Category: Economics: Ch 15

The latest GDP numbers from the Office for National Statistics contained in Quarterly National Accounts, Q2 2014 show the economy’s output expanded by 0.9 per cent in the second quarter. This follows on the back of a 0.7 per cent increase in output in Q1 2014. The economy’s output is now thought to be 0.7 per cent above its Q1 2008 peak. Yet, the data show very different profiles for the four principal industrial sectors. The service sector appears to be ploughing ahead while the rest (production, construction and agriculture) lag behind.

Chart 1 shows quarterly economic growth since 1980s (click here for a PowerPoint of the chart). It illustrates nicely the inherent volatility of economies – one of the threshold concepts in economics. The average quarterly rate of growth since 1980 has been 0.5 per cent. On the face of it, a quarterly growth number of 0.9 per cent would appear very robust. Of course, this has to been set in the context of the 2008/9 recession. UK output peaked in Q1 2008 (£414.424 billion at 2011 prices). The revised data now show that there followed 5 quarters of declining output (previously, data suggested the duration of the recession was 6 quarters). During this period output shrank 6 per cent (GDP at 2011 prices had fallen by Q2 2009 to £389.388 billion ).

Chart 1 highlights two earlier downturns. First, there is the recession of the early 1980s. We can see the 5-quarter recession that commenced in Q1 1980. By the end of this recession output had shrunk by 4.5 per cent. Second, there is the recession of the early 1990s which commenced in Q3 1990. Again, this recession lasted five quarters. By the time the economy had come out of recession it had shrunk 2.2 per cent.

Consider now Chart 2 (click here for a PowerPoint of the chart). It allows us to analyse more recent events by tracking how industrial output has evolved since 2006. It suggests an unbalanced recovery. From it, we observe that in Q2 2014 service-sector output was 6.5 per cent higher than in Q1 2008. However, a very different picture emerges for the other principal industrial types. Output across the production industries remains 9.7 per cent lower, 9.2 per cent lower in agriculture and 8.9 per cent lower in the construction sector.

In short, the British economy continues to struggle to rebalance its industrial base. The business cycle remains heavily dependent on the service sector.

Articles
UK GDP revised up: what the economists say Guardian, Katie Allen (30/9/14)
UK economy grew 0.9% in second quarter, says ONS BBC News, Katie Allen (9/5/14)
UK GDP: Did the UK economy do well after all? Independent, Ben Chu (30/9/14)
UK economy grew 0.9% Herald, Ian McConnell (1/10/14)
Economy tracker: GDP BBC News (30/9/14).

Data

Quarterly National Accounts, Q2 2014 Dataset Office for National Statistics
Quarterly National Accounts, Q2 2014, Statistical Release Office for National Statistics

Questions

  1. What is the difference between nominal and real GDP? Which of these helps to track changes in economic output?
  2. Looking at Chart 1 above, summarise the key patterns in real GDP since the 1980s.
  3. What is a recession?
  4. What are some of the problems with the traditional definition of a recession?
  5. Can a recession occur if nominal GDP is actually rising? Explain your answer.
  6. What factors lead to economic growth being so variable?
  7. What factors might explain the very different patterns seen since the late 2000s in the volume of output of the four main industrial sectors?
  8. What different interpretations could there be of a ‘rebalancing’ of the UK economy?
  9. What other data might we look at to analyse whether the UK economy is ‘rebalancing’?.
  10. Produce a short briefing paper exploring the prospects for economic growth in the UK over the next 12 to 18 months.
  11. What is the difference between GVA and GDP?
  12. Explain the arguments for and against using GDP as a measure of a country’s economic well-being.

A key economic objective of governments around the world is economic growth, where economic growth is taken to mean growth in Gross Domestic Product (GDP). This can be refined as growth in GDP per head or growth in Net National Income (NNY or NNI) – this takes account of depreciation and net flows of income to and from abroad. But is GDP (or NNY) an appropriate measure? There continues to be much debate about this and there is a lot of support for adopting an alternative measure – the Genuine Progress Indicator (GPI) as a target for economic policy.

GDP measures the market value of production and is the value added at each stage of production. If the value of a nation’s production is what you want to measure or target, then GDP is quite a good indicator. Its main drawbacks are that it uses market prices, which may be distorted, and that much of production in the informal sector is not included.

But if GDP growth is taken to be a proxy for development or growth in wellbeing of the residents of a country, then it has serious shortcomings. This is not to say that GDP gives no indication of progress. Generally, countries with higher GDP per head have a better standard of living, but it is not necessarily the case that, if Country A has higher production in the formal sector than Country B, its residents will be happier, more fulfilled and have fewer economic or other problems.

GDP, by focusing on production, ignores many environmental and social costs of that production. Valuable but not tradable resources, such as clean air, rivers and oceans, may be sacrificed for the sake of extra production and this is recorded as a gain in GDP.

Similarly, unless GDP is specifically weighted by income groups, which virtually never happens, it does not take into account income distribution. Much of the growth in production in both rich and poor countries in recent decades has gone to the richest people. Take the case of the USA. In 1944 the share of income going to the top 1% share was 11.3%, while the bottom 90% were receiving 67.5%. Such levels remained roughly constant for the next three decades. But then things began to change.

Starting in the mid- to late 1970s, the uppermost tier’s income share began rising dramatically, while that of the bottom 90% started to fall. The top 1% took heavy hits from the dot-com crash and the Great Recession but recovered fairly quickly: [preliminary estimates for 2012 by Emmanuel Saez] have that group receiving nearly 22.5% of all pre-tax income, while the bottom 90%’s share is below 50% for the first time ever (49.6%, to be precise).

So what does GPI measure and why may it be a better target for policy-makers than GDP or NNY? The answer is that it includes a number of important items that affect the well-being of a country, such as resource depletion, social activity and income distribution, that are not measured in GDP. So what would cause GPI to rise? According to The Guardian article below, examples would include:

Getting more energy from renewables; increased energy efficiency; reducing the income gap; putting more reliable, durable products on the market (have you heard of planned obsolescence?); volunteering more for your community; preserving wetlands, forests, and farmland; shorter commutes and transport routes. In fact, there are 26 ways the GPI can go up, all measured in dollars that boil down to a single number.

GPI is being increasingly adopted as a measure of progress. In the USA, it is officially used in Vermont and Maryland and is being considered in other states, such as Hawaii, Washington and Oregon.

And there are other alternatives. For example, since 1990, the United Nations Development Programme (UNDP) has published an annual Human Development Index (HDI) As Box 27.1 in Economics, 8th edition states:

HDI is the average of three indices based on three sets of variables: (i) life expectancy at birth, (ii) education (a weighted average of (a) the mean years that a 25-year-old person or older has spent in school and (b) the number of years of schooling that a 5-year-old child is expected to have over their lifetime) and (iii) real GNY per capita, measured in US dollars at purchasing-power parity exchange rates.

The following articles look at the suitability of GDP and GPI and whether, by targeting growth in GDP, governments are guilty of downplaying the importance of other economic and social objectives.

Beyond GDP: US states have adopted genuine progress indicators The Guardian, Marta Ceroni (23/9/14)
Forget the GDP. Some States Have Found a Better Way to Measure Our Progress. New Republic, Lew Daly and Sean McElwee (3/2/14)
Gross domestic problem Aljazeera, Sean McElwee (6/6/14)
Creating the Circular Economy, Part II Environmental Leader, David Dornfeld (17/9/14)
Development: Time to leave GDP behind Nature, Robert Costanza, Ida Kubiszewski, Enrico Giovannini, Hunter Lovins, Jacqueline McGlade, Kate E. Pickett, Kristín Vala Ragnarsdóttir, Debra Roberts, Roberto De Vogli and Richard Wilkinson (15/1/14)
The Problems With Using GPI Rather Than GDP Forbes, Tim Worstall (5/6/14)

Questions

  1. What does GDP measure?
  2. Does GDP of a country equate to the turnover of a firm?
  3. If growth in NNY is superior to growth in GDP as a measure of economic growth, why are GDP figures more generally used than NNY figures when assessing a country’s economic performance?
  4. How suitable is using GDP as a measure of a nation’s production?
  5. What does GPI measure?
  6. Is GPI superior to GDP as a measure of a nation’s level of development? Explain why or why not.
  7. Give some examples of where a growth in GDP might correspond to a decline in economic well-being.
  8. For what reasons could GPI measures be described as subjective?
  9. Would it be a good idea for a country to target growth in GPI/GDP? Explain your answer.
  10. In addition to real GNY per capita, the Human Development Index includes measures of education and life expectancy. For what other social objectives might education and life expectancy be useful proxies?

Now here’s a gloomy article from Robert Peston. He’s been looking at investors’ views about the coming years and sees a general pessimism about the prospects for long-term economic growth. And that pessimism is becoming deeper.

It is true that both the UK and the USA have recorded reasonable growth rates in recent months and do seem, at least on the surface, to be recovering from recession. But, according to investor behaviour, they:

seem to be saying, in how they place their money, that the UK’s and USA’s current reasonably rapid growth will turn out to be a short-lived period of catch-up, following the deep recession of 2008-9.

So what is it about investor behaviour that implies a deep pessimism and are investors right to be pessimistic? The article explores these issues. It does also look at an alternative explanation that investors may merely be being cautious until a clearer picture emerges about long-term growth prospects – which may turn out to be better that many currently now predict.

The article finishes by looking at a possible solution to the problem (if you regard low or zero growth as a problem). That would be for the government to ‘throw money at investment in infrastructure – to generate both short-term growth and enhance long-term productive potential.’

Note that Elizabeth also looks at this article in her blog The end of growth in the west?.

The end of growth in the West? BBC News, Robert Peston (26/9/14)

Questions

  1. What is meant by the ’25-year yield curve for government bonds’? Why does this yield curve imply a deep level of business pessimism about the long-term prospects for UK economic growth?
  2. What are the determinants of long-term economic growth?
  3. Looking at these determinants, which ones suggest that long-term economic growth may be low?
  4. Are there any determinants which might suggest that economic growth will be maintained over the long term at historical levels of around 2.6%?
  5. Do demand-side policies affect potential GDP and, if so, how?
  6. What policies could government pursue to increase the rate of growth in potential GDP?
  7. What current ‘dramas’ affecting the world economy could have long-term implications for economic growth? How does uncertainty about the long-term implications for the global economy of such dramas itself affect economic growth?
  8. Is long-term growth in real GDP an appropriate indicator of (a) economic development and (b) long-term growth in general well-being?

The growth rates of the Western world have been somewhat volatile for the past decade, with negative growth sending economies into recession and then varying degrees of economic recovery. Growth rates elsewhere have been very high, in particular in countries such as China and India. The future of economic growth in the west is hotly debated and whether the western world has been forever changed by the credit crunch remains to be seen.

The article below from the BBC, written by Robert Peston, the Economics Editor, addresses the question of the future of the western world. Opinions differ as to whether the west is finally recovering from the recession and financial instability or if the credit crunch and subsequent recession is just the beginning of many years of economic stagnation. The article in particular focuses on the yield curve and the trends in government debt or gilts. This tends to be a key indicator of the expectations of the future of an economy and how confident investors are in its likely trajectory. Though technical in places, this article provides some interesting stances on what we might expect in the coming 2-3 decades for economic performance in the West.

Note that John also looks at this article in his blog Cloudy Skies Ahead?

The end of growth in the West? BBC News, Robert Peston (26/9/14)

Questions

  1. Which factors affect the economic growth of a nation?
  2. Confidence from consumers, firms and investors is always argued to be crucial to the future economic growth and in many cases, the recovery of an economy. Explain why this factor is so important.
  3. What is the yield curve and what does it show?
  4. How can the yield curve be used to offer predictions about the future strength of an economy?
  5. Why are governments seen as the safest place to lend?
  6. If Larry Summers is correct in saying that it is a negative equilibrium interest rate that is needed to generate full employment growth, what does this suggest about the future economic performance of the western world?
  7. In the article, there is a list of some of the key things that make investors anxious. Review each of these factors and explain why it is so important in generating anxiety.

One of the key prices in any economy is that of oil. Whenever oil prices change, it can have a knock-on effect on a range of other markets, as oil, or some variation, is used as an input into the production of countless products. The main products that consumers will see affected are energy prices and petrol prices..

Although on the supply-side, we see a large cartel in the form of OPEC, it is still the case that the forces of demand and supply directly affect the market price. Key things such as the demand for heating, economic growth, fears of war and disruption will change the demand and supply of oil. The possibility of militant strikes in oil producers, such as Syria, would normally reduce supply and push up the market price. However, we have actually seen oil prices drop much faster than we have in two years, dropping below $100 per barrel since September 5th. The slowdown of economic growth in Asia, together with the return of Libyan production at a level greater than expected have helped to push prices down and have offset the fears of global production.

The market forces pushing prices down, while good for consumers and firms that use crude oil or one of its by-products, are clearly bad for oil producers. (Click here for a PowerPoint of the chart.) Countries are urging OPEC to halt its production and thereby shift supply upwards to the left putting a stop to the downward oil price trend. Several countries are concerned about the impact of lower prices, and one country that may be significantly affected is Russia. Some are suggesting that the impact could be as big as 4% of Russia’s GDP, taking into account the ongoing political crisis with Ukraine.

The market for oil is highly susceptible to changes in both demand and supply-side factors. Microeconomic changes will have an impact, but at the same time any global macroeconomic factors can have significant effects on the global price. Expectations are crucial and as countries release information about the size of the oil stocks and inventories, it is adding to the downward pressure on prices. Some oil experts have predicted that prices could get as low as $80 per barrel before OPEC takes significant action, influenced heavily by countries like Saudi Arabia. The following articles consider this global market.

Articles

Iran urges OPEC to halt oil price slide Financial Times, Anjli Raval (26/9/14)
Oil overflow: as prices slump, producers grapple with a new reality The Globe and Mail, Shawn McCarthy and Jeff Lewis (27/9/14)
Weak demand, plentiful supply drive decline in oil prices International Distribution (26/9/14)
Oil prices plunging despite ISIS CNN Money, Paul R La Monica (25/9/14)
Oil prices fall on EIA report of big U.S. crude stocks build Reuters, Robert Gibbons (17/9/14)
Sanctions and weaker oil prices could cost Russia 4% of GDP – official RT (25/9/14)

Data

Spot oil prices Energy Information Administration
Weekly European Brent Spot Price Energy Information Administration (Note: you can also select daily, monthly or annual.)
Annual Statistical Bulletin OPEC

Questions

  1. What are the key factors on the microeconomic side that affect (a) demand and (b) supply of oil?
  2. Explain the key macroeconomic factors that are likely to have an impact on global demand and supply of oil.
  3. Militant action in some key oil producing countries has caused fears of oil disruption. Why is that oil prices don’t reflect these very big concerns?
  4. Use a demand and supply diagram to explain the answer you gave to question 3.
  5. What type of intervention could OPEC take to stabilise oil prices?
  6. Why is the Russian economy likely to be adversely affected by the trend in oil prices?
  7. Changes in the global macroeconomy will directly affect oil prices. Is there a way that changes in oil prices can also affect the state of the global economy?