated to have increased by 1.0 per cent in Q3 2012 compared with Q2 2012
Output of the production industries was estimated to have increased by 1.1 per cent in Q3 2012 compared with Q2 2012
Output of the service industries was estimated to have increased by 1.3 per cent in Q3 2012 compared with Q2 2012
So we can permit ourselves a smile. However not everything is doing so well
Construction sector output was estimated to have decreased by 2.5 per cent in Q3 2012 compared with Q2 2012, following a decrease of 3.0 per cent between Q1 2012 and Q2 2012
The construction sector has been a consistent problem which is not helped by the bickering amongst the bodies which measure it as to actually what is going on. Also if we look for some perspective we see that we have climbed the hill back to where we were a year ago.
GDP in volume terms was estimated to have been flat in Q3 2012, when compared with Q3 2011
If we look back we see that it was estimated that we “lost” some 0.5% of GDP in the second quarter of 2012 due to bank holidays and so on so we are down to maybe 0.5% of underlying growth. There was also an additional 0.3% of GDP in Olympics ticket sales registered in this quarter but of course the Olympics had a downward influence on other areas such as shopping in Central London.
Revisions are a danger
These numbers only contain some 45% of the data that will be known in a year’s time so the danger of revisions is present and they may be substantial.
Why the numbers are being overstated if we compare with the past
If we look at the ONS report we see this.
Unless otherwise stated, all data in this bulletin are seasonally adjusted and have had the effect of price changes removed (ie the data are deflated).
What they mean by that is that the numbers are collected and then a measure of inflation is used to convert them into “real” or volume numbers. This is not especially complicated but the way that this measure called the GDP deflator is constructed has been changed in recent times. It is my contention that this is likely to lead to a lower measure of inflation and with the same price level a higher level of recorded growth. Or as the group Pilot put it some years ago.
Hey,hey it’s magic!
Let me explain what has happened
It used to be that the GDP deflator was based on the Retail Price Index but this was changed.
The second is replacement of Retail Price Index (RPI) series with Consumer Price Index (CPI) series in forming the deflators
Oh okay why?
However, CPI has a number of advantages over the RPI for this purpose, as discussed below, and the international guidance is clear that the CPI should be using in preference.
Missing in the list of advantages is that fact that the CPI tends to give a lower number for inflation than the RPI sometimes substantially lower! Now I do not wish to overstate the impact of this as it was already in minor use (5%) but around 18% of the data collected used the RPI. So on that a lower inflation measure for the same reading will give a higher growth measure. Also I have discussed before around 18 months ago if I recall correctly changes to producer price inflation methods which tended to reduce the level of inflation recorded. So again here for this sector lower recorded inflation for the same number leads to higher recorded economic growth.
So we are left with the uncomfortable view that since this change in September 2011 we will record the same circumstance as giving a higher rate of economic growth than before. Or if you like ceteris paribus no longer exists.
This adverse change in how we measure inflation is something of a curse of our time is it not? I will be at the RPI consultation tomorrow to argue the case against it being “improved” too. Also I think that “improved” can go into my financial lexicon too.