As has been widely reported, the latest projections by the International Monetary Fund (IMF) suggest that the UK will be the only major economy not to see a rise in its Gross Domestic Product (GDP) this year, although growth will return to around 1% in 2024. This has been confirmed by the latest release of monthly GDP estimates by the Office of National Statistics. Although few think that this is good news, what does it really mean?
The key issue is what GDP actually measures and what it does not. Certainly, it is taken as a general indicator of national prosperity and success, but it’s not at all clear that headline GDP figures are really up to that job.
As famously summed up by a heckler during the European Referendum in 2016: ‘That’s your bloody GDP. Not ours’! The recent history of a growing GDP has often seemed to have little impact on the economic well-being of the general population. The idea that growth in GDP is necessarily a good thing can seem meaningless to many when their own economic lives continue to be precarious and challenging.
GDP and growth
If growth in GDP captures little of our everyday economic lives, what does it actually measure? The most important thing about GDP is that it is a measure of value-added, not the sum of all economic activity. This means, the figure is intended to be the total value of all goods and services consumed by a final user, leaving aside everything that lies behind the final purchase. Think of it like the surplus or profit a business makes, rather than its turnover (although this is an imperfect analogy).
To try and figure this out, statisticians divide economic activity into those things that are components of, or contribute to, another product or service and those that are the final product or service. However, it is often difficult to decide which category certain goods or services fall into. While the calculation of GDP can be made in a number of ways using a range of equations, the real difficulty for statisticians is deciding what goes into each category and what is excluded.
How, for instance, might we account for the refurbishment of a warehouse? Are the building materials final purchases? Is the refurbishment work a final service? Or are these merely components towards the delivery of a supply chain service (warehousing)? Or, indeed, is the supply chain itself just a set of intermediate activities?
There are no really simple answers to these questions, and so the reason that each quarter’s figures are often revised is due to the complexity of this calculation and the periodic refinement of the data available as more information from companies is gathered.
Nevertheless, growth in GDP expressed as a single figure is seen as a key indicator of economic success. It is presumed to measure improvement in a population’s standards of living, and by extension, enhanced socio-economic welfare. Growth of GDP is taken to indicate things are getting better and decline means things are getting worse.
It’s a simple and appealing measurement, but ultimately misleading.
GDP per capita
One easy way to correct a key misapprehension fostered by headline GDP figures is to measure them in conjunction with the size of the population: GDP per capita. This then modifies the measure to account for the tendency of larger countries to have more economic activity and smaller countries less, by dividing the value added in a year by the number of people in the country.
One example of why GDP per capita can be an important analytical measure is what has often been referred to as Japan’s ‘lost decade’, when Japan’s economy was widely regarded as having a post-boom depression during the 1990s. However, even while the global policy elite wrung it hands, because the population was shrinking at the same time, GDP per capita data revealed that it was likely that for many Japanese this had no real material negative impact on their economic lives. There was less economic activity and fewer people, meaning the share for each person (on average) remained stable.
A more timely and locally significant example of the difference between the two figures is the position of the UK in the richest countries ranked by these two measures of GDP. Where we rank in tables of richest countries is often presented as an indication that really things are going quite well. Indeed, we often hear claims that a government’s success can and should be measured by how the size of our economy compares with other countries.
Certainly, on headline GDP, the UK remains well within the top ten economies in the world, with the IMF ranking putting the UK at fifth largest in 2022. However, once we include the size of the population the UK drops to outside the top 20; currently around 23rd on IMF figures. While the UK remains one of the richest countries in the world, it is by no means as comparatively rich as claims we are the fifth ranked country for GDP might lead one to believe.
As this suggests, the claim by recent governments that we are really do pretty well compared to other countries might need to be modified. A perception that we are outside the top 20 richest countries might well lead us to think differently about what a GDP figure indicates about our relative economic success.
Who gets what?
To return to the heckle ‘That’s your bloody GDP. Not ours’, even if we take GDP per capita as a better measure, this still assumes the total GDP is distributed equally across all of a country’s population. We know this is not the case. This means that even the GDP per capita for a country can be misleading when there is significant inequality in wealth and/or incomes. In other words, growing GDP may largely benefit the well off if there is relatively high inequality.
This might lead us to focus not only on GDP or even GDP per capita, but on measures of inequality as an indicator of how widely the wealth and income being produced is being spread. However, focussing on inequality, while revealing, tells us little about the year-on-year success or otherwise of the overall economy. This might then push us back to GDP as the best available measure by which to judge the economic trajectory of the UK.
Looking at GDP data since 2010, what we find is that the UK’s GDP has grown (albeit unevenly) from £463tn to £558tn at the end of last year. This is a rise of approximately 20% over the last 12 years. But when we look at GDP per capita, we again find an uneven growth path, resulting in GDP per capita of £29,893 in 2010, growing to £32,904 12 years later. This is an increase of around 10%, or half the rate of headline GDP.
So, in the end GDP has its uses provided we understand what we can read into the headline figure and what we cannot. The simplistic treatment of growing headline GDP as good and falling GDP as bad, while offering good headlines, mis-states how this may be experienced across the country.
By looking at GDP per capita, we can we start to think a little more sensibly about the plight of the UK in the current global political economy. Rather than trumpeting, or decrying, each quarter’s (often subsequently revised) headline GDP figure, we might better look to longer term shifts in GDP per capita to decide whether we are really finding economic success.