BU's Emeritus Professor Nigel Jump writes the next in a series of economic blogs looking at the impact of covid-19 on the economy.
CURRENT SITUATION
In 2020, the UK economy, measured by real GDP, shrank by 9.9%. This was by far the biggest drop ever recorded in a calendar year, taking some £260bn off annual UK output. At the end of 2020 (Q4), real GDP was about 7.4% below its year ago level. Covid19 and the measures taken to address its pandemic explain the huge fall. The ONS recognises unusually big measurement and comparison problems with historical and geographical series in these numbers. Revisions are likely, but the basic message is clear: the hit on consumption and investment made the UK’s performance worse than that of many others.
Most analysis of any economy starts with this measure of real Gross Domestic Product (GDP). It is the basic statistic of the flow of economic activity in a country (or other defined area) over a specific time period. This means adding up, separately, all the output, incomes and/or expenditure in a year or quarter, net of inflation and reconciling these to get a total for the whole economy and its parts.
For example, using the expenditure method, the ONS adds up money spent through UK household consumption, business investment, government spending, and net trade (exports-imports) and then takes into account the net change in stocks (output generated but not yet consumed). For the UK, consumption is by far the largest element and trade is usually a negative. Generally, the UK’s problem is that private and public investment is not high enough to raise markedly future growth potential in comparison with key competitors.
Normally the rate of change in GDP is compared with some previous equivalent period and/or some estimate of potential to calculate and analyse a rate of growth. The rate of growth is an indicator of whether a country is booming, plodding or recessing. Also, GDP is often divided by a workforce measure or a population total to get GDP per employee or per head. This is the start of any analysis of relative productivity: the source of all understanding of standards of living.
One problem with GDP is deciding exactly what to include (what we value), how to measure it, and how to change the definition and content over time.
- For example, using the output method, without double counting, the ONS adds up production (such as agriculture, utilities, manufacturing and construction) and services (including retailing, accommodation, transport and communications, business, finance and professional services, and public, education, and health services). Over time, industries and outputs, and therefore what to include and exclude in these categories, change.
- For example, GDP did not include mobile phones in the 1970s but now it does. When to include innovations like this and/or when to drop old activities (faxing?), and how much to weight them in the overall pot, is an ongoing issue for economists and statisticians. And, because countries differ on what is “in” and what is “out” and how to measure them, cross-comparison can be tricky. This is particularly true for valuing some services, such as education and health.
At a regional or local level, the equivalent to GDP is Gross Value Added (GVA). GDP and GVA are not exactly the same, (differing as to how flows of taxes and subsidies are taken into account). Also, because we seldom have sub-national price indicators or inter-regional trade flows (no rates of inflation or current account for Dorset), adjustments for prices are not often made at a sub-national level. In essence, for a representative survey of firms or agencies, statisticians attempt to measure the addition to value made in a period and to aggregate these for all parts of the economy. Broadly, sales revenue minus bought-in costs is the value added which is netted through or along supply chains.
This whole process of measuring the flow of economic value is a difficult, approximate and technical procedure. Still, it has got better over time and generates roughly consistent and useful results that can be compared over the years or between countries/regions. For example, in 2018, Bournemouth Christchurch and Poole recorded about £26,000 of GVA per head, 8% below the national average. Dorset County was about £22,000, 23% below the national average. That performance is rather underwhelming. Take care, however, with interpretation. National averages are boosted upwards by the Greater London effect. Dorset’s relative performances were not as bad they look at first sight for such constrained urban and more rural areas. We have to consider what is a useful comparison: which “league” are we in?
Another problem that has always been there but is now gaining ground as an important consideration for debate, is what is NOT included in GDP or GVA – often, because it is not captured, measured or interpreted by anyone:
For example, historically, home working was not really counted in GDP. After the Covid19 pandemic, accurately measuring output from home working may become more of a priority.
Similarly, the flow of environmental values or costs is not usually well accounted for. These ‘externalities’ (outside normal markets) are at the heart of issues such as climate change, biodiversity and nature conservation. For example, if I pollute your land, but do not have to compensate you for the damage I’ve done, (maybe because I’m up-river from you and dump my waste in the flow down to you), my ‘value added’ might be inflated. Moreover, if a forest generates important carbon capture services, but these are not included as part of GDP/GVA, the forest may be under-valued when someone wants to chop it down to make way for other development. There are many examples of these ‘value’ problems, and they are becoming more relevant to how we conduct and assess business performance in the 21st century. Such factors are likely to change the measurement and interpretation of GDP quite a bit in the years ahead.
CURRENT PROSPECTS
This all suggests more attention needs to be paid to the “balance sheet” of national and local economic activity as well as the “profit and loss account.” A better analysis of our assets, their use and their sustainability should be at the heart of future economic analysis alongside a better measure of GDP/GVA.
What are Dorset’s assets, how are they valued and are they being accumulated or depreciated over time? Assets can be:
- natural (seas and marine stocks, beaches and coastlines, fields, rivers and hills, wildlife and biodiversity, minerals, waters et al),
- human (population, workforce, age range, skills etc),
- physical and digital (infrastructure, buildings, machinery, software and so on) and
- financial (wealth in all its forms).
Accurate comparative valuation of these assets is important for estimating and incorporating beneficial use and limiting abuse of resources over time. Just as we need to preserve and enhance the human capital in our labour stock and the physical capital in our companies, we need to preserve and enhance our natural capital for sustainable conservation and value generation.
Why is all this relevant to a short-term, local blog such as this? Because the strength and sustainability of the recovery from the pandemic recession will depend on the balance sheet - the quality and quantity of our assets in the form of natural, physical, human and financial capital AND on the profit and loss: the growth of an updated, better calculated real GDP flow.
Indirectly, the latest analysis by the Bank of England in its (February 2021) Quarterly Inflation Report offers insight on these issues. The Bank expects a weak first quarter in 2021 followed by a rapid pick up. It identifies high risks on both sides of this central view, depending, as we discussed in our previous blog, on
- a) how excess savings (principally for high earners and the retired) are activated/spent by consumers. Are pandemic changes in spending patterns permanent or temporary; are the reactions of domestic and foreign spending going to be different; are scarring effects from the pandemic permanent or temporary?
- b) whether business investment increases. Will uncertainty diminish; are company debts taken on in the crisis a longstanding constraint or not; and can the previous decades’ low investment, productivity and low growth potential be changed for the better?
- c) how speedily the labour market improves. Will redundancies drop back and reverse quickly; will most furloughed employees return to work speedily; and how rapidly will human capital losses be repaired and then enhanced?
There is a lot of uncertainty out there and some danger of “false dawns”. It may be a year before we have hard GDP evidence of what kind of recovery we have, and then we must factor in long term balance sheet and growth issues, such as the opportunities and necessities of addressing climate change and new international trade relations. As we watch real GDP move over the next twelve months, there is a chance for government, firms and others to consider the long run prospects for public and private investment. We need an understanding of how our economic assets and, therefore, growth potential can evolve.
