When skim milk looks like cream

Numbers provide information about different aspects of the world. But how reliable and useful is the information? Daily temperature, pressure and rainfall are accurate about the past and provide a forecast of the future. Short term forecasts tend to be more reliable than longer term ones. Economic statistics like GDP (Gross Domestic Product), inflation, employment/unemployment, interest rates, and stock market prices are recorded for the past often with forecasts for the future. How reliable are these statistics which each often measures a group of activities not one variable like temperature and pressure? This is the case with GDP which measures the output of all sectors of an economy.

Canada is chastised for not spending 2% of GDP on defense, a level reached by some other NATO countries. But what if the GDP of different countries is not a reliable comparative measure of a country’s yearly output? And what if different countries include different items in their defense expenditures? I will leave the latter for the defense gurus to discuss, and suggest why GDP has always been an approximate measure of output and today is increasingly so and more unreliable as a comparative measure.

 

Consider the following, much of which can be found in Diane Coyle’s excellent book, GDP, A brief but affectionate history (Princeton 2014):

 

  1. In 2010, Ghana’s GDP was increased 60% overnight when the country’s statistical agency changed the weights assigned to each sector of the economy when calculating GDP. Previously the weights for 1993 were being used.
  2. Six other African countries are undertaking a similar exercise which may increase their GDP by as much as 40%. Nigeria, already a large African economy, may then exceed South Africa, at present the largest on the continent.
  3. The service sector of all OECD economies now accounts for a larger share of GDP than previously, over 75% in many cases. Services output is notoriously difficult to measure in contrast to goods. How do you measure the advice given by a lawyer, accountant or economist? By the amount paid for the advice. But what happens if it is given for free (probably an unlikely case)? In the first case there is a record for inclusion in GDP, but not in the latter, even though production has taken place.
  4. Each country’s underground economy is by definition not measured. Services are often activities which are more susceptible to being exchanged without a record being kept, thus diluting the accuracy of GDP accounting. Tax measures often influence the size of the underground economy.
  5. There are many other examples of services which don’t get recorded. The woman who marries her chauffeur, the man who marries his housekeeper both cause GDP to decline while there is no change in the underlying economic activity – although other aspects of their lives may change drastically.
  6. While consumers tend to focus on items which are more expensive today than yesterday, many things have decreased in price and some are now consumed for free. They are not included in GDP as currently measured but do constitute part of a country’s economic output. I use to pay for long distance phone calls. Many today are free with access to the internet. Facetime is free. Skype calls are a fraction of what was formerly charged for long distance calls. Emails substitute for letters and the costs associated with writing and delivering them. In each case the nature of the economic output has not changed but it is no longer measured for inclusion in GDP accounting.
  7. Consider the production and distribution of videos, music, television, newspapers, books, magazines, education (online), all of which are affected by communications technology. Their real output has increased but measured in monetary terms their per unit value has declined. GDP relies on figures which measure monetary not real output, and with the growth of services this is far more difficult to do.

 

Other uses of GDP

Countries are classified as high, medium and low income based on GDP per capita. Their responsibilities and treatment will depend on where they rank. At times, a country may want to advertise that it has moved up the scale, such as its attractiveness for foreign investment. But for receipt of foreign aid, it may prefer to stay as a less developed country. Ghana’s sudden increase in GDP per capita in 2010 may result in it no longer being a recipient for certain types of aid and require it to make a larger contribution to the budgets of international organizations.

A country’s treatment for trade preferences is also determined by its level of per capita GDP. Ghana has become a middle income country and is now required to negotiate a free trade agreement in order to keep its preferences in the EU, and will be removed from Canadian GSP (General System of Preferences) in 2015

 

Conclusion

The foregoing represents only some of the difficulties in measuring and interpreting GDP. These have increased over time especially due to technological change. Like changes in weather conditions, changes in GDP get widely reported. The increasing unreliability of the latter should be an issue of concern for those using this information. GDP data often result in adjustments to fiscal and monetary policies, and inform investors about buying and selling securities.

In the medical arena, doctors prescribe on the basis of indicators like temperature and blood pressure. If the readings are false then the treatment may kill the patient. In the realm of economics, false or misleading information can undermine the health of an economy. This occurs now in the case of an important economic measure. Next time you read about change in a country’s GDP, interpret it with a few grains of salt.

Other economic statistics should also not be taken at face value, like the unemployment rate, inflation and the current account surplus or deficit on the balance of payments. In contrast, the current price of a stock, the interest rate and terms for various types of private and public debt are numbers which mean what they say. The moral is that familiar numbers do not always mean what they appear to say…..there is some quotation about skim milk made to appear like cream, but I have lost the source for this saying

 

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