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Calculate this country’s GDP

20 October 2014
by Patrick Love

national accountsLast week, the media reported on the questions Oxford University asked candidates as part of their entrance interview. The questions aren’t designed to test knowledge of facts, but to give students a chance to show how they think about solving problems, whether they can see links between one subject taught at school and another, and so on. One of the questions in history was “How much of the past can you count?”. The idea, as interviewer Stephen Tuck told the Daily Mail, is to provoke a discussion about “all sorts of issues relating to historical evidence. For which periods and places and aspects of the past is data readily available?”. It’s a question you could ask in economics too: how much of a country can you count? And one that the newly updated Understanding National Accounts from the OECD answers.

Governments have always wanted to have data on who and what they govern – a population census is part of the Christmas story for instance – and, as we mentioned in this post, the origins of the modern system of counting a country can be traced back to the 17th century and William Petty’s Political Arithmetick. Petty developed and applied his techniques in England’s first colony, surveying land in Ireland that was to be given to Oliver Cromwell’s troops. His statistical methods were rudimentary, often involving estimation based on exports, deaths and the number 30: a 30% increase in exports means the population increased by 30%; multiply the number of deaths by 30 to find out the size of the population. His components of national accounts though contain much that is still familiar – land, real estate and other personal property, ships…

How though do you count all this? Samuel Beckett, one of the Anglo-Irish descendants of Cromwell’s invaders, tackles this problem in Malone Dies, when the eponymous hero decides, on his deathbed, to make a list of everything he possesses. He’s overwhelmed by the complexity of the task and can’t figure out what to include and how. (Is a pair of shoes one or two items? And what about the laces?). In fact he doesn’t get much further than the pencil and notebook he was going to use to make his inventory and gives up.

OECD statisticians are made of sterner stuff, and know exactly what they’re including and why. Petty would recognise our colleagues’ claim to provide “information on the economic interactions taking place between different sectors of the economy (households, corporations, government, non-profit institutions and the rest of the world) to allow for macroeconomic analysis and evidence-based decision making”.

Given the military origins of his Arithmetick, he’d also be pleased to see the main change in the new system of calculations introduced in 2008: “…expenditure on research and development and weapons systems (warships, submarines, military aircraft, tanks, etc.) are now included in gross fixed capital formation, i.e. investment. This is recognition that expenditure on these items provides long-lasting services to businesses, non-profit institutions, and the governments who use them. This increases the level of GDP across time, but the impact on GDP growth rates will generally be minor.”

Understanding National Accounts was first published in 2006 to give experts and non-experts a practical summary of how to calculate the accounts, but also an understanding of the principles and data sources behind them. Most countries have now adopted the 2008 methodology, but the new edition reflects three other developments too.

First, the financial crisis highlighted the need to better explain how strong movements in economic activity are actually reflected in national accounts. Second, national accounts can be a source for tracking households’ material well-being in line with the emphasis on “better lives”, beyond the traditional objective of economic growth and GDP, exemplified by the OECD Better Lives Initiative,. Finally, the data on trade in value added now being compiled in parallel to core national accounts shed a new light on the interconnectedness of economies.

Obviously somebody reading about national accounts already has some interest in economics, but one of the strengths of the book is that it takes nothing for granted, and explains every technical term clearly and simply, even familiar ones like “the bizarre title “Gross Domestic Product”, or GDP”. Likewise, to explain the difference between GDP and gross national income (GNI), it uses a simple example: “The earnings of workers living in Germany but working in neighbouring parts of Switzerland or Luxembourg have to be added to the German GDP to obtain its GNI. Conversely, the earnings of the seasonal or regular workers living in France or Poland and working across the border in Germany have to be deducted from the German GDP to obtain the German GNI.”

Once you’ve read the main text, you can test your knowledge using a series of exercises (the answers are provided). It’s true that “Calculate the GDP of this economy” is for the bold and the brave, but maybe all national accountants recognise themselves in the Petty’s birth horoscope: “Jupiter in Cancer makes him fat at heart” even if they’d prefer to avoid a second opinion that “vomits would be excellent good for him”.

Useful links

OECD Statistics Directorate

OECD data portal

Is GDP a satisfactory measure of growth? François Lequiller, co-author of Understanding National Accounts talks to the OECD Observer

A long-term view on inequality

16 October 2014
by Brian Keeley
254px-Egypt,_Egyptian_Girls

Different time, same problem?

Today’s posting is published on international Blog Action Day, which this year is focusing on income inequality.

A time-traveller from 200 years ago would find our world almost unrecognisable. Our technologies and lifestyles would seem almost magical – motorcars, air travel, our obsession with smartphones. The visitor from the past would also notice enormous social shifts: Today, we live longer; most of us can read; many of us have a say in who governs us; and, in much of the world, women and men are treated pretty much equally.

Still, there’s one thing that mightn’t surprise our visitor too much: Even though poverty is not what it once was, humanity is still divided between haves and the have-nots.

But is the world today really more unequal than in 1820, a time when emperors still sat on the throne in China, when monarchs ruled much of Europe and when mass industrialisation was still in its infancy? If you’re hoping for a simple yes or no, prepare to be disappointed. As the OECD’s recently released How Was Life? report shows, the world today is both more unequal and about as unequal as it was back in 1820. It all depends on how you look at it.

People typically think of inequality in the context of where they live – a rich guy passes in his Lamborghini, reminding you that you’ll probably never be able to afford one yourself. Economists call this “within-country inequality,” and it actually hasn’t changed very much since 1820.

But, from a global perspective there are at least a couple of other ways to think about inequality. One is in terms of “between-country” inequality – in other words, the gap between rich and poor countries. The other is to treat the entire planet as a single country – in other words, to look at the gap between rich and poor people worldwide, regardless of where they live.

Over the course of the past couple of centuries, probably the most striking change in inequality has been the emergence of rich and poor nations. As Angus Maddison discussed in The World Economy: A Millennial Perspective, back in 1820 countries in North America, Western Europe and Australasia, as well as Japan, had only about double the income of the rest of the world.

But then, in the 19th century, the world experienced what’s sometimes called “the great divergence,” when Western Europe and North America, in particular, began dramatically to pull away. As The Economist noted recently, in 1820, Britain was only about five times richer than the world’s poorest nation; today, the United States is about 25 times richer than the world’s poorest nation.

This divergence is sharply reflected in the How was Life? figures for between-country inequality. Back in 1820, the Gini figure for inequality between countries was just 16, which is extremely low. (Remember, 0 equals absolute equality on the Gini scale*, where everyone has the same income, and 100 equals absolute inequality, where one person bags all the income.) Today, by contrast, between-country inequality stands at 54.

What about if we treat the entire world as a single country? Here, it’s clear that inequality has risen, but more slowly than between countries: For 1820, it’s estimated that world inequality was 49 on the Gini scale; today it’s put at around 66.

What explains these trends? It’s hard to distil two centuries of history, but one factor looks to have played a significant and recurring role – globalisation. Throughout much of the 19th century, the world economy became increasingly globalised, but that process halted with the outbreak of the World War I and receded further with the split between the capitalist and communist zones before re-emerging in the 1980s.

There are reasons to think that the long period of de-globalisation in the 20th century was reflected in global income inequality, and, in particular, in an unusual pattern in global income distribution. Typically, we’d expect to see a “bell curve” – lots of people with incomes around the average and, at either end of the curve, some people with extremely low incomes and a few with extremely high incomes. But in the mid-20th century, we see the emergence of a curve with two “bumps”.

inequality

Source: How Was Life? (OECD, 2014)

It seems likely that these two bumps reflect the divisions of the post-World War II economy: On one side is the “rest of the world,” which included many communist states that actively pursued narrow income gaps; on the other is the “wealthy West,” which enjoyed increasing prosperity while also pursuing policies to narrow inequality.

Beginning in the 1980s, the bumps begin to fade. In a globalising economy, the wealth gap between countries began to narrow as places like China entered the global economy. By contrast, the wealth gap within countries began to rise. In part, that was a result of the collapse of the Soviet Union and the Eastern bloc. But it also reflects rising inequality in OECD countries. Since the 1980s, they, like many other countries, have faced tough choices over how to prosper in an increasingly global economy. In some cases, policies that have been good for competitiveness have not been all that great for equality.

* At the risk of upsetting statisticians, we’re using what the World Bank’s Branko Milanovic calls “Gini points” (a scale of 0 to 100), rather than the more traditional Gini coefficient scale of 0 to 1.

Useful links

Income inequality since 1820,” by Michail Moatsos, Joery Baten, Peter Foldvari, Bas van Leeuwen and Jan Luiten van Zanden (from How Was Life?, OECD 2014)

Mapping the history of wellbeing – Sue Kendall introduces How Was Life?

OECD work on inequality

Behold the power of fungus… and biodiversity offsets

16 October 2014
by Guest author
Korean friendship bell with Ganoderma fungus motif

Korean friendship bell with Ganoderma fungus motif

The Convention on Biological Diversity (COP 12) is taking place in Pyeongchang, Korea, until 17 October 2014. Today’s post is from Naazia Ebrahim of the OECD Environment Directorate

When you think of biodiversity conservation, you probably think of the classic images: the polar bear, the lion, the elephant, the giraffe. The ecological community likes to call them charismatic megafauna, with only a hint of satire.

But did you know that the only thing that can neutralise the deadliest, antibiotic-resistant superbug on this planet is a fungus? Now, note that it was discovered in the soil of a Canadian national park, and it rather makes the argument (well, the anthropogenic argument) for conservation of biodiversity in all its shapes and forms by itself. Behold the power of a fungus!

Unfortunately, most biodiversity has been having a rough time of it lately.

As we have all heard recently, WWF’s 2014 Living Planet Report has reported a 52% decline in mammals, birds, reptiles, amphibians and fish overall from 1970 to 2010, while IUCN’s Red List indicates that a quarter of mammals, over a tenth of birds, and 41% of amphibians are at risk of extinction. The decline is worse in the tropics, and particularly in Latin America, where species populations have dropped by 83% since 1970. Significantly scaled up efforts will be needed if we are to reach the 2011-2020 Aichi Biodiversity Targets – agreed upon at the 2010 conference of the Convention on Biological Diversity – in time. And this is true not only for conservation, but also for the sustainable use of biodiversity and natural resources.

Here at the OECD, we’re looking at how to scale up finance for biodiversity, and how instruments for conservation and sustainable use of biodiversity can be designed and implemented in more effective ways. One instrument, biodiversity offsets, has recently been gaining much attention from government and business alike. Based on the polluter pays approach, biodiversity offsets operate under a “no-net-loss” principle, and have the potential to reduce the costs of achieving environmental objectives.

To be sure, there are difficulties. The most obvious one is that biodiversity is not like carbon: one unit emitted here does not equal one unit saved there. Biodiversity is highly specific, and often highly localised; there are many ecosystems that wouldn’t necessarily exist if ecological conditions changed slightly. So project developers need to be particularly careful at building in safeguards; offsets must be a last resort after avoidance and mitigation; offset design must adhere to strict requirements for ecological equivalence; and monitoring and verification must be extremely robust.

As we work through establishing good practice insights, we hope that biodiversity offsets will be able to provide developers with an additional tool to reduce their adverse impacts on biodiversity in a cost-effective way. That really would be a win-win – and one that would make all superbug-fighting fungi happy.

Useful links

The OECD held a workshop on biodiversity offsets in November 2013, with representation from governments, industry, and civil society. Keep an eye out for our publication, forthcoming in early 2015.

Preliminary OECD Policy Highlights on Biodiversity Offsets

Chapter on Biodiversity Offsets from Scaling up Finance Mechanisms for Biodiversity

Financial literacy: What for?

15 October 2014
by Guest author
Good morning. How can I confuse you?

Good morning. How can I cheat you?

In preparation for the 2015 Global Forum on Development, which will focus on how access to financing can contribute to inclusive social and economic development, the OECD Development Centre and the United Nations Capital Development Fund (UNCDF) have developed a series of articles exploring the key issues and dimensions of financial inclusion. Today’s post from Sarah Bel of the UNCDF Better Than Cash Alliance and James Eberlein of the OECD Development Centre highlights some of the overarching themes related to financial literacy.

Most of our problems are based on finances. Money is always an issue. I have to still provide for both my parents who are not working and make sure they are fed; I must pay their insurance policies because they no longer have the ability to pay them. I don’t earn enough money to afford all of that. - A 35-year-old man from Lesotho, interviewed as part of the UNCDF Making Access Possible initiative

Have you ever tested your financial literacy? Read what follows and you’ll get a better sense of why this matters more than you may have thought.

Low-income consumers must make complex financial decisions even more frequently than middle or high-income consumers, given their smaller operating margins and their limited and irregular incomes. A forthcoming report by UNCDF on Lesotho and Swaziland shows that many workers forfeit up to 40% of their income because of burdensome loan repayments. Indebtedness in the informal consumer market is often an indicator not only of poverty, but also limited financial literacy.

Yet these problems are not limited to poor consumers or low-income countries. While households in advanced and emerging economies have gained increased access to a wide range of financial products, they seldom have the capacity to fully understand and master them. In response to the growing concerns about over-indebtedness, policymakers across the world are focusing on “predatory” lending, which takes advantage of financial illiteracy to push inappropriate loans to consumers who cannot repay them. Some common-sense reforms, like those implemented in France, now require lenders to include a disclaimer (“You are responsible for paying back a loan. Verify your ability to repay the loan before borrowing.”) Additionally, all marketing material must include plain-language explanations of the long-term cost of loans (interest rate, total amount due and the final cost of the credit). South Africa’s Broad-Based Black Economic Empowerment (BBBEE) legislation has specific regulations around financial education and consumer empowerment as stipulated under the Financial Sector Codes. The purpose of these types of regulations is to improve financial capability and increase financial inclusion. But while such reforms have helped improve the protection of financial consumers, they only address part of the problem.

Many people, in developed and developing countries alike, know little about basic financial concepts and do not engage in savvy financial behaviours. An OECD paper shows that in almost all of the 14 countries across 4 continents taking part in the study, at least half of the adult population failed to identify the impact of interest compounding on their savings, and revealed that fewer than one in five people would shop around when buying financial products.

Unfortunately, the picture isn’t any brighter when it comes to young consumers. The recently published OECD PISA financial literacy assessment revealed that around one in seven students in the 13 OECD countries and economies taking part in the assessment are unable to make simple decisions about everyday spending, and only one in ten can solve complex financial tasks. This result is astonishing and requires prompt action to ensure that tomorrow’s adults understand bank statements, the long-term costs of consumer credit and how insurance works, among other basic financial services and products. Indeed, improving the financial literacy of young people will help ensure that they can benefit from savings, retirement and healthcare coverage — much-needed safety nets in the absence of parents and/or social systems. And in case you wonder if you’re any better off than a 15-year-old when it comes to financial literacy, have a look at these sample questions.

To help governments design and implement policies to increase financial skills, including among young people, the OECD and its International Network on Financial Education (INFE) developed High-level Principles on National Strategies for Financial Education, which were endorsed by G20 leaders in 2012. They encourage countries to develop nationally co-ordinated frameworks for financial education policies and provide general guidance on the main elements of an efficient national financial education strategy, such as an effective mechanism to co-ordinate with civil society and the private sector.

Governments may involve financial service providers and other key stakeholders to build the financial capabilities of young people and adults through a variety of delivery channels. Rwanda’s national strategy, for instance, underlines the importance of using not only schools to deliver financial education, but also other innovative channels to reach vulnerable, out-of-school youth. Umutanguha Finance, one of the ten institutions supported by the UNCDF initiative YouthStart, empowers teenagers to deliver financial education on issues like savings to younger children. This peer-to-peer approach is particularly useful because young people tend to listen to their peers more than adults, and the participative approach helps foster youth as agents of change in their own communities.

Financial literacy programmes can play an important role in reducing economic inequalities as well as empowering citizens and decreasing information asymmetries between financial intermediaries and their customers. Public authorities have a responsibility to develop financial education policies and set up robust financial consumer protection frameworks to ensure that consumers are informed and understand the financial products available to them. Innovations such as electronic payments are tipping the economic scales in favour of those who have, for too long, been excluded from the system. But unless consumers are equipped to make sound decisions about use of financial services, no amount of innovation will bridge the gap.

Useful links

OECD work on inequality, inclusive growth, financial education and consumer policy

UNCDF Making Access Possible, YouthStart and Better than Cash Alliance initiatives and Pacific Financial Inclusion Programme

FinMark Trust Financial Education Toolkit

The growing pains of investment treaties

13 October 2014
by Guest author
FDI-inflows-2013

Click for more FDI statistics

Today’s post is from OECD Secretary-General Angel Gurría

International investment treaties are in the spotlight as articles in the Financial Times and The Economist last week show. An ad hoc investment arbitration tribunal recently awarded $50 billion to shareholders in Yukos. EU consultations on proposed investment provisions in the Transatlantic Trade and Investment Partnership (TTIP) with the United States generated a record 150,000 comments. There is intense public interest in treaty challenges to the regulation of tobacco marketing, nuclear power and health care.

Some 3000 investment treaties provide special rights for covered foreign investors to bring arbitration claims against governments. Principles of fair and equitable treatment included in many treaties are uncontroversial as general principles of good public governance. But the treaty procedures for interpreting and enforcing them in arbitration claims for damages are increasingly controversial.

A trickle of arbitration claims under these treaties has become a surging stream. Over 500 foreign investors have brought claims, mostly in the last few years. Investor claims regularly seek hundreds of millions or billions of dollars. High damages awards and high costs have attracted institutional investors who finance claims.

Providing investors with recourse against governments is valuable. Governments can and do expropriate investors or discriminate against them. Domestic judicial and administrative systems provide investors with one option for protecting themselves. The threat of international arbitration gives substantial additional leverage to foreign investors in their dealings with host governments, especially when domestic systems are weak.

At the same time, there is mounting criticism. Arbitration cases can involve challenges to the actions of national parliaments and supreme courts. As Chief Justice Roberts of the US Supreme Court wrote earlier this year, “by acquiescing to [investment] arbitration, a state permits private adjudicators to review its public policies and effectively annul the authoritative acts of its legislature, executive, and judiciary” In a similar vein, Chief Justice French of the High Court of Australia recently noted that the judiciary in his country had not yet made any “collective input” to the design of investment arbitration and that it was time to start “catching up”. This broadening interest in the system will enrich the debate on the future of investment treaties.

Governments and business leaders are also seeking to reform treaties so as to ensure that they help attract investment, not litigation. Some major countries, such as South Africa, Indonesia and India, are terminating, reconsidering or updating what they perceive to be outdated treaties that excessively curtail their “policy space” and entail unacceptable legal risks. Germany opposes the inclusion of investment arbitration in TTIP. The B20 grouping of world business leaders recently called on the G20 to address investment treaties.

International organisations such as the OECD can help governments and others to shape the future of investment treaties. I propose the following agenda for joint action to reform and strengthen the investment treaty system.

Resolve investor claims in public. The frequently secretive nature of investment arbitration under many treaties heightens public concerns. The treaties of NAFTA countries and some other countries have instituted transparent procedures. But nearly 80% of investment treaties create procedures that fall well short of international standards for public sector transparency. This is a major weakness. In July, UNCITRAL (the United Nations Commission on International Trade Law) approved a multilateral convention on transparency. Governments can now easily make all investor claims public. Over a century ago, Lord Atkinson emphasised that a public trial is “the best security for the pure, impartial, and efficient administration of justice, the best means of winning for it public confidence and respect”. Governments – with the support of major investors — should rapidly take action to ensure that investment arbitration adopts high standards of transparency.

Boost public confidence in investment arbitration. Governments have borrowed the ad hoc commercial arbitration system for their investment treaties. But this borrowing is increasingly questioned. Sundaresh Menon, as Attorney-General of Singapore, has observed that “entrepreneurial” arbitrators are subject to troubling economic incentives when making decisions on investor state cases. Advanced domestic systems for settling disputes between investors and governments go to great lengths to avoid the appearance of economic interests influencing decisions. Investment arbitration needs to do the same.

Do not distort competition. The concept of national treatment is a core component of investment and trade agreements. It promotes valuable competition on a level playing field. Investment treaties should not turn this idea on its head, giving privileges to foreign companies that are not available to domestic companies. Governments should protect competition and domestic investment by, for example, ensuring that treaty standards of protection do not exceed those provided to investors under the domestic legal systems of advanced economies. Some case law interpretations of vague investment treaty provisions go beyond these standards, and are unrelated to protectionism, bias against foreign investors or expropriation. Governments that allow for such interpretations should either make public a persuasive policy rationale for these exceptional protections for only certain investors, or take action to preclude such interpretations of their treaties.

Eliminate incentives to create multi-tiered corporate structures. By allowing a wide range of claims by direct and indirect shareholders of a company injured by a government, most investment treaties encourage multi-tiered corporate structures. Each shareholder can be a potential claimant. Indeed, many treaties encourage even a domestic investor to create foreign subsidiaries – it can then claim treaty benefits as a “foreign” investor.

If complex structures were cost-free, perhaps it wouldn’t matter. But they aren’t. Complex structures increase the cost of insolvencies and mergers. They also interfere with the fight against bribery, tax fraud and money laundering because they can obscure the beneficial owner of the investment. Governments should promptly eliminate investment treaty incentives to create multi-tiered corporate structures.

We need international capital flows to support long-term growth through a better international allocation of saving and investment. But the investment treaty system needs to be reformed to ensure that the rights of citizens, governments, enterprises and investors are respected in a mutually beneficial way.

Useful links

OECD work on international investment

OECD work on international investment law

Legal principles applicable to joint government interpretation of investment treaties was one of the issues discussed at the March 2014 OECD Roundtable on Freedom of Investment

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