Happy?

In case you missed it, 6 weeks ago, 20^th March, was World Happiness Day, which seems a little ironic given what has happened since then. This dates back to 2012, when the United Nations passed a resolution recognising World Happiness Day, sponsored by Bhutan. This is unsurprising since, in the early 1970s, they adopted Gross National Happiness as a more important objective than Gross Domestic Product, with all major new projects having to measure their impact on the country’s Gross National Happiness before being approved. The UN motion was recognition that there was dissatisfaction with measuring wellbeing by looking solely at GDP and countries should be seeking to measure a wider view of welfare which includes health, education, sustainability, equity, etc. David Cameron, when elected Prime Minister in 2010, promoted this approach and, in 2011, the UK’s Office for National Statistics carried out its first happiness survey to measure well-being. Like other such surveys, they asked four questions –  how satisfied are you with your life, to what extent do you feel things you do are worthwhile, how happy did you feel yesterday and how anxious did you feel yesterday – and  people answered on a scale of 10 (very) to 0 (nil). Their recent survey (March 2018 to March 2019), found a slight improvement in average happiness from 7.52 to 7.56, with the greatest improvement coming in London. While the answers to these questions are subjective, by comparing them over time we can see how people’s perceptions change.

The latest UN Report found that, for the third year in a row, Finland is the happiest country in the world, having overtaken Norway in 2018, while the UK is 13^th and the least happy country is Afghanistan.

Country Happiness Rankings 2020

1. Finland
2. Denmark
3. Switzerland
4. Iceland
5. Norway
6. Netherlands
7. Sweden
8. New Zealand
9. Austria
10. Luxembourg

For the first time, the UN looked at the happiest cities and, not surprisingly Finland’s capital Helsinki was top, followed by Aarhus, Denmark and Wellington, New Zealand. London was the UK’s happiest city, coming 36^th in the UN rankings.

Another well-known measure is the Happy Planet Index which considers wellbeing, using the world Happiness Survey but supplementing it by considering life expectancy, inequality and the impact the average inhabitant makes on the environment. Their results (2016) are very different to the UN analysis with Costa Rica first, followed by Mexico and Columbia and Chad last, preceded by Luxembourg.

Some parts of the world have gone even further. Maryland, in the USA, uses a Genuine Progress Index  which starts with GDP and then adjusts it by adding  a value for invisible “goods” e.g. leisure time, volunteering, & housework and subtracting a value for “regrettables” e.g. , inequality, pollution, commuting time and crime prevention spending such as burglar alarms.

With so many different measures, it is not surprising that there are so many different rankings. Possibly the only definite fact is that welfare is hard to measure.

GDP – what does it measure and is it still useful?

Gross Domestic Product, which measures the total market value of goods and services produced in an economy in a period of time, is regarded by economists as the single best measure of economic activity. It provides a measure of how well a country is doing relative to other countries and, if adjusted for inflation, i.e. measured in constant prices or real terms, it shows progress over time. When converted into a common currency such as the US dollar, its size reflects a country’s economic power in the world while its PPP (purchasing power parity) value is used to compare living standards between countries. Equally importantly, it provides information which the government can use to manage the economy.

It is measured in three ways – output, income or expenditure in an economy – and, in theory, these should be the same since expenditure on a product determines its monetary value and also generates the incomes of the factors of production involved in its production. The output method involves looking directly at the value of the output of goods and services produced less the inputs used to produce them, plus indirect taxes minus subsidies. The income method considers the income earned by households and businesses in the production of goods and services and the expenditure approach measures spending by households, businesses (investment in capital and stocks of goods) and the government, plus net exports (exports less imports) of goods and services. Government services, such as healthcare or education, which are not paid for directly, are particularly difficult to measure. In the past, the Office for National Statistics has looked at the cost of providing these services; more recently it supplements this by looking directly at outputs such as the number of patients seen.

It is accepted that GDP does not measure the value of activities which are not traded, such as volunteering or services undertaken at home by parents such as childcare or cleaning; it does not directly measure  welfare, takes no account of inequality and most recently, concern has been expressed that it does not take into account the depletion of natural resources. Thus, if Brazil increases its logging in the Amazon, its GDP increases through the production of timber, without any corresponding reduction to take account of resources used up. Similarly, ironically, a disaster is good for GDP since it will require  re-building of houses, factories, roads, etc, which is counted, while the initial damage is not subtracted. GDP does not adequately take account of improvements in quality, particularly with electrical goods – computers are estimated to be 1,000 times more powerful than 30 years but in real terms are cheaper.  It also does not accurately reflect the hidden economy, although since 2014, UK GDP data has included an estimate of the value of  illegal drugs and prostitution (£10bn in 2014) in the GDP data.

There has been concern over the accuracy of GDP estimates, which are frequently revised following initial publication as more data becomes available. The UK is similar to other countries in this respect but where the problem becomes important is when the country might be entering a recession, with all the political and economic significance attached to it. The definition itself (two successive quarters of negative growth) is questionable since it suggests an economy shrinking by 0.1% in two successive quarters is in recession and therefore doing badly, while one growing by 0.1% in one quarter and then shrinking by 2% in the next quarter is okay.

15 years ago, only half the adult population had access to the internet. By 2015 only 10% of adults did not have internet access. Today two thirds of adults own a smartphone, a percentage which has more than doubled in nine years. This increase in on-line activities has been one factor behind the increasing discussion of the usefulness of GDP as an economic indicator and the government commissioned Professor Sir Charles Bean to produce a review of government statistics. He noted that, when an economy mainly produced tangible products, measuring GDP was relatively simple. As services became more significant, GDP calculations became more difficult and, in recent years, with the rise of on-line services, such as Spotify and Google, the validity of GDP statistics has become even more doubtful. Previously, for example, if I wanted to go on holiday to Paris, I might buy a map. Today, I will use google maps instead. Although the physical quantity of goods produced has dropped, I receive the same “product” in a different form, but it will not be recorded in GDP data. As Professor Bean writes, “Digital products delivered at a zero price ……  are entirely excluded from GDP. …….  The issue is analogous to that posed by public goods provided free of charge at the point of delivery. But, unlike that example, there is not even a protocol that dictates their value is related to the value of inputs used in their creation.”  (Page 76, Independent Review of UK Economic Statistics – Professor Sir Charles Bean)

He considers what has been omitted and also looks at the way the digital revolution has made us more productive saving time ( or less productive if you get bored reading this and go off and email friends or buy something on-line) and estimates that the digital economy currently adds approximately 0.5% p.a. to our GDP growth which we are not adequately measuring. Given the current low levels of UK GDP growth, this is a significant adjustment.

What sort of economy will the new Prime Minister inherit?

In elections, the economy is usually a key focus  on the campaign trail with opposition parties taking every opportunity to criticise the government while the latter explains how they have improved the economy after the disastrous state they found it in when they took office.

In this election, with its focus on Brexit and many lavish future spending plans, the current state of the economy has not yet featured heavily but were one asked to comment on its current state, it would be difficult since there is so much contradictory evidence at present.

Consider the following data and one sees why it is so hard to see how we are doing.

• Although GDP grew by 0.3% in the third quarter of the year, the yearly growth of 1% is the lowest since 2010. Will this increase or fall after the election?
• Unemployment is now 3.8% which, in historic terms, is low. However this is slightly up on the last month so does this, pessimistically, suggest we are on the cusp of an increasing period of unemployment, especially since unemployment is a lagged indicator – firms do not immediately reduce labour when demand for their products fall. Alternatively, one can look at the figures and note that the falling number of people in work is because part-time employment has fallen by more than the rise in full time jobs so, positively, more people are in “real” employment or have the part-time workers who have failed to find full time jobs simply stopped looking and left the labour force?
• Productivity has only increased by 2.4% since June 2007. Before then the UK had averaged 2% per year, so we are producing over 20% less than we would have been had the trend continued. Possibly this is due to the long tail we have in the UK in terms of productivity with too many firms a long way below the best in their industry. How can this be improved?
• Inflation fell to 1.5% last month because of lower gas and electricity prices but retail sales fell last month as consumers possibly lost confidence in the economic outlook for the next few months. Earnings are increasing at 3.6% so real incomes are rising at 2.1% but if productivity is static, then inflation will increase as firms’ costs rise.
• UK exports have dropped, possibly because of Brexit uncertainty and the slower world GDP growth following the US-China trade war.
• The public finances have deteriorated. Borrowing has risen by a fifth during the first half of the financial year, and in September was £9.4bn compared to £8.8bn last year and the national debt was £1.8tn at the end of the financial year ending March 2019, equivalent to 84.2% GDP. Therefore how will the political parties finance their announced increases in spending without considerable increases in tax or borrowing?
• UK consumer debt is rising, standing at £59,441 per household in August 2019. What will happen when interest rates increase as they are likely to do if government spending increases significantly or if the economy enters a downturn when Brexit occurs? Are we heading for another financial crisis?

Public Spending – The End of Austerity?

Cricket fans look forward to the Ashes, racegoers to the Grand National but for economists, the year has two highlights, namely when tax and public spending changes are announced. This is particularly the case for Keynesian economists who see the balance between taxation and government spending as the key determinant of the level of aggregate demand. Last week saw the Chancellor set out the government’s public spending plans for departments for 2020 – 2021. Possibly (and cynically) with an election looming, he announced the end of austerity with an increase of £13.4bn or 4.1%  in government spending. All areas would rise at least in line with inflation, with the main beneficiaries being the field of law and order (police, prisons and courts), defence, health and education. The increased spending will mean that the government’s share of GDP will increase for the first time since 2009.  The money for this will come from borrowing which is predicted to increase from 1.1% to 2.0% of GDP but, even with the increase, this keeps the public finances in line with the previous Chancellor’s target of cyclically adjusted borrowing of no more than 2% of GDP.

The spending announcement has raised eyebrows in some quarters. This is partly because of the process. Paul Johnson, Director of the Institute for Fiscal Studies, writing in the Times, pointed out that, normally, public spending reviews are a long process, with ministers arguing their case to the Treasury and big decisions being made in Cabinet. Given that the date of the announcement was made only a week before it happened, he wonders whether there has been sufficient time for a thorough review of all the conflicting demands on the government’s limited resources. Another concern among commentators is whether the Chancellor will be able to meet his fiscal rule. Last week’s announcement heralded the largest increase in spending since 2004 and it is worth remembering that in 2004, the UK economy was booming. Today the rise in spending comes at a time when growth is likely to slow. Therefore we can applaud the increase in terms of a counter-cyclical measure but expect that the 2% rule will need to be re-written in the next few months.

How is the UK doing?

In the run-up to a big boxing or tennis match, the media is fond of making comparisons between the two competitors, comparing key measures such as height, weight and reach. As we approach Brexit on 31^st October or later,  it is worth doing the same exercise for the UK and world economies to see what state the UK is in.

Optimists, looking at data published in August, highlight the increase in average earnings of 3.6% in the year to June, the highest increase since June 2008, the rise in employment to 32.8 million (largely due to increased females working), giving the joint highest participation rate ever.

However pessimists focus on the fall in GDP of 0.2% from April to June, the sharpest fall in high street sales since December, 2008 (although these are survey figures, so might not be representative) combined with a fall in internet shopping, the increase in inflation to 2.1%, the small increase in unemployment to 3.9%, the lower than expected government budget surplus and the balance of payments current account deficit amounting to 5.6% of GDP. They also worry about the quality of some of the new jobs being created, possibly on zero hours contracts, and ask whether the rise in employment is because firms are reluctant to commit themselves to expensive investment projects because of low confidence in the economic outlook.

The current state of the world economy is also a concern for the UK. Germany suffered a fall in GDP in the last quarter and is expected to move into recession (two consecutive quarters of negative growth), the trade war between the US and China is dragging on and growth in the latter is slowing, and the International Monetary Fund has cut its forecast for world growth to 3.2%, the lowest for ten years. The world economic situation has been a key factor in last month’s fall in UK manufacturing output – the fastest rate of fall for seven years. However, worryingly, another explanation provided was that some foreign firms are cutting the UK out of their global supply chains in anticipation of Brexit (but bear in mind that manufacturing is now only 10% of UK GDP).

However what was a feature in the news last month was the technical concept of an inverted yield curve. The yield on a financial asset, such as a government bond, is the rate of return based on its purchase price and, normally, it is higher for long term assets than short term ones. If the government borrows money for three months, the rate of interest would normally be lower than if it borrowed for ten years. This is because lenders are rewarded for committing their money for a longer, and therefore riskier, period. When this is reversed, i.e. governments can borrow at a lower rate of interest for ten years than one or two, it signals that the markets expect that the future will be poor and the government will cut short-term interest rates in the future, therefore savers will wish to lock into the current long-term rates of interest. An inverted yield curve also shows that savers wish to lock into safe assets, such as US, German and UK government bonds, and are prepared to pay a higher price for them. The higher price reduces the yield from the bonds. An additional concern is that current interest rates are already at very low levels so the scope for reducing them is limited so, despite concerns about high government borrowing, fiscal policy might be the only weapon left.

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 1^st 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.