Today’s UK economic growth (GDP) update poses more questions than it answers

Today sees the publication of the latest estimates for UK economic output for the first quarter of 2013. These are the final estimates for what is called Gross Domestic Product and no change is expected to the previous quarterly growth of 0.3% and annual growth of 0.6%. However I wish to take the opportunity to continue my occasional series where I peer under the bonnet of these numbers to demonstrate that the situation is much more uncertain and unreliable than many would have you believe.

What is GDP used for?

There are a multitude of uses for it from estimating both the size of and the rate of growth in our economy to an ersatz measure of well-being. Such matters attract a lot more attention when there is contraction followed by stagnation as we have experienced post credit crunch.

But also GDP is used as a comparison tool between countries and is also used as a measure of debt affordability when compared to national debts. GDP to national debt percentages are regularly quoted and have become something analysed ever more.

What is GDP?

Here we have the beginnings of trouble as there are in fact three ways of measuring it which use production or output, expenditure and income respectively. The standard measure and the one quoted unless otherwise stated is invariably output.

If you are wondering what happens if they do not give the same answer? Then be relieved that you are asking a practical rather than a theoretical question as this from the Office of National Statistics demonstrates.

The size and direction of the quarterly alignment adjustments in the first quarter of 2013 indicate that, for 2013 quarter one, the levels of both expenditure and income were lower than that of output.

What happens then?

Published GDP estimate – ONS only publishes one, balanced estimate of GDP, taking account of the data from all three approaches to a greater or lesser degree.

If that seems somewhat ad hoc and imprecise then it is. Although we find that in practice output is used and the following happens.

For all periods, the expenditure and income estimates are aligned to the headline GDP figure.

You can thank Nigel Lawson for that bit as he thought that three different numbers might scare the horses so to speak and gave instructions for there to be only one. I discovered this when doing some research into the income series which in the United States has offered useful insight and been a better guide at times than output.

So we end up using this in practice.

The production approach to GDP, known as GDP(P), is the sum of all production activity within an economy. In the form of an equation, this is described by:

GDP(P) = output – intermediate consumption + taxes on products – subsidies on products

If you think how do they measure that precisely? Then you are on the road to realising that presenting a quarterly economic growth number of 0.3% as the UK just has is an example of spurious accuracy. Especially if we remind ourselves that the other two methods (income and expenditure) gave lower answers.

Revisions

The statisticians at the Office for National Statistics do their best to make the numbers more accurate over time. Although this reinforces the concept that the initial spot estimates which attract so much media attention are unreliable. Indeed today’s update has given us some examples of how it is a mistake to over rely on them.

One media obsession about a double-dip has gone (remember also the treble-dip hype).

GDP growth between Q4 2011 and Q1 2012 has been revised from a fall of 0.1% to flat, thereby removing the phenomenon of two consecutive quarters of negative growth.

Also we see another way in which the credit crunch continues to be a different experience in these updates.

In Q1 2013, GDP was estimated to have been 3.9% lower than the pre-financial crisis peak in Q1 2008. Previously GDP was estimated to have been 2.6% lower for the same period.

The peak to trough fall of the economic downturn in 2008/09 is now estimated to be 7.2%.

Usually recessions get revised downwards over time as the scale of the fall is reduced and occasionally eliminated whereas the credit crunch contraction estimate has just risen.

This theme of the credit crunch being something of a different experience is important as I believe that the considerable change that it represents makes economic data particularly unreliable right now. For example in the worries about UK productivity where falls have been recorded I think that a lot of care is needed. How sure are we that the statistics are accurate and reliable? One of the worst things we can do is make a policy response to an inaccurate number.

Ch-ch-ch-ch-changes

You might think that this era might not be the best time to make changes to the calculations and muddy the waters. However this is not so.

Inflation Measurement

I discussed this in detail in my Notayesmanseconomics blog back on the 25th of October 2012. In essence inflation is measured in the national accounts via what are called implied deflators and the calculation of it was changed as the ONS explains below.

The second is replacement of Retail Price Index (RPI) series with Consumer Price Index (CPI) series in forming the deflators

This has this effect as I pointed out on the 25th of October 2012.

So on that a lower inflation measure for the same reading will give a higher growth measure.

So a change representing some 18% of the implied deflator was made (CPI already represented 5%) which will over time lead to higher numbers for UK real GDP and therefore recorded economic output and growth.

I am particularly reminded of this today as we note that in spite of such upward changes the credit crunch has been revised downwards.

Of Royalties and Research and Development

There are planned changes in these areas next summer to bring the UK in line with what has become in the statistical arena a chilling phrase “international standards”. The main change is in regard to research and development where something previously treated as a cost which is recorded as a benefit when it leads to new or higher output suddenly Superman style goes into a phone booth and comes out as an addition to investment.

So our economy will suddenly be larger and growth may be revised higher too. The obvious problem is that statisticians are discovering an apparently larger economy just as we are discovering it is ever more troubled!

For those who wish to look at the detail I discussed the changes in relation to the United States economy on April 22nd.

Imputed Rent

You may be wondering what this concept is so via the ONS let me explain.

In the National Accounts, the output of housing services comprises not only the services produced by rented dwellings but also those services provided by owner-occupied dwellings.

This is an uncomfortable concept as for example I do not rent my home in any way as I live in it and yet the rental value of it is apparently adding to the UK’s economic output and perhaps growth! However if we give the statisticians the benefit of the doubt here I note that even they have concerns.

The question then becomes how to determine the rent of a similar rented dwelling and match it to an owner-occupied one.

This has become a bigger issue over time as the size of imputed rents used in the calculations has risen. For example they were £117.5 billion in 2011 using 2011 prices but only £86.2 billion in 2007. This is slightly awkward as this means that they are apparently a growing part of our economy. Interestingly they are growing faster than actual rents collected in the economy as they rose by 21% rather than 36%!

The ONS has been investigating this area and has published this only this morning.

Throughout the year a large development project has taken place to change the treatment of ‘Imputed rentals on owner-occupied dwellings’ and ‘Maintenance and repairs of the dwelling’,

Okay and if we cut to the chase the result is?

As can be seen in Table 2 above, the net effect of the new method is not zero for total UK HHFCE (or for GDP). This is because the increase in imputed rentals expenditure is larger than the reduction in maintenance and repairs. (HHFCE) is household final consumption expenditure.

Let me put that into numbers. The impact of  UK imputed rent has been raised by £17.6 billion in 2011 as the rise in maintenance was lower than the rise in rents.

This area has attracted my interest as when I looked into the UK’s inflation statistics there were problems with the rental series which has been changed. This seemed to bother officials much less than me as they used rents in the new measure of house price inflation called CPIH. But as we move to the wider implications it seems that issues here are popping up in our GDP statistics too.

Comment

It is not my purpose to destroy any faith that readers may have in economic growth figures as represented by GDP numbers. However the production of spot numbers each quarter gets much more analysis than their accuracy deserves and it is my intention to suggest that they are taken with a dose of salt. Unfortunately some of the changes that are being introduced mean that the dose of salt will need to be larger rather than smaller.

There was I believe something for us to learn from the title of this article from Willem Buiter who was my tutor for a year back in the dim and distant past.

I know I know nothing; but at least I know that

This entry was posted in GDP, General Economics, Growth, UK economy, UK Inflation Prospects and Issues and tagged , , . Bookmark the permalink.
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  • anteos

    great article as always Shaun.

    I’d read about the imputed rent con trick a while ago, and it astounded me. Its almost 10% of GDP now. Is it true that it constantly goes up, even when we had the HPC in 2009?

    thanks

  • Joe

    It sounds like GDP should be presented as a range, say -0.2 to +0.8, which is then maybe refined over time to 0.0 to +0.6? If we said 0.3 plus or minus 0.5% then the media would just report the 0.3, but if presented as a range, I find it unlikely that they’d take the effort to try and reduce it to one number.

  • Anonymous

    Agreed. I’d love to see a graph with:

    growth
    pre-calculation imputed rent
    post-calculation imputed rent

    Yet again this calculation locks the UK into the perverse situation where rent goes up, people have less money and we are told it’s growth.

    We have to break the cycle of more expensive living costs being a “good thing”.

  • forbin

    no no no , today’s methods mean an increase in tax , be it VAT or income tax , will increase GDP !

    its all good! the headline rate goes up and the politicos and all break their arms patting themselves on their backs…….

    Today Mini Tru announced an increase in the chocolate allowance from 4 ounces to 2 !

    1984 here we come…..

    Forbin

  • pavlaki

    Having run a region where fairly accurate figures were submitted from a number of factories and sales organisations I still believed that our final consolidated figures were accurate ‘within a range’. I have therefore always taken countries GDP figures as an indicator and not a precise measure of growth as there is just no way that an entire country could be accurate to a decimal place! The interesting thing is that Britain’s figures are almost always revised up whilst the Eurozones are revised down. Psychology at work or spin?

  • Mike from Enfield

    My brain is still reeling a little after reading that but, if I’ve got this right, my patriotic duty would be to:

    1. completely abandon any future house maintenance unless I could be certain that it would generate a larger increase in un-realised rental income

    2. spend all my disposable income on booze, fags & petrol (all of which are highly taxed)

    …as both would raise GDP and, by extension, well-being!

  • david

    Link to that news story I mentioned last night.
    http://english.caixin.com/2013-06-26/100547348.html

  • Anonymous

    forbin,
    How do you work that out? Tax rises dampen demand and are usually neutral to negative in terms of GDP… Aren’t they?

  • Robert S

    Shaun,

    I used to think highly of the ONS, but your articles and their quotes, have turned my opinions 180 degrees. They are either employ total fools and/or are highly polticised and I can’t believe a thing that they say. Admittedly I never read their reports, so I don’t know if they say this, but when a polling firm issues polling data, they always give a margin of error. So where you quote them, “GDP growth between Q4 2011 and Q1 2012 has been revised from a fall of 0.1% to flat…”, I’m sorry but I do not believe that for a minute as it’s well within a margin of error. And how dare they state, “…thereby removing the phenomenon of two consecutive quarts of negative growth.”, when they’re statisticians and should not be making such provocative statements.

    I apologise for such harsh words, but when things stoke my fire I feel compelled to write. And keep up the excellent anaylsis, please!

    Robert

  • forbin

    I think Shaun is pointing out we’re changing to international standards

    so in future we’ll be like the others – rounding down

    theres also the hidden critique that we’re abandoning best in class to go for middle of the road reporting or maybe worse .

    I for one would like for once for our figures and reporting to be setting the standards , instead we go for cheap – well what else can we call it ?

    Forbin

    PS: yes we can call it below accurate …. ;-)

    PPS: yes I have always thought we report an absolute figure when all such accounting has bands of range – ie 0.0 +- 10%

  • Anonymous

    Higher rent is a good thing for the landowners and BTL brigade.

  • Anonymous

    Yes, I really don’t think the UK ever fully removed the shackles of feudal days. It’s pretty sad that the population unflinchingly accept it all.

    The only time they become animated is when stepping on the heads of the young via perceived house price gains. If some are born to rule, I’m sorry to say that Brits are born to be ruled.

  • forbin

    its the logic they use – if a rise in rents produces GDP growth then surely a rise in taxes will do the same

    …. and everyone else has got it wrong……. ( I was trying to make a joke ;-) )

    Forbin

  • Rods

    Hi Shaun,

    Another good blog.

    Another area where the new up is really down!

    Manipulation by Governments to get the statistical results and sound bites they want, is these days the norm and seems to be getting worse.

    Unfortunately, for the politicians, reality will intervene at some point, like it did in the USSR. I think the only real measure at the moment is the size of the Government’s annual deficit, although last year they tried to make the new down as up, again manipulation and spin over reality.

  • JW

    Hi Shaun

    As we have discussed before, ‘official’ statistics have now been manipulated, smoothed and weather corrected to such an extent that they are now just used to convey any ‘message’ desired by our ‘masters’.

    Our feeling of wellbeing is best measured by our psychological condition. Do we feel our jobs are secure? Do we think our children’s future are secure? Do we think our ‘wealth’ is secure? Do we think our health is secure? Do the uncertainties in our society make these easier or harder questions to answer?

    Also our society depends on electricity to work. Today its announced the probability of black-outs by 2015/6 has increased to 25%. As this depends on the completely impossible energy demand reductions forecast by NGC being attained, its more likely there is a 50% chance. To try to alleviate this the govt is talking about reintroducing incentives for large industry to reduce load last seen in the days of the ‘Bulk Supply Tariff’. I am vividly reminded of the 1970s.

    The Emperor has no clothes!

  • Anonymous

    Osbourne is as bad as Brown. I see him as a man bailing out buckets of reality from his sinking ship with a spoon.

  • Anonymous

    Oil wealth has made many Brits “comfortably numb” over the past 30 years.

    British workers are fairly productive and Britain has some world class products to sell. With courageous politicians making tough decisions – only modest reductions in the standard of living are needed, but sadly our current leaders are unwilling to level with us and face the music – it’s easier to pretend there is no problem while leading us down the path to debt penury.

  • Anonymous

    Hi Anteos

    There was no dip in this series in 2009 in fact I have just scanned the whole data set back to 1963 and it looks as though there has never been a dip! Curiouser and curiouser….

  • Anonymous

    Hi Joe

    That would be vastly better system which would be more accurate and realistic. It would of course be a lot less media friendly and less open to spinning by politicians (and some economists..) but I think it would make the wider public aware of the uncertainty and doubt.

  • Anonymous

    Hi Mike

    Actually how much house maintenance you do is irrelevant unless you are part of the survey undertaken.

    “Previous estimates of maintenance and repairs by owner-occupiers were based on a historic percentage. From Blue Book 2013, estimates are more precise. They are now based on expenditure
    patterns for the relevant quarter, taken from ONS’s Living Costs and Food (LCF) survey.”

    To be fair to the ONS at least they are trying to get this right but the old “historic percentage” system seems a bit like sticking a finger in the air.

  • Anonymous

    Hi David and thanks

    For those wondering about this then the issue at hand is why has this new story not come to wider prominence?

    “Riots in the northwestern region of Xinjiang have left 27 people dead,”

  • Anonymous

    Hi Robert

    I do have some sympathy for the ONS over the subject of the “double-dip” as I would imagine that the pressure from the government on this point would have been immense.

  • Anonymous

    Hi JW

    I am old enough to remember my family stockpiling candles etc. in the three day week era of the 1970s when there were power cuts. If we end up back in the same situation it will be entirely due to the negligence of the UK’ s political class which has balked at doing anything about this. I recall discussing a decade ago that we needed to plan replacements for maturing power stations but the decisions were delayed or not taken. Over this period all 3 parties have been in power in some form.

    Instead we have had expensive vanity projects involving wind power. I have nothing against wind power but it requires a back up for when it does not blow so will only ever be a partial answer that is currently very expensive.

    One thought for you though finally we have found a silver lining in the cloud of the credit crunch! As without it UK energy demand would be higher and perhaps blackouts might have come with this springs cold snap.

  • JW

    No Shaun, wind and solar power are completely useless expensive ‘cons’ on the population. We should never be retiring perfectly useable coal and gas-fired stations. The economic problems have had little effect on demand.

    Some things are beyond the control of politicians, this isn’t, its absolute sheer incompetence.

  • Anonymous

    Here is a story of solar power in Bulgaria that might make you laugh.

    A solar power generator was recently found to be daily selling 32 times his hourly maximum generating capacity. Investigations found he was buying electricity from the grid and selling it back as “green electricity” with a big mark up.

  • Anonymous

    I disagree. Politcians of all sides know that if they say no to the electorate they will not be in office to enact their policies.

    The electorate are always ok with cutting *something* so long as it doesn’t effect *them*. Brits are numbskulls rather than comforably numb!

    The only ones I have any sympathy for are the young. Soaked in advertising after generations have failed to stop the proliferation of corporations sending signals 24*7, mired in debt and told that it will all add up once they get a degree. Nothing could be further from the truth. They are being farmed.

  • Anonymous

    Hello, Shaun. Thank you for your summary of the UK National Accounts. I used to work on the Canadian System of National Accounts. As far as I know, it is the general practice to make GDP(E)=GDP(I). Statistics Canada and the US Bureau of Economic Analysis does so too.

    The US BEA doesn’t calculate GDP(P) and Statistics Canada calculates it at basic prices, while GDP(E) and GDP(I) are at market prices. Conceptually the estimates shouldn’t match and they don’t if only for this reason. So it does seem debatable at least whether the ONS should make volume GDP(E) and volume GDP(I) estimates match.

    Since Statistics Canada went to chain Fisher estimates there is also a quite unnecessary source of difference between the volume GDP(E) and volume GDP(P) estimates due to the former being calculated with quarterly links and the latter with annual links. This seems to have been avoided by the ONS, where, as I understand it, both volume GDP(E) and volume GDP(P) estimates are calculated using the chain Laspeyres formula with annual links.

    That being said, considerable efforts are made to ensure that volume GDP(P) and volume GDP(E) estimates tell pretty much the same story. The GDP(E) estimates have always been the headline estimates for volume GDP in Canada, whether they deserve to be or not.

    Any Canadian user of the SNA data who doesn’t believe in reconciliation of the volume estimates could calculate the official volume GDP(E) estimates excluding the statistical discrepancy if they wanted using the old constant price series, which were additive. The chain Fisher estimates are non-additive, so this is no longer possible, and StatCan does not publish an aggregate for GDP(E) excluding the statistical discrepancy as it might have done. This would allow someone who was interested to also calculate a volume GDP(I) estimate excluding the statistical discrepancy. It really is a shame. Not every user likes things simple, and it is useful to be reminded, as you have done, that the National Accounts are actually fairly complicated.

  • Russell

    I would just ask B and Q to keep some anonymised records on certain maintenance products….