What do today’s UK GDP numbers actually tell us?

Today is a day where the UK economy is likely to be able to bask in the equivalent of the summer sun that feels like it has been beating down on the UK for ages now. However like sustained hot weather, good periods of economic growth have been extremely rare in the UK in recent times. Indeed the thunderstorms which struck on Tuesday night seem much more of an apt analogy for the credit crunch era.

Today’s update

The Office for National Statistics (ONS) has released these numbers this morning.

Gross domestic product (GDP) increased by 0.6% in Q2 2013 compared with Q1 2013…….GDP was 1.4% higher in Q2 2013 compared with the same quarter a year ago.

So there is plainly some better news there even if the annual comparison is flattered by the fact that there was an extra Diamond Jubilee bank holiday last year. In fact the better news spreads to my profession of economics too as for once most forecasts were if not on the button quite near. That does not happen that often these days.

Looking into the detail there was some hopeful news here too.

All four main industrial groupings within the economy (agriculture, production, construction and services) increased in Q2 2013 compared with Q1 2013.

Not since the autumn of 2010 have we seen that although care is needed as the service sector was by far the largest influence providing some 80% of the growth. Not quite the rebalancing we were promised is it? But at least manufacturing grew as opposed to the contraction at the beginning of the year. Also construction is showing signs of emerging from the economic depression that has been inflicted on it which is welcome to a sector which has been experiencing the equivalent of a nuclear winter.

In Q2 2013, output in the construction industry was estimated to have increased by 0.9% compared with Q1 2013

What about the “rebalancing” we were promised?

The last Governor of the Bank of England Mervyn King used to regularly regale us with tales of likely rebalancing in the UK economy away from services towards manufacturing and industrial production. Let us see how that went.

A partial recovery in (industrial) output in 2010 was not sustained and the sector remains 13.9% below its 2007-08 level. As compared with levels in 2000, output is some 16.2% lower.

So it has faced its own depression and lost decade and interestingly some of it took place before the credit crunch was even a figment of our imagination. However the area we are supposed to be rebalancing away from has done a lot better.

After a fall of 5.4% from the peak in Q1 2008 to the trough in Q2 2009, services output now stands just 0.2% below its peak, having almost recovered to the previous level of output.

So in fact services have recovered and industrial output has a long way to go. A long way from the rebalancing of our economy that we were promised is it not?

Indeed there is food for thought on this subject if we look at the area of our economy that is currently growing the fastest.

Between Q2 2012 and Q2 2013 distribution, hotels & restaurants output increased by 4.0%.

I hope that hoteliers and restauranteurs will forgive me if I hope that a fair bit of distribution growth is in there. After all Napoleon Bonaparte did call us a nation of shop-keepers.

Some Perspective

Sometimes it takes a little while to get one’s head around the numbers as there can be evidence of one step forwards and two steps back. For example the last set of numbers for the first quarter of 2013 showed Gross Domestic Product rising by 0.3% on the preceding quarter. However if we then factor in this.

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.

So in fact for one step forwards in overall output terms we had in fact taken five steps back. Eek! This is a reminder that these numbers are often heavily revised and a further reminder that the credit crunch is different to what was regarded as the normal pattern as ordinarily recessions are revised higher and not deeper as time passes.

So our economy grew but ended up having a lower level of output than we thought we already had with the main culprit being this.

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

If you think about it this change is very significant in several ways. Firstly the credit crunch had a deeper and more severe impact than our official statisticians originally thought. Secondly although statisticians will have been crawling all over the data like a particularly itchy rash, some 4 or 5 years later a fundamental change has been made. Those who have made the case for economic policy based on nominal GDP targeting face the inconvenient truth that too often they will be aiming at the wrong target.

Problems with the use of GDP numbers

I have discussed the many issues in this area in detail in the past on this blog (for example here http://www.mindfulmoney.co.uk/wp/shaun-richards/todays-uk-economic-growth-gdp-update-poses-more-questions-than-it-answers/ ) but recently a new potential anomaly has come to my attention.

Government Spending

If we look at the official numbers this has been contributing to UK economic growth.

The index for government & other services increased by 0.1% in Q2 2013, following an increase of 0.4% in the previous quarter……. Between Q2 2012 and Q2 2013 government & other services output increased by 1.6%.

This is, of course, somewhat inconvenient for the austerity mantra unless you use the austerity definition provided by my financial lexicon. If we look deeper the apparent paradox grows as there was no  fall in the government spending category which has grown by just under 4% in the credit crunch era and is the only main category to have risen.

Examining the numbers

If we put these numbers under the microscope we see that there has been very little inflation in this sector and actual disinflation in 2011-12. If we use the implied deflator for this area it was 100 in 2009 and rose to 102.3 in 2011 before falling to 101.7 in 2012. So much lower than the overall implied deflator which rose by 6.7% over the same period or the official -Consumer Price Index- measure of inflation which rose by 11%.

If we recall that “real growth” is calculated by taking the output numbers and then subtracting inflation as measured by the deflator I hope that you get my point. Keeping the deflator low raises the level of recorded growth and so there are questions to say the least about how our govenrment sector has done so well in this regard. After all, are not areas such as health and defence subject to considerable inflation?

This issue arose in discussions with Pete Comley who asked me for some technical advice on his recently published book called “Inflation Tax”. He had looked into the government numbers provided by the ONS and was stunned by the deflator numbers and lack of apparent justification for them. Perhaps the government could give the rest of us some advice on how to keep inflation so low……

Comment

Today’s economic growth numbers from the UK are welcome as they show a hopeful trend in 2013 and because they have been achieved in spite of a difficult international environment. Also anything which makes our debt problems look even marginally more affordable should be accepted with welcome arms. However an annual rate of growth of 1.4% is only a marginal improvement in our conditions and if we look backwards for perspective we note that we have only grown by 2.2% since 2010 and that we are still some 3.3% below the crisis peak.

In addition there are many problems with using GDP as a measure of economic growth and national well being. As only 44% of the data was available, the danger of revisions to today’s report is even larger than normal and in truth we can never be sure that we ever get the numbers right. Furthermore as I have discussed today as the light of scrutiny is applied to the numbers more and more potential anomalies, discrepancies and questions emerge.

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  • forbin

    Hello Shaun,

    So the GoP has something to be happy about

    “Chancellor George Osborne. “Britain is holding its nerve, we are sticking to our plan, and the British economy is on the mend…”

    1, I think he’s confused himself with the country

    2, more wishful thinking and proving that the economy can recover despite the politco’s tamperings

    3, GDP figures ? aren’t these the new adjusted “gerry mandered” figures ??

    Well at this rate we’ll have grown ( if 1.4% is to be believed ) to double our GDP size in 50 years so the debt will be half the problem in 2063 – now when do those bonds expire??

    and if the difference in wages to CPI , yet alone RPI will mean the burden will be greater to pay back – except the top 1% ofcourse ( or Google , companies will be safe )

    and we can all be richer by borrowing of our houses as their prices spiral to infinity and beyond!

    Hasn’t anyone told the chancellor that debt is NOT wealth ?

    Well Shaun lets hope we get some Chinese growth in the next few years – about 5.3% was needed to meet the chancellor austerity plan – seems the BBC is quite on that …

    Forbin

  • Drf

    Hi Shaun,

    An excellent analysis of the problems which the UK really has. As you have observed previously and now again here, the delusion with supposed GDP and its supposed growth is what lies at the root of it all. A refusal to face the fact that the political tinkering with now almost all of the officially published data confuses it all so much, that most do not understand where we are at! That of course is the goal, to decieve. As a result the official number for supposed GDP has now become completely useless for comprehending the economic state of the UK, because it tries to show a different position from truth, for political purposes only. Ministry of Truth stuff again I fear!

    The Keiser Report places a realistic opinion on all of this today.

  • http://jayarava.blogspot.com Jayarava

    Excellent analysis.

    Another way of looking at this is to look at long term trends in GDP growth. From 1955 (at least) to 2007 the economy grew along a shallow exponential curve. If we compare where that trend would have taken us to where we are now we’re about 12% of predicted GDP behind the trend (though in 2007 we were actually ahead of the trend probably due to the rapidly inflating credit bubble).

    Since we are still below the peak of 5 years ago it’s starting to seem that there will be no recovery in the proper sense of the word – we will simply never get back to the long term trend of GDP growth, even if we eventually do get back to pre-crisis levels of GDP growth.

    A big chunk of potential earning will never be realised. And as far as I see this has never happened before. The characteristic of the UK economy in the recessions of 1973-2001 was a period of above trend growth following the recession in order to bring us back to trend. That is simply not happening this time. In fact the present trajectory of GDP still seems to be diverging from the long term trend.

    My figures and analysis here: http://moderndebtjubilee.blogspot.co.uk/2013/07/06-gdp-growth-in-context.html

  • anteos

    Hi Shaun

    great dissection as always. I was wonder where the ‘imputed rent’ con fits into all this. I recently read that its over 10% of GDP now, and increasing?

    thanks

  • forbin

    antoes

    thats a good thing – not a problem

    people who dont pay rent also save the GoP money. when unemployed the renter is having his house paid for him , those that own out right do not . And they are free to take on lower paid jobs to help the economy – so its another benefit to the GoP .

    implied in this is the GoP need to tax everything that it can , regardless of morality .

    or do you think that immediately everyone one without a mortgage should take one up ?

    at what level ? enough borrowed to cover the average rent in your area – or we’ll tax you on the difference ?

    haven’t you hear thats how we got here in the first place ? Too much DEBT ??

    Forbin,

    PS: For whom the gods wish to destroy they first make mad

  • Mike from Enfield

    Hi Shaun,
    Thank you for a well written and informative article. However, having read the equivalent items on the BBC, ITV and Guardian websites, penned by what are obviously genuine experts, I believe you could achieve significant efficiency gains. Here’s what you do:

    1. Paste in the headline numbers with neither thought nor comment
    2. Pad it out with predictable and stupid comments from government and opposition
    3. Quote some ‘experts’ with their usual rubbish metaphors (‘coming out of the shadows’, ‘not quite on dry land yet’…etc.)
    4. Finish off by making the most banal and obvious points you can think of (‘likely to influence the bank of England’s thinking’)

    This simple formula works every time and allows you to write authoritative and respected articles in mere minutes.

    Seriously though, if you are capable of writing consistently informative analyses with a minuscule fraction of the resources available to these organisations then there is something very wrong with them if this is the best they can do.

  • Anonymous

    Hi Mike,
    ‘Seriously though, if you are capable of writing consistently informative analyses with a minuscule fraction of the resources available to these organisations then there is something very wrong with them if this is the best they can do.’
    Agreed.
    Then you have Shauns ability to go back multiple months/years or so, to when he pointed out the flaws in ‘official’ statements, and show how those flaws (or misrepresentations/omissions etc) are playing out down the track he predicted. To be keen to be judged on track record, having produced original content, in times of unconventional circumstances, is most impressive.
    Thanks Shaun.

  • Pete

    Firstly thanks Shaun for the name call about my new book just published (Inflation Tax: The Plan To Deal With The Debts). Any gratuitous plugs are most welcome!

    To understand how we’ve got such a low GDP deflator for government spending you need to understand more about how it is calculated. GDP and the deflator are rather like a ‘black box’. There is no coherent detailed technical document saying how it is done precisely. This is somewhat amazing given the importance of the measure. Part of that is purely the complexity of it of course, but nevertheless it is somewhat surprising that it is not easily open to public scrutiny.

    However there is a very neat summary of the calculation of it in last May’s BoE’s Inflation Report – see page 21 in: http://www.bankofengland.co.uk/publications/Documents/inflationreport/ir12may2.pdf.

    Basically what this says is that most of government expenditure is compared with volume measures for it and hence the GDP deflator calculated by deduction. These volume measures for government expenditure are calculated from things like the number of hospital admissions, number of kids getting grades A-C at GCSE etc.

    For example, say for sake of argument that all government spending was on secondary education whose key purpose is to get students with grades A-C. If last year this was 60% of students and this year it went up to 63%, the volume measure for GDP would have gone up 5%. If the government spent 5% more on education, then the deflator would be calculated as zero.

    Clearly spending 5% more on education in 2013 is unlikely to suddenly impact on the grades of students in just 2013, who have been in secondary education for many years. It is a much slower process than that. Furthermore the extra spending might be towards creating new facilities that are not even built yet.

    You can see this in the data in that BoE report. During the Blair/Brown years, massive amounts of extra cash were poured into government spending and comparatively little return was seen for them in each year it was spent. This led to quite high deflators on government expenditure.

    The process has now gone into reverse. Spending has been halted (largely) but the “improvements” in volume measures from the investments over the last decade still continue. Therefore since 2010, we’ve had the bizarre situation where the implied deflator has been almost zero for any government expenditure.

    The implications of this are very handy for the government, as Shaun points out. It means that GDP is being made to look a lot higher than arguably it should be purely because of the quirky way they deflate government spending.

    Furthermore in my book, I point out that until around 2006, there was almost no difference between the GDP deflator and RPI (average 0.1% difference over 25 years). Since 2010, the GDP deflator has been 2.2% lower than RPI. Had we’d still been deflating GDP by RPI effectively, we’d have been in almost constant recession for the period of the collation. Very handy for George Osborne some might say.

  • Mike from Enfield

    I can report that your plug has met with at least some success as I just bought it on kindle.

  • JW

    Hi Jayarava
    Could you not argue that since the early 80s the financialisation of the economy has produced a false ‘exponential curve fit’ to the data. The post 2007 world fitted to an earlier period, prior to Nixon’s decision of the USD in the arly 70s would be much more like a straight line. Albeit the latest numbers are still ‘through the looking glass’ in their nature.

  • JW

    Hi Pete
    Those ‘improvements in volume measures’ explain a lot. Excellent stuff.

  • JW

    Hi Shaun
    Simply superb piece today, and the standard of responses is similarly exceptional.

  • http://jayarava.blogspot.com Jayarava

    Not sure about this. Your methodology is not clear to me.

    The long term trend in GDP as measured by the ONS is fairly clear – an exponential curve fits 1955-2007 with an r2 of > 0.99. Mind you a square polynomial also fits almost as well. I haven’t done it for a while, but the last time I looked the trend more or less continues back to the beginning of figures in the mid 1900s with a couple of minor changes. The present jag is completely unprecedented in modern times.

    The line from 1992-2007 is pretty straight line (r2=0.9981) but if you go back further it starts to look very bent because of the big recession then.

    Interesting if you draw a straight line through 2010-2013 the line does indeed slope up and gets to the same level as Q1 2008 (£375 bn) in about 2018. So the people who were predicting 10 years of depression 2 or 3 years ago seem to be about tight. At that point the long term trend line predicts GDP of £475 bn. So we will be 21% below trend and counting.

  • Pete

    Shaun,

    Since you published this morning, Merryn Somerset Webb has blogged again on the issue of abuse of the GDP deflator – see http://moneyweek.com/merryns-blog/the-secret-deflator-used-to-fiddle-the-gdp-figures/#comment-44726

    She has a great graph comparing GDP with NGDP deflated by RPI: http://moneyweek.com/wp-content/uploads/2013/07/13-07-25-GDP-v-NGDP.png.

  • Anonymous

    Hi Forbin

    I didn’t realise I was holding my nerve either….

    As to the debt we did at least issue some 55 year Gilts recently so they should be okay for us to repay on your maths and trajectory. In fact if the UK’s track record is any guide then paying a coupon of 3.5% per year until then is none too shabby.

  • Anonymous

    Hi Jayarava

    Thank you and welcome to my part of the blogosphere.

    In my profession concepts of trend growth and its consequences like “output gaps” have done a fair bit of harm since the credit crunch began. As the world’s axis spun so to speak they became otiose and I believe as you imply that there will be no return to them for quite some time and maybe not atll.

  • Anonymous

    Hi Anteos

    I do not think that it is that high (for example in was 6.6% in the autumn of 2012). However not only was it rising anyway but the ONS recently went back and revised the numbers higher which I do not think are in that report. So probably not quite and I await their next update on this…..

    Apologies for the confusion which is not of my doing.

    Some wry humour may come from the fact that imputed rent was 2 and a half times actual rents received in that quarter!

  • Anonymous

    Thank you Guys.

    I did get some light humour myself when I noticed this on the Guardian live blog ( which is kind enough to regularly quote me).

    “Britain is finally getting back on its feet, reckons Nida Ali, economic advisor to the EY ITEM Club, but issues such as youth unemployment must be addressed.

    The headline GDP figures were bang in line with expectations, driven by private sector expansion, signalling underlying momentum in the economy. This is very encouraging and qualifies as the right kind of growth that we have been lacking over the past couple of years.

    Ali predicts that Britain will achieve growth of “more than 1% this year”.

    Ah growth of more than 1% when we have already had 0.9%….

  • Anonymous

    Hi JW

    Thank you.

  • Anonymous

    Hi Pete

    Thank you for letting me know about that and I have left a comment on Merryn’s blog too as I discussed the RPI/Implied Deflator issue when I temporarily returned to my Notayesmanseconics blog.

    For those wondering about it here is a link.

    http://notayesmanseconomics.wordpress.com/2012/10/25/why-was-the-calculation-of-uk-gdp-changed-lower-recorded-inflation-so-higher-growth/

    This whole episode shows that there are many questions in this area that lack proper answers.

  • Anonymous

    Shaun, there is an excellent article by Terry Bradley of the ONS on “Reconciliation of the differences between the Consumer Price Index and the Implied Price Deflator” which helps to answer the questions you posed. I can’t do justice to his paper in a few sentences but if you want it very briefly, there are differences in both formula and scope between the IPD and the CPI. The difference in formula is that the IPD is a chain Paasche price index with annual links, while the CPI is a chain Lowe index with a two year lag in introducing expenditure weights and it has December links. Calculating the IPD as a chain Lowe index with the same expenditure weights as the CPI it shows more inflation; moving from annual links to fourth-quarter links (since December links are impossible) also raises the inflation rate for the IPD.

    There are a lot of differences in scope between the two series but it seems that the most important by far are Financial Intermediation Services Indirectly Measued (FISIM) and imputed rents. FISIM had a very important impact from 2007Q2 to 2010Q1 while imputed rents was more important from 2010Q2 to 2011Q2.

    The article looks at the difference between the CPI and the IPD for Household Final Monetary Consumption Expenditure (HHFMCE), not between the CPI and the IPD for GDP. Here the differences in scope dwarf those between the CPI and the IPD for HHFMCE, since GDP also includes current government expenditures, capital formation and net exports. A similar analysis of differences in scope could explain why the CPI or the RPI was moving differently from the IPD for GDP, but is it really worth it?

    The US BEA and StatCan have done similar analyses to the one performed by Terry Bradley. I don’t know of any statistical agency that analyzes differences between their CPI and their GDP deflator. At economistsview.typepad.com there is an excellent 2008 paper, “The GDP Deflator and the Inflation Rate”, that explains very clearly just why you wouldn’t expect the GDP deflator to move like the CPI. (Being an American paper, it ignores differences in scope regarding homeownership costs, since in the US both the CPI and the GDP deflator use imputed rents as a proxy.)