There is nothing inevitable or ‘natural’ about using GDP to measure the economy. The Office for National Statistics has embarked on a journey toward a more rounded assessment of economic well-being, argues Professor Diane Coyle.
Just before Christmas, the Office for National Statistics took a giant step, in its normal low key manner: it published the UK’s first ever Economic Well-Being bulletin.
None of the statistics in this publication are new. The milestone is bringing them together to paint a rounded picture of how much better-off – or not – changes in the economy are making us. The change in Gross Domestic Product (GDP) is included but, vitally, in per capita terms, and as one part of a ‘dashboard’ of indicators somewhat similar to the dashboard a big company would use to monitor its performance.
The official statisticians are not the only people who think the quarterly ritual of City economists and commentators making a song and dance about the headline change in GDP – is it 0.2% or 0.3% – is a nonsense. The figure for the change every three months is the outcome of a very complicated process of collecting data from many different sources, adjusting it for seasonal changes, summing it, adjusting for inflation and so on. The inevitable margin of error is sometimes bigger than the headline number. Revisions occur frequently. With hindsight, recessions can be revised away.
More important than any of these practical issues, the definition of GDP involves many judgements. It is not a natural object, which can be measured more or less accurately. It is supposed to be the total amount of economic activity measured at market prices. But unpaid work in the home is excluded because this is not ‘in the market’, yet government services are included even though there is no market for those and calculating a ‘real terms’ value for them is therefore difficult. The definition of how to measure finance has changed repeatedly over the years because financial markets often do not operate with clear prices.
The most recent definitional changes made the news because the ONS started to include – in line with international standards – illegal market activities such as drugs and prostitution. It is a bit of a paradox that prostitution and drug dealing are included in the standard measure of how the economy is doing, but not childcare or other work in the home.
There is nothing inevitable about using GDP as the measure of economic performance. Throughout history ‘the economy’ has been understood in different ways – in fact, before the 1920s or 30s, nobody would have thought about ‘the economy’, but instead in terms of the ups and downs in trade. There were severe recessions or depressions – in our terminology – during the 19th century; but it was not until the 20th century, with the expansion of the franchise, that anybody thought it was the government’s business to respond to them and therefore to measure what was going on.
The work that underpinned the creation of GDP was carried out in the 1930s, by Simon Kuznets in the US and Colin Clark in the UK. The aim was to develop an aggregate measure of the economy, but Kuznets in particular argued for a measure of well-being rather than activity. For example, he would have excluded activities such as advertising, which he was clear benefited nobody. However, the necessities of the war led instead to the creation of a measure of activity, GNP (and later GDP), developed by JM Keynes and his colleagues at the Treasury, James Meade and Richard Stone. The need was to understand how much capacity the economy had and how big a sacrifice consumers would be asked to make for the war effort.
GDP is still an essential measure for the Bank of England and the Government to steer the economy as a whole; but it always was and still is an inadequate measure of economic well-being.
There is a debate about whether or not it is better to develop an alternative single indicator, for example deducting ‘bads’ such as the cost of pollution or fighting crime from GDP; or instead to present a ‘dashboard’ of different indicators. In 2009 a commission led by Joseph Stiglitz, Amartya Sen and Jean-Paul Fitoussi recommended the dashboard approach. Their argument is that well-being has many dimensions and does not lend itself to a headline number.
The ONS’s new publication follows this approach. The figures published on 23 December paint a richer and more detailed picture than the revised GDP figures that were out on the same day. The economy is recovering and people are growing more optimistic. However, GDP per capita has risen far more than domestic incomes per head. The gains have not been widely shared and have mainly been enjoyed by non-UK residents. Net wealth is rising – mainly due to the net wealth held by financial corporations. But unemployment is down and so is inflation – both good news for households. Household spending is back to close to its mid-2008 level.
The Economic Well-Being bulletin was published with relatively little fanfare, but it is a genuinely important milestone in how we assess the economy’s performance. GDP was the right measure for its time, but we need a better approach to measuring the economy now.
Professor Diane Coyle’s ‘GDP: A Brief but affectionate history’ was published by Princeton University Press in March 2014.