Grossly distorted GDP statistics need an overhaul

Aerial view of London © iStockphotos
The finance sector skewed pre-crisis GDP figures

Gross domestic product (GDP) is our main gauge of economic output. It has always been dodgy, but in the digital age we may need to dispense with it entirely, says Max King.

There are, according to Benjamin Disraeli, three kinds of lies: “lies, damned lies and statistics”. Yet popular opinion treats the release of every item of economic data, often rushed out prematurely and prone to multiple subsequent revisions, with a reverence that no serious economist would condone. Economic statistics are then routinely weaponised for political ends, a task made easier by the frequent contradictions between different sets of data.

The most fundamental of economic statistics is the measurement of national economic output, generally referred to as GDP (Gross domestic product), and its rate of change. But, as Professor Diane Coyle of Cambridge University points out, “economists have been cheerfully downloading GDP and other national accounts figures without giving much thought to the statistical niceties”. She suggests that GDP data increasingly provides a “Grossly distorted picture”.

In mid-February, for instance, the BBC reported that “in 2018, the UK economy expanded at its slowest annual rate in six years after a sharp contraction in December”. This was based on Office for National Statistics (ONS) data that measured annual growth at 1.4%, down from 1.8% in 2017. Cue media angst about Brexit, stagnating productivity and structural weaknesses in the UK economy. In the past, such slow growth would have been accompanied by rising unemployment and a rising government budget deficit.

What output figures miss

Yet a week later, the ONS announced that UK employment had hit another record high at 32.6 million, that the employment rate at 75.8% was the highest since estimates began in 1971 and that wages in real terms were the highest since 2011. A few days later, it announced that after a record surplus in January, year-to-date government borrowing had fallen to the lowest level for 17 years. On the basis of these data releases, which are relatively easy to collect and hence reliable, economic growth is significantly higher than the GDP data suggests.

GDP data has always been regarded as an incomplete indicator of economic activity. It excludes unpaid work, such as in the home, omits environmental externalities that may reduce the benefit of growth (such as pollution) and ignores resource depletion. War often has a stimulating effect on the economy, though the short-term benefit is an illusion. The same is true for crime; low crime levels in Japan result in the low usage of CCTV and security guards, to the detriment of economic activity. The value of the service economy is assumed to be reflected in the salaries paid to those who work in it, though it is far from obvious that this is true for administrative, regulatory and governmental work.

“Common sense tells us that GDP data is understating advances in human well-being”

Professor Coyle suggests the problem has got significantly worse in recent years. Firstly, the booming finance sector exaggerated growth in the run-up to the 2008 financial crisis. Not only was this unsustainable but the economic value soon proved to have been grossly exaggerated. Yet there has been no subsequent revision downwards of the inflated growth it appeared to have produced. This has made the subsequent recovery, robust in real terms, look anaemic in data terms.

Accounting for technology

Secondly, “there is no sign of digitalisation in the economic statistics, with no data collected on quite a lot of new activities”. Economic data simply cannot capture the value of activities such as telephony, photography, information access and transmission, which are now, to all intents and purposes, free to users. In addition, LED light bulbs are estimated to have led to a collapse in the cost of luminescence of over 99%. Incorporating new goods, or quantifying changes in the quality of various products, has always been an inexact science in GDP data, but the problems have multiplied. As Professor Coyle says, “the quality adjustment and product differentiation challenges make a compiler of the GDP deflator want to weep”.

“We need to explore,” she continues,” whether an accounting framework from the mass-production age can function in the digital age or whether a different approach is needed.” That is a challenge for academic economists, but common sense says that GDP data is significantly understating advances in human well-being, especially in developed economies. This helps to explain why the apparent economic stagnation of much of the eurozone has not led to an eruption of public discontent; people may grumble at the polls, but unemployment is falling and life is getting better.

So what is in prospect for 2019? The best answer comes from Chauncey Gardner, the character played by Peter Sellers in the comedy Being There. His simple prognostications about his garden are mistaken for profound metaphors about the economy. “There will be growth in the spring,” he says.