Changes to GDP Calculation!

In April it was reported that the UK economy grew by 0.8% in the first quarter of 2014.  This was a slight increase on the 0.7% in the final quarter of 2013.  This was the fifth consecutive quarter of GDP growth, although the Office for National Statistics that compile the figure said that the economy was still smaller than its peak in 2008. Since then the National Institute for Social Research (NIESR) which is a highly respected independent economic research company has estimated that GDP for the quarter ending in May has increased by 0.9%.  These figures are normally a very accurate estimate of the official figures which will be published in a month’s time.  It should always be recognised that whatever figures are first announced that they will be substantially revised over subsequent quarters as a recognition that the data collected is refined and becomes more accurate.  It is estimated that the UK will experience a strong recovery this year of about 2.9% or more and that this compares with an anticipated average rate of growth of 2.5%.  Reports that GDP has recovered to that achieved before the recession in 2008 are small comfort as the economy should have been growing since then at 2.5% and has some way to go before it is where it should be.  It will need several years of above normal growth to achieve this

Gross domestic product or GDP is a measure of the country’s economic activity based on surveys of businesses and government departments.  It is the monetary value of all the finished goods and services which are produced in the country within a specific period and is used as a barometer of economic health.  It can be useful for comparing the various factors that make up the economy – consumers, businesses and governments.  The figure is usually updated quarterly although it is calculated on an annual basis. A contraction of the GDP figure over 2 consecutive quarters is considered to indicate that an economy is in recession.

The basic calculation for GDP uses the formula: GDP = C + G + I + NX

C is the consumer spending or private consumption

G is government spending

I is business capital spending

NX is the total exports less total imports

It can be determined in one of three ways as either the output (production) figure, the income figure or expenditure figure. The output figure is a sum of the market value of final goods and services produced in a year, while the income figure is the total of incomes of employees, profits of businesses and tax collection by government minus subsidies on production and products during the year. The expenditure approach is the sum of all household expenditure incurred plus consumption expenditure of non-profit making organisations plus government consumption expenditure and capital formation plus exports minus imports during the year.  These figures should produce the same result, however, they rarely do and the difference is dismissed as a statistical aberration but is an indication of how difficult it is to collect reliable data.

In order to compare GDP figures from one year to the next it is necessary to adjust for the effect of inflation (or deflation).  Without any adjustments the figure is regarded as nominal, current or historical GDP.  Once adjustments have been made the figure is regarded as real or constant GDP.

When comparing GDP between countries it is also necessary to adjust the value according to exchange rates.  By calculating the GDP per capita economists often make a comparison of the standards of living between countries.  It is also a problem that the components used by individual countries are not the same for all.

One frequent criticism of the GDP measure has been that it does not take into account any activity or transactions that are not reported to the government such as illegal trade, tax avoidance activities or black market transactions.  It also excludes household production and volunteer services.  Another criticism is that it ignores the value of all the assets of the economy.

Following a call by the European Union to standardise and broaden the calculations for GDP, The Office for National Statistics has announced changes to the way that GDP is measured and in September 2014 the national accounts will include a wider range of constituents including research and development costs, and black market activities.

This change will not be limited to the UK as the European Union is requiring its members to implement new statistical rules so that economies can be more readily compared.

Changes will be applied retrospectively and will result in the 2009 GDP figure being revised up by £65 billion or 4.6% with £22 billion coming from R&D and £23.6 billion from changes to the way that non profit institutions such as charities and religious institutions provide households with various free services.

The major change is that Research and Development expenditure will be treated as investment rather than intermediate consumption.  In future defined benefit pension schemes will increase the level of GDP by a further £5.1 billion and also double the UK's savings ratio. These are controversial inclusions as they may overstate economic output or worse still double count the figures.

People building their own homes will also be included and are thought to contribute a further £4bn or 0.3% of GDP. Bizarrely another £9.7 billion will be attributed from illegal drug dealings and prostitution are now to be included in the figures as estimates are already reported to government!

As a complete measure of an economy’s growth or retraction and with the inclusion of inflation in the final figure the GDP is regarded as a very useful measure against which monetary policy can be formulated.  The problem of using the measure is that it is delayed because of the time taken to collect the data but can still be compared with the monetary conditions at the time so that the right conditions could be created in order to manage inflation.  By standardising the inclusion of data in the figures across countries it should also help to refine the management of economic conditions for the control of growth and inflation.