THE CONSERVATIVES MUST REGAIN CONTACT
WITH ECONOMIC REALITY
George Osborne has been heavily criticised for his commitment to Labour’s spending plans, reported in The Times 3/9/2007, ‘Today I can confirm that for the first time that a Conservative government will adopt these spending totals. Total government spending will rise by two per cent a year in real terms. At the same time the share of national income taken by the State will fall as the economy grows faster than the government does.’
So he based his proposal on ‘the economy grows faster than the government does’. This refers to the growth in GDP which, of course, is now zero. Officially, the growth in GDP in quarter one 2008 was 0.2 per cent and, in quarter two, 0.0 per cent.
Conservatives should be aware that the statistical mechanism which produces the GDP figure is highly suspect and, in reality, GDP is already falling. GDP per head (with migrant workers annually adding 0.65 per cent to the workforce) is falling heavily.
There is a major question mark over the calculation of GDP with the GDP Deflator in particular coming under scrutiny.
This index is supposed to deflate nominal GDP growth to real GDP growth (using a basket of all goods and services produced domestically – imports are deducted and import prices are a negative).
Yet the GDP Deflator, the adjusting mechanism for inflation, is now massively more (2.6 per cent) than the substantive figure, real growth (0.0 per cent), which it is adjusting from nominal growth. A slight error in the GDP deflator, therefore, makes an enormous difference to the real GDP growth figure.
The GDP deflator index has become a matter of controversy in the US where real GDP growth in the second quarter was restated at 3.3 per cent, while the GDP deflator was 1.3 per cent – totalling nominal GDP growth of 4.6 per cent. On the face of it, this analysis, produced by the Bureau of Economic Analysis, appears completely askew from the Index of Gross Domestic Purchases (purchases by US residents of goods and services wherever produced), which showed nominal growth of 4.4 per cent, a deflator of 4.2 per cent and real growth of 0.2 per cent.
After all, 85 per cent of US purchases are still US sourced.
However, the published real GDP figure of 3.3 per cent caused writers like Anatole Kaletsky to pen a paean of praise (The Times, 4th September) to the US economy.
Even to my surprise, the respected John O’Sullivan (The Daily Telegraph, 16th September 2008) referenced this suspect figure.
The controversy in the US revolves around the fact that imports are a deduction in the calculation of GDP and, especially, a rise in import prices is non-intuitively a deduction when calculating the GDP deflator (the same applies to the UK). At a time of increasing prices for imports, this could drag down the GDP deflator and push up the estimated figure for real GDP.
There have also been widespread changes in the GDP deflator made over recent years including a move to geometric means and chain-linking which National Statistics estimated some years ago would reduce the deflator and, therefore, increase the GDP figure by 0.5 per cent per annum. There have also been hedonic adjustments – that is, adjustments for quality changes.
The UK does not have the same sophisticated debate over the GDP deflator as the US where there have been greater changes to the GDP deflator.
So, without endorsing all the criticisms, there is substantial reason to believe the GDP deflator in both the UK and US is underestimated and, therefore, real GDP is quite overstated.
The national economy was not growing faster than the government when George Osborne made his commitment to raise government spending by two per cent in real terms.
In reality, real GDP was already in decline. As the increased imports and increased import prices already reflected in the GDP deflator work through the economy and are reflected in future quarter GDP calculations they will show up as increased costs, increased charges against value added so we can expect a fall in GDP in forthcoming quarters, less of course, the statistical jiggery pokery with chain linking and hedonic adjustments.
The sooner George Osborne retreats from his promise, the quicker the Conservatives can regain contact with reality and one of the realities is not to trust the GDP figure and not to reference it as an indicator of economic growth and, of course, developments in the last year make this even more urgent.
FUTURUS/27 September 2008
So he based his proposal on ‘the economy grows faster than the government does’. This refers to the growth in GDP which, of course, is now zero. Officially, the growth in GDP in quarter one 2008 was 0.2 per cent and, in quarter two, 0.0 per cent.
Conservatives should be aware that the statistical mechanism which produces the GDP figure is highly suspect and, in reality, GDP is already falling. GDP per head (with migrant workers annually adding 0.65 per cent to the workforce) is falling heavily.
There is a major question mark over the calculation of GDP with the GDP Deflator in particular coming under scrutiny.
This index is supposed to deflate nominal GDP growth to real GDP growth (using a basket of all goods and services produced domestically – imports are deducted and import prices are a negative).
Yet the GDP Deflator, the adjusting mechanism for inflation, is now massively more (2.6 per cent) than the substantive figure, real growth (0.0 per cent), which it is adjusting from nominal growth. A slight error in the GDP deflator, therefore, makes an enormous difference to the real GDP growth figure.
The GDP deflator index has become a matter of controversy in the US where real GDP growth in the second quarter was restated at 3.3 per cent, while the GDP deflator was 1.3 per cent – totalling nominal GDP growth of 4.6 per cent. On the face of it, this analysis, produced by the Bureau of Economic Analysis, appears completely askew from the Index of Gross Domestic Purchases (purchases by US residents of goods and services wherever produced), which showed nominal growth of 4.4 per cent, a deflator of 4.2 per cent and real growth of 0.2 per cent.
After all, 85 per cent of US purchases are still US sourced.
However, the published real GDP figure of 3.3 per cent caused writers like Anatole Kaletsky to pen a paean of praise (The Times, 4th September) to the US economy.
Even to my surprise, the respected John O’Sullivan (The Daily Telegraph, 16th September 2008) referenced this suspect figure.
The controversy in the US revolves around the fact that imports are a deduction in the calculation of GDP and, especially, a rise in import prices is non-intuitively a deduction when calculating the GDP deflator (the same applies to the UK). At a time of increasing prices for imports, this could drag down the GDP deflator and push up the estimated figure for real GDP.
There have also been widespread changes in the GDP deflator made over recent years including a move to geometric means and chain-linking which National Statistics estimated some years ago would reduce the deflator and, therefore, increase the GDP figure by 0.5 per cent per annum. There have also been hedonic adjustments – that is, adjustments for quality changes.
The UK does not have the same sophisticated debate over the GDP deflator as the US where there have been greater changes to the GDP deflator.
So, without endorsing all the criticisms, there is substantial reason to believe the GDP deflator in both the UK and US is underestimated and, therefore, real GDP is quite overstated.
The national economy was not growing faster than the government when George Osborne made his commitment to raise government spending by two per cent in real terms.
In reality, real GDP was already in decline. As the increased imports and increased import prices already reflected in the GDP deflator work through the economy and are reflected in future quarter GDP calculations they will show up as increased costs, increased charges against value added so we can expect a fall in GDP in forthcoming quarters, less of course, the statistical jiggery pokery with chain linking and hedonic adjustments.
The sooner George Osborne retreats from his promise, the quicker the Conservatives can regain contact with reality and one of the realities is not to trust the GDP figure and not to reference it as an indicator of economic growth and, of course, developments in the last year make this even more urgent.
FUTURUS/27 September 2008