Why bother with GDP?

Modern GDP statistics (“the value of goods and services produced in a given period”) have their origin in the USA around the 1930s with the work of Kuznets, who produced the first national income data in order to see the impact of the Great Depression on the US economy. They became more important during the Second World War when the UK government, prompted by Keynes, and the US government needed to be able to manage the war effort to maximum effect while still providing enough resources for consumption.

A major criticism of GDP is that it takes no account of what is produced, merely its value. As a result,  disasters can be good for GDP if they involve countries reconstructing roads or buildings damaged in the disaster. War is also a good way of boosting GDP since it will involve producing more tanks, weapons and aircraft! Similarly, two forks are, in GDP terms, as useful as a knife and fork, but less useful in reality when trying to spread butter. GDP and GDP per capita also take no account of how the income is shared among the population. A rich oil producing country might have a high GDP per head but, if the income is concentrated in the hands of a few, the standard of living of the majority might be below that of a country with a lower average of GDP.

Measurement of GDP is difficult since it is impossible to measure every transaction and therefore relies on surveys e.g. the Living Costs and Food Survey for about 5,000 households and monthly surveys of approximately 45,000 businesses. The development of technology has made the measurement of GDP more difficult. The UK Government set up an inquiry under Charlie Bean – OB and former Deputy Governor of the Bank of England – who identified activities which are now much harder to measure and value such as using Google Maps rather than buying a paper OS map or streaming films rather than buying or renting DVDs. Another problem is that many things have become cheaper and better – my new DVD recorder is easier to use and records more than a previous model but, in GDP terms, it is less valuable because it is cheaper.

There have been many debates over what should be included in GDP and although these might seem largely irrelevant, they matter when trying to compare countries’ GDP. In the past certain things, such as the sale of cannabis in cafes in Holland were legal and therefore recorded while a similar purchase in Romford would not be counted. However Eurostat wanted consistency among its members and decided that all transactions for goods or services involving money were to be recorded, whether they are legal, illegal, good or bad. Therefore, in a purely numerical way, those who argue in favour of increasing GDP as being a key government objective, could argue that encouraging the sale of drugs or prostitution is as valid as increased spending on education or health – something even an economist would find hard to justify! More relevantly sales of guns in the UK are part of the shadow economy but in the US they are legal, widespread and contribute to GDP.

GDP data is particularly suspect in developing countries where a significant percentage of production takes place in the hidden economy; for example, in Zimbabwe only 6% of the labour force is formally employed. Similarly, my purchase of bottled water from Sainsbury’s is counted in the UK’s GDP, but the effort of an African villager who spends hours walking to and from a stream to collect “free” water has no value according to GDP statistics. There are also basic measurement difficulties in LDCs, such as obtaining accurate population figures, accurately measuring inflation and valuing the hidden economy, e.g. only half the maize produced in Nigeria is sold in a shop or market.

There is now a consensus that we are trying to measure too many things in our single GDP number and, although we can improve it by using GDP per head or median GDP or NNP, it is still deficient.

Economists have therefore started both to consider other possible methods of estimating economic activity and to develop alternative measures which go beyond simply the output of goods and services. One way of tackling the former is to look at light intensity to indicate economic activity in different areas with increases in intensity over time indicating growth. Such methods indicate that the proportion of economic activity occurring in villages, and not always measured, is more significant than thought and therefore the GDP of many developing countries is, similarly, larger than previously calculated. It also provides a fascinating snapshot of the difference between the North and South Korean economies.

However a major concern is how we measure the damage which our focus on output is doing to the environment. China’s focus on growth has resulted in 40% of its river water being undrinkable and one cannot always see the stars at night because of pollution. GDP does not take into account depreciation of natural resources lost to build houses and factories and damage to the environment but this is not easy to do. How does one put a monetary value on a rainforest, beautiful view or footpath by a river? One way is to make an estimate based on how much people pay to see them and, for things which benefit the environment, how much it would cost to replicate them. The UK government in 2012 formed the “Natural Capital Committee” to advise the government on things such as ‘forests, rivers, minerals and oceans’ and by 2020 the ONS must include a measure of natural capital in the UK’s national accounts. The aim is to move towards sustainable growth. Along the same lines, a US think tank has invented Earth Overshoot Day – the date when the earth used up its regenerative capacity for the year. In 2018 this occurred on 1st August.

Other measures include the Genuine Progress Index – a measure of economic welfare which is currently in use in Maryland. GDP is the base but invisible “goods” e.g. leisure time, volunteering, & housework are added while “regrettables” e.g. crime prevention spending such as burglar alarms, pollution and commuting time are subtracted. The Happy Planet Index tries to measure what matters – namely sustainable wellbeing for all and tells us how well nations are doing at achieving long, happy, sustainable lives.  Some countries have followed Bhutan which developed a Gross National Happiness index which sets out priorities such as psychological well-being, health, education, living standards, good governance and ecological resilience. Before adoption, all new projects must undergo a GNH impact review. We carry out an annual happiness survey as does the OECD and many of its members. These focus on six key variables which determine happiness – GDP/head, healthy years of life expectancy, having people to turn to, trust in others, freedom to make decisions and donations to charity.

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Bicycle Wars

The trade war between America and China rumbles on, confused somewhat by the recent actions which the US has taken over the involvement of Huawei in technologically-sensitive areas of the economy. The use of tariffs to protect industries involved in areas of national security can be justified by WTO rules. President Trump has been free in his use of this justification He has used it to justify tariffs on steel since it is an important product for the defence industries. His use of the argument that he has to protect strategic industries suffers when he simultaneously talks of the need to reduce the “BAD” US balance of payments deficit, which, according to him is the fault of foreign countries and not due to a lack of competitiveness among US industries.

Another more long-term example was highlighted by The Economist in a recent article about bicycle exports from China to America. (The same article also provides an insight into of the workings of global supply chains.)

In the 1970s, the vast majority of bicycles sold in the USA were made in the USA – around 15 million. By the late 1980s, US producers were suffering from Chinese-made bicycles entering the American market very cheaply and then, suffering even more when the Chinese producers further cut their already-low prices to drive out domestic US production – an example of dumping. Remaining US producers sought anti-dumping tariffs but the US government was more interested in good relations with China and did not act.

Some bicycles are still made by a US firm – BCA, the Bicycle Corporation of America, which was launched when Walmart decided to operate a Buy-American campaign. However BCA is now a subsidiary of a Chinese firm, Kent, (previously a US family firm which was half bought by a Chinese firm) and, furthermore, BCA only assembles in the USA, it buys its parts from a Kent factory in China.

Last September bicycle prices were raised by 10% tariffs and a further 15% tariff was imposed in May, hitting US consumers.

What right did President Trump have to do this? He used a US government power – section 301 – which allows the US government to protect intellectual property. How does this apply to Chinese bicycles?

A look at the world economy.

Recently there has been considerable attention given to the current, positive economic indicators for the UK economy. The three months to February showed the number of people in work reaching a new high of 32.71 million, or 76.1%, the highest for 48 years, the unemployment rate falling to 3.9%, the lowest since 1975 and average weekly earnings increasing by 3.5% in the year to February. With March CPI inflation unchanged at 1.9% (and core inflation also unchanged at 1.8%), real incomes are increasing although there is  concern that inflationary pressure will increase as earnings continue to rise while productivity remains weak.

However for the UK, which is a very open economy, what happens elsewhere has a significant impact on our performance. Three areas are significant – Europe, China and the USA.

Europe is struggling. Its strongest economy, Germany, has cut its growth forecast for 2019 for the second time in three months, now predicting growth of only 0.5%. The reasons cited for the slowdown are the continuing trade dispute between the USA and China, a general world slowdown, Brexit uncertainty and falling car sales. Italy is also a cause for concern. Not only is it predicting growth of only 0.2%, its financial situation is worsening and there is concern that it will breach the targets agreed with the European Commission for government borrowing and its national debt. While the Eurozone was able to deal with a financial crisis in Greece, if Italy, a key member of the Eurozone, continues to run excessive deficits, the implications for financial stability would be more serious.

The Chinese economy appears to be doing well. Over the first three months of the year, GDP grew at an annual rate of 6.4%. However there is concern over the impact of the continuing trade dispute with the USA, worry about the increases in China’s debt, which is financing the growth, and, possibly most importantly, fears over the sustainability of its growth because of its reliance on infrastructure spending. In most countries, high infrastructure spending would be a positive feature but there is concern in China about an infrastructure “bubble” with reports of new cities being constructed which have few people, cars or shops.  One way of appreciating the scale of the spending is to consider a Washington Post report that China used more cement between 2011 and 2013 than the USA used during the entire 20th century. These concerns coincide with China’s diminishing balance of payments surplus as the Chinese buy more foreign goods and travel overseas more and its exports are falling. In 2007, the surplus was 10% of GDP, it is now only 0.4%. While this is good for the UK if Chinese consumers buy more UK exports and decide to visit UK tourist destinations, if it heralds a slowing of China’s growth, the positive impact might be short-lived.

The third pillar of the global economic triangle is the USA and US economic growth slowed to an annual rate of 2.6% in the last three months of 2018. The high growth in 2018 was partially caused by a large tax cut and an increase in government spending and it is expected that once the effects of the stimulus wears off, growth this year will fall towards its long-term level which the Federal Reserve suggest is between 1.7% a year and 2.2%, some way below President Trump’s target of 4%. USA prospects are likely to be influenced by the impact of trade negotiations with China and the EU which are unknown at present but if we are unable to strike a trade deal with the US and UK businesses find tariffs placed on their exports, the impact on the UK could be severe.

Heading for a crash?

The last week has not been kind to the British motor industry. Production fell to 1.52m cars in 2018, a five year low, with a 22% fall in December making the drop the largest yearly drop since the Financial Crisis.  At the start of the week, Nissan confirmed stories circulating over the weekend that it would not be building its new X-Trail SUV in Sunderland. This is despite a government announcement two years ago that it had reached a deal with Nissan to ensure, among other things that the new model would be built in Sunderland. Last month, Jaguar Land Rover (JLR) announced that they are planning to cut 4,500 jobs and this was followed by figures they published last week announcing a £3.4bn loss in the last three months of 2018 as a result both of falling diesel sales and falling demand from China which previously accounted for almost 1/3 of their sales. This loss compares with profits of £190m over the same period in 2017. In addition, their new electric vehicle is being developed and built in Austria and they have announced that the Land Rover Defender will be built in Slovakia.

The industry has suffered from two major factors. Firstly, sales of diesel vehicles have slumped following the VW emission scandal in 2015 and tighter emission controls on cars. As a result, British sales of diesel cars slumped by 30% in 2018. This means that rather than have one factory in Japan and another in Europe for the X-Trail, the Japanese factory will be large enough to meet the expected demand.

Secondly the lack of progress over Brexit, combined with a trade deal between Japan and the EU, which the UK will not be a part of if we leave with “no deal” has impacted on Nissan’s decision. The Japan-EU deal will create the largest free-trade area in the world with virtually all customs duties being abolished between the participants. Over the next seven years tariffs will be phased out and, equally as important, the EU and Japan will agree to accept international product specifications, thereby making it easy for them to compete in the other’s market. If we do not reach a deal with the EU, car exports to the EU will face a 10% tariff.

Why is the motor industry so important? We are the 11th largest car manufacturer in the world and the 4th largest in the EU behind Germany, France and Spain, with JLR, Ford, Nissan and BMW Mini being the four largest UK producers, employing 54,000 workers between them, almost 75% of total direct employment in the industry. There are many more who are employed in producing components and transporting finished vehicles and parts. The industry accounts for almost 4% of GDP and is  a major exporter, particularly to the EU and the USA, producing 10% of our exports. Last year 1.24 million of the 1.52 million cars produced were exported. It attracts significant foreign investment; in the year before Brexit, there was £5bn of inward investment into the industry from overseas. Last year this fell to £½bn.

However not all in the industry is gloomy. High value manufacturers, such as Aston Martin, McLaren and Rolls Royce, are doing well. The problem is that they are dwarfed by the larger producers who are suffering.

Trade Wars

In an attempt to escape from the latest Brexit news, this week’s blog examines the trade war between the USA and China. Until recently, economics textbooks glossed over tariffs, quotas and protectionism; they were mentioned as possible approaches to improving a country’s balance of payments but it was accepted that although there were customs unions in existence, such as the EU, with a common external tariff (i.e. all products entering the union paid the same tariff, irrespective of where the goods entered the customs union, tariffs were not changed frequently as an economic weapon. This was because the accepted view among economists and (most) politicians was that world free trade was beneficial, allowing goods and services to be made  in the countries most suited to their production (lowest opportunity cost in economic terms) and then traded for products made overseas, thereby allowing consumers to benefit from lower prices and an increased standard of living.

However all of that has changed with the imposition of tariffs by the USA on Chinese goods and retaliation by China, followed by retaliation for the retaliation by the USA! The crisis began in July, after months of negotiations, when the USA imposed 25% tariffs on an initial $34 billion of Chinese goods, including machinery, electronics, cars and computer components such as hard drives.  China then retaliated and the following month the USA placed 25% tariffs on a further $16bn of Chinese goods which were matched by reciprocal Chinese tariffs on American goods such as cars. Then in September, President Trump imposed further 10% tariffs on $200 billion of Chinese goods and has threatened to increase this to 25% next year. China has retaliated with tariffs on $60 billion of US goods. The rationale for the American tariffs was two-fold – firstly that, according to President Trump, China had an “unfair” trade surplus in goods of $376 billion with the USA, thereby hitting American jobs, and secondly that China engaged in unfair trading practices, frequently involving foreign firms being forced to share their technology with Chinese ones.

The effects of the tariffs will depend on many factors. It is possible that businesses might find a way round the tariffs. For example, US soya producers have complained about the tariffs on their products but there is already evidence that they have been able to increase their exports to Brazil and Brazilian firms have exported to China. However many US businesses have expressed concern over the rise in costs of components imported from China and the effect they will have on consumer prices in the US. On the other hand, President Trump has argued that the tariffs will persuade US firms to produce more in the US to avoid the tariffs but others suggest that US firms will still produce overseas, where manufacturing costs are cheaper, but in countries other than China. A key factor will be the price elasticity of demand for the goods affected. This will determine whether producers can pass on the tariff,  whether they will have to absorb some or all of it and whether they will need to cut output with subsequent effects on output and employment.

What’s in store for the UK economy in 2018?

Santa has been and gone, the sleigh is parked in the long-stay car park, the reindeer are out to graze for a few months and it is time to think about what 2018 will have in store for the UK.

However economic forecasting is difficult. Unlike the natural sciences, such as physics and chemistry, we cannot base our predictions on previous laboratory experiments. Furthermore, although economists frequently assume “ceteris paribus”, the real world is not like this. For example, we do not know what the outcome of the Brexit negotiations will be, whether the bitcoin bubble will burst, and, if it does, what the impact will be, whether there will be a new Prime minster  or a general election this year or even what will happen to oil prices.

In an article published in the last week of 2017, The Times examined predictions made by key economic bodies (the Bank of England, the CBI, the Office for Budget Responsibility, the Institute of Financial Studies and the British Chambers of Commerce) a year ago for the economy in 2017. As the table below indicates, the results are not encouraging.

  Growth Inflation Unemploy-ment Wage Increase House-hold Spending Increase
End 2016 Figure 1.9% 0.7% 4.9% 2.8% 2.8%
Highest prediction for 2017 1.6% 2.7% 5.4% 2.75% 1.5%
Lowest prediction for 2017 1.1% 2.1% 5.1% 2.1% 0.6%
Actual figure for 2017 (latest estimate) 1.7% 3.1% 4.3% 2.5% 1.0%

 

The UK’s growth performance has dropped from first place among the G7 in 2016 to close to the bottom and, in addition to the data above, we should note that share prices in the USA and the UK are at record highs, as is employment in the UK. However particularly worrying is the fall in real incomes which has impacted on consumption growth.   UK productivity growth has been low, with businesses tending to increase labour rather than spending on capital. Although the very latest figures show an improvement, this is because hours worked have dropped rather than output increasing. In addition, house price growth, particularly in London, has slowed.

In thinking about what might happen to the UK in 2018, there is the old saying that “when America sneezes, the world catches a cold”. This is still applicable but we might include China since the performance of the world’s largest economies will have both direct and indirect effects on the UK, since their faster growth will directly impact on our export sales and indirectly as rapidly growing demand for raw materials overseas pushes up prices for UK firms and consumers. On the other hand, we do not know whether President Trump’s desire to implement policies  focussing on “putting America first”, will have an impact on the rest of the world.

The IMF is positive about the prospects for the world economy in 2018. It predicts that world GDP will grow by 3.7% and this recovery is likely to continue for a further four years. This faster growth is the result of the three main economic areas (North America, Asia and Europe) all recovering rapidly at the same time. Businesses in the USA and France are confident following the election of business-friendly Presidents Trump and Macron, and this confidence should have a positive impact on investment. In addition, even though there have been interest rate rises in the USA and the UK, the level of world interest rates and the positive effects of QE continue to facilitate growth. The IMF therefore expects that average unemployment in the G7 will drop below 5% this year for the first time since the 1970s while inflation will remain below 2%.

Time to feel sorry for economic forecasters.