Esther Bolton, OECD Statistics Directorate
GDP growth always gets a lot of attention, but when it comes to determining how people are doing it’s interesting to look at other indicators that focus more on the actual material conditions of households. Let’s focus on a few alternative indicators to see how households in Ireland are doing.
GDP and household income
Real household disposable income per capita grew at the same pace as real GDP per capita in Q4 2016, both increasing 2.3% from the previous quarter. However, that does not mean that real GDP and real household income always grew in tandem as shown in chart 1. Real household income levels in Ireland only recently returned to their pre-crisis level (the index was 103.5 in Q4 2016 from a baseline value of 100 in Q1 2007 before the economic crisis), following more than 7 years below that level. On the other hand, real GDP per capita is up more than 27% since Q1 2007 (the index was 127.3 in Q4 2016) due to the remarkable growth rate seen in Ireland in Q1 2015.
What occurred in Ireland in 2015 reflects the growing importance of global value chains, combined with the increasing importance of “intangible assets” used in production, as multinational enterprises (MNEs), in particular, have sought to maximise profits and minimise costs, including through optimisation of their global tax burden, by (re)allocating some of their economic activities in different parts of the world. In 2015, MNEs relocated intangible assets to Ireland, where these assets are being used by Irish enterprises (including Irish affiliates of foreign MNEs) to generate value added.
This is an excellent example of why GDP should not be interpreted as an indicator of the purchasing power or the material well-being of a country. GDP is primarily a gross measure of economic activities on the economic territory of a country, and of the income generated through those activities. High levels of GDP thus do not necessarily mean high levels of income flowing to the residents nor does it mean that their growth rates will be similar(read this post for an explanation on Irish GDP large increase in 2015). A major reason is that some of the income generated by production may be repatriated to non-residents, for example in the case of income generated by affiliates of multinational enterprises.
The divergence between GDP and household disposable income can clearly be seen in Chart 1 with real GDP per capita growing sharply (by 21.3% in Q1 2015 from the previous quarter), while real household income increased by only 1.6%.
The presence of a significant number of foreign affiliates of MNEs (responsible for around half of Ireland’s business sector GDP, that is to say, excluding agriculture, most self-employment, the public sector and some financial services activity) is not the only reason why there can be a divergence between the growth of household income and GDP. Government interventions can also play a role.
As GDP was contracting throughout the quarters of 2008, household income was sustained by increased unemployment benefits and other social benefits received by households. As a result, between Q1 2008 and Q4 2008, the net cash transfers to households’ ratio showed a sharp increase; see Chart 2. Since Q4 2010 the ratio has trended down.
Confidence, consumption and savings
Household disposable income is a meaningful way to assess material living standards, but to get a fuller picture of household material well-being one may also want to look at households’ consumption behaviour.
Consumer confidence (chart 3) trended upward, from a low seen in Q1 2009, until Q4 2015 when it reached its peak (104.7). Since then it has been declining to 103.0 in Q4 2016, yet still 10 points higher than Q1 2009.
Despite the recent downward trend in consumer confidence, the increase in household income helped boost real household consumption expenditure per capita (chart 4), which rose 0.5% in Q4 2016 from the previous quarter (from 95.7 in Q3 2016 to 96.2 in Q4 2016). Since Q1 2013 real household consumption expenditure per capita has increased in line with developments in real household income. However, Irish households are still buying less goods and services than before the crisis.
Because household income increased more than final consumption expenditure, the households’ savings rate (chart 5), which shows the proportion that households are saving out of current income, increased 1.2 percentage points to 13.5% in Q4 2016. The ratio has been trending up since Q1 2016, suggesting that households remain cautious about their future income.
Debt and net worth
The households’ indebtedness ratio, i.e. the total outstanding debt of households as a percentage of their disposable income, may reflect (changes in) financial vulnerabilities of the household sector and provides a useful yardstick to assess their debt sustainability.
The household indebtedness ratio dropped considerably since the crisis, by nearly 75 percentage points, from its highest point in Q4 2009 (230% of disposable income, compared with 155 % of disposable income in Q4 2016). This corresponds to the largest drop in the debt ratio seen amongst OECD countries. The decline was driven by a decrease in loans (primarily mortgages) and rising household income.
When assessing households’ economic vulnerabilities, one should also look at the availability of assets, preferably taking into account both financial assets (saving deposits, shares, etc.) and non-financial assets (for households, predominantly dwellings). Because information on households’ non-financial assets is generally not available, financial net worth (i.e. the excess of financial assets over liabilities) is used as an indicator of the financial vulnerability of households.
In Q4 2016, households’ financial net worth was stable at 214 % of disposable income (chart 7). Since Q1 2009, it has been trending up driven primarily by the reduction in household debt (as seen in chart 6) and increasing financial assets (mainly pension assets and currency and deposits). Between 2009 and 2016, household financial net worth increased by around 145 percentage points. However, some caution is needed interpreting this figure since financial net worth does not take into account housing assets which saw spectacular growth due to a bubble in house prices until it burst in 2007 followed by sharp declines afterwards.
The unemployment rate and the labour underutilisation rate (chart 8) also provide indications of potential vulnerabilities of the household sector. More generally, unemployment has a major impact on people’s well-being. The unemployment rate was 7.1% in Q4 2016, pursuing the downward trend observed since Q1 2012 when it reached a peak of 15.1%. The labour underutilisation rate takes into account the share of underemployed workers and discouraged job seekers. Since Q4 2015, this rate has been twice the size of the unemployment rate, compared with around one and half time pre-crisis, indicating higher slack in the labour market.
Overall, the last quarter of 2016 saw a continued increase in Irish households’ material wellbeing with income and consumption per capita continuing to expand, a further decline in debt, an increase in financial net worth (although total net worth still remains below its pre-crisis level ) and a fall in the unemployment rate. However, the savings rate increased in line with declining consumer confidence (although consumer confidence is now much higher than its pre-crisis level). And despite the continued fall in the unemployment rate, many workers would prefer to work more, as indicated by the remaining high level of the underemployment rate.
One should keep in mind that households’ income, consumption and savings may differ considerably across various groups of households; the same holds for households’ indebtedness and (financial) net worth. The OECD is working on these distributional aspects and preliminary results can be found here and here.
To fully grasp people’s overall well-being, one should go beyond material conditions, and also look at a range of other dimensions of what shapes people’s lives, as is done in the OECD Better Life Initiative.
“Are the Irish 26.3% better off?”, OECD Insights post, 5 October 2016
For many years, OECD has been focusing on people’s well-being and societal progress. To learn more on OECD’s work on measuring well-being, visit the Better Life Initiative.
Interested in how households are doing in other OECD countries? Visit our household’s economic well-being dashboard.
Statistical Insights: What does GDP per capita tell us about households’ material well-being?
Although GDP per capita is often used as a broad measure of average living standards, high levels of GDP per capita do not necessarily mean high levels of household disposable income, a key measure of average material well-being of people. For example, in 2014 Norway had the highest GDP per capita in the OECD (162% of the OECD average), but only 115% of the OECD average for household disposable income. And in Ireland, GDP per capita was 24% above the OECD average, while household disposable income per capita was 22% below the OECD average. Conversely, in the United States GDP per capita was 34% above the OECD average while household disposable income was 46% above the OECD average. These differences between GDP per capita and household disposable income per capita reflect two important factors. First, not all income generated by production (GDP) necessarily remains in the country; some of it may be appropriated by non-residents, for example by foreign-owned firms repatriating profits to their parents. Secondly, some parts may be retained by corporations and government and not accrue to households.
International rankings of household disposable income per capita and GDP per capita can differ significantly
GDP per capita, by design an indicator of the total income generated by economic activity in a country, is often used as a measure of people’s material well-being. However, not all of this income necessarily ends up in the purse of households. Some may be appropriated by government to build up sovereign wealth funds or to pay off debts, some may be appropriated by firms to build up balance sheets, and yet some may be appropriated by parent companies abroad repatriating profits from their affiliates. At the same time, households can also receive income from abroad for example from dividends and interest receipts through investments abroad.
As such, a preferred measure of people’s material well-being is household disposable income per capita, which represents the maximum amount a household can consume without having to reduce its assets or to increase its liabilities.
The above-mentioned factors can create significant differences between measures of household disposable income per capita and GDP per capita. The United States for example see its position relative to the OECD average jump by more than 10 percentage points (46% above the OECD-average of household disposable income, compared to 34% above the OECD average of GDP per capita), ranking it 1st among OECD countries on household disposable income compared to 3rd on GDP per capita (figure 1). This reflects in part repatriated (and redistributed) profits from US multinational activities abroad but also relatively lower general government expenditure and taxes on households..
On the other hand, Norway falls from 1st on a GDP basis to 4th on a household disposable income basis while Ireland drops dramatically (from 4th to 19th). For Ireland, one of the reasons relates to the presence of a significant number of foreign affiliates of multinational enterprises (responsible for around half of private sector GDP). While Irish GDP per capita was well above the OECD-average (24% higher), Irish household disposable income was significantly below the OECD-average (22% lower). Similar differences in household disposable income per capita relative to GDP per capita can also be seen in other countries where foreign affiliates play an important role in overall GDP (and that have only limited outward foreign investment) such as Hungary and the Czech Republic. Switzerland also sees falls in its household income vs GDP ranking, partly because of the relatively large number of cross-border workers.
For Norway, however, the divergence reflects other factors, linked to the large surplus generated by the Norwegian mining sector (around 25% of total economy value added), which is invested by the Norwegian government in its sovereign wealth fund.
Note: Data refer to 2013 for household adjusted disposable income for Mexico, New Zealand, and Switzerland.
Developments in household disposable income per capita can also differ significantly from developments in GDP per capita
Many factors can also contribute to diverging patterns of growth between household disposable income and GDP, for instance, declining shares of compensation of employees in value-added, and rising shares of profits retained by corporations. And in real terms, differences in consumer price inflation and changes in the GDP deflator, reflecting in part evolutions in terms of trade, can also contribute to divergences. Differences in tax and redistribution policy can also play a significant role.
Prior to the global financial crisis (2001-2007), real economic growth in many countries outpaced growth in real household disposable income, (figure 2, panel 1). However, post crisis (2008-2014), around 60% of countries saw real household disposable income grow faster than real GDP, as governments intervened (including through automatic stabilisers) to cushion the negative impact of the crisis on households’ income. But countries hit hardest by the crisis saw real household disposable income contract at a faster pace than GDP (figure 2, panel 2).
Figure 2. Real GDP and real household disposable income, per capita
Average annual growth rates; adjusted for price changes
Note: In panel 1, average annual growth rates for Mexico 2003-2007. In panel 2, average annual growth rates for New Zealand and Switzerland 2008-2013
The measures explained
Gross Domestic Product (GDP):
Gross domestic product (GDP) is the standard measure of the value added generated through the production of goods and services in a country during a certain period. Equivalently, it measures the income earned from that production, or the total amount spent on final goods and services (less imports).
Household adjusted disposable income:
Household adjusted disposable income equals the total income received, after deduction of taxes on income and wealth and social contributions, and includes monetary social benefits (such as unemployment benefits) and in-kind social benefits (such as government provided health and education).
Purchasing power parities (PPPs):
In their simplest form, PPPs are price relatives that show the ratio of the prices in national currencies of the same good or service in different countries. The Big Mac currency index from The Economist magazine is a well-known example of a one-product PPP. The Big Mac index is “the exchange rate that would mean that hamburgers cost the same in America as abroad”. For example, if the price of a hamburger in the UK is £2.29 and in the US, it is $3.54, the PPP for hamburgers between the UK and the US is £2.29 to $3.54 or 0.65 pounds to the dollar.
Where to find the underlying data
The underlying data are published in the OECD data warehouse: OECD.Stat.
- OECD (2016), “Aggregate National Accounts, SNA 2008 (or SNA 1993): Gross domestic product”, OECD National Accounts Statistics (database).
- OECD (2016), “Detailed National Accounts, SNA 2008 (or SNA 1993): Non-financial accounts by sectors, annual”, OECD National Accounts Statistics (database).
- OECD (2016), “National Accounts at a Glance”, OECD National Accounts Statistics (database).
- OECD (2016), “PPPs and exchange rates”, OECD National Accounts Statistics (database).
- Bournot, S. , F. Koechlin, and P. Schreyer (2011), “2008 Benchmark PPPs measurement and uses” OECD Statistics Brief no. 17. www.oecd.org/std/47359870.pdf
- European Commission; IMF; OECD; UN; and World Bank (2009), “System of National Accounts 2008“ http://unstats.un.org/unsd/nationalaccount/docs/SNA2008.pdf
- Lequiller, F. and D. Blades (2014), Understanding National Accounts: Second Edition, OECD Publishing,Paris.
- Ribarsky, J., C. Kang and E. Bolton (2016), “The drivers of differences between growth in GDP and household adjusted disposable income in OECD countries”, OECD Statistics Working Papers, No. 2016/06, OECD Publishing, Paris.
For further information please contact the OECD Statistics Directorate at [email protected]
 In all graphs and calculations, the following OECD-countries have been excluded, because of lack of data on household disposable income: Iceland, Israel, Luxembourg and Turkey.
 For convenience, household disposable income refers to household adjusted disposable income, which includes goods and services provided for free or at reduced prices by government and non-profit institutions serving households. It predominantly consists of health and education services and provides a more comparable measure, across countries and over time.
 Note that this suggests that some care is needed in interpreting the sustainability of household disposable income over the longer term. Contemporaneous comparisons for example look at sustainability in the context of sustainable household finances, i.e. not building up household liabilities or reducing assets. But over the longer term persistently high government deficits or unfunded pension schemes may imply future declines in household disposable income (all other things being equal), while government surpluses may act as a buffer against potential declines (again all other things being equal).
On 12 July 2016, the Irish Central Statistics Office published data showing that real GDP grew by 26.3% in 2015. This huge leap led many commentators to question the figures and wonder whether GDP adequately reflects economic activity. To answer this, one first has to be clear about what GDP is – what is being captured when one tries to measure Gross Domestic Product.
The international standard, the 2008 System of National Accounts (SNA), says: “Production is an activity, carried out under the responsibility, control and management of an institutional unit, that uses inputs of labour, capital, and goods and services to produce outputs of goods and services”. GDP corresponds to the value added, i.e. the balance of total output and the intermediate use of goods and services related to this production. It consists of the remuneration for the input of labour, in the form of compensation of employees, and the remuneration for the input of tangible and intangible capital, in the form of operating surplus.
Up until the last few decades, intangible capital was largely used where it was produced. However, globalisation, in particular the growing importance of global value chains, combined with the increasing importance of “intangible assets” used in production, has changed the production landscape, as multinational enterprises (MNEs), in particular, have sought to maximise profits and minimise costs, including through minimisation of their global tax burden, by (re)allocating their economic activities across the world. These relocations include transfers of economic ownership of Intellectual Property Products (IPPs), with associated risks as well as benefits from their use. The latter is in the form of income from the production of goods and services, including receipts from licenses and patents, accruing to the host economy.
The above issue to a large extent explains the case for the recent increase in Ireland’s GDP, albeit with the added complication that the intellectual property is used in contract manufacturing type of arrangements. Under these arrangements, Irish enterprises (among which Irish affiliates of foreign MNEs) involve contract manufacturers, including those domiciled outside Ireland, to produce final products using the blueprints from the IPPs. The subsequent distribution and sale of these products, organised by the Irish enterprises, results in value added being created in the Irish economy, which also includes income generated by the IPPs.
The use of intangible assets in production can generate significant value added, and so the recording of value added through their use reflects one dimension of economic reality. But in some cases the question is whether that economic reality (value added) is recorded in the correct place, in Ireland or elsewhere. To determine this, the SNA looks to economic ownership as opposed to legal ownership. The economic owner of an asset is the entity that assumes the risks and gains the rewards of ownership, and it would be wrong to assume that legal and economic ownership necessarily align. In the Irish case, it is clear that the legal ownership has been transferred to Ireland, but it is important to stress that it does not immediately follow that economic ownership has also been transferred. However, decision making and control, two important criteria used in assessing economic ownership, do appear to have been relocated to Ireland as well, justifying the inclusion of the associated value added leveraged from the use of the underlying intellectual property in Ireland.
That is not to say that this is an entirely satisfactory outcome for everybody. The increasing use of intellectual property in production challenges the arguably “archaic” views of production that sees growth through a prism of physical factors of production, such as tangible capital and labour. Some have argued that adjustments should be made to better reflect an alternative view of economic reality. However, it is simply impossible to adjust for the relocation of IPPs, and to create a complete set of alternative prices for the transfer prices charged by the multinationals for their internal cross-border deliveries alike. Statisticians would, for example, have to impute prices, in a consistent way at a global level, using questionable assumptions, such as allocating an equal proportion of profits to nationally available compensation of employees. They would also need to adjust the business accounting data for the relocation of IPPs. Legal arrangements would also not allow for the international exchange of individual data, needed to make these adjustments in an internationally consistent way. But perhaps more importantly, the fact is that the relocation of IPPs does actually represent an economic reality, even if that may not be the preferred perspective for all types of economic analysis.
What further complicates the understanding of the Irish case is that often GDP is interpreted as an indicator of the purchasing power or the material well-being of a country. In this respect, it is important to state that GDP is primarily a gross measure of economic activities on the economic territory of a country, and the income generated through those activities. High levels of GDP thus do not necessarily mean high levels of income flowing to the residents. This is because some of the income generated by production may be repatriated to non-residents, for example in the case of income generated by affiliates of multinational enterprises. Another part may be needed to compensate for the additional depreciation costs. In the case of Ireland, Net National Income (NNI), which equals GDP plus net receipts of compensation of employees and property income (interest, dividends, reinvested earning of foreign direct investment, etc.) from the rest the world minus depreciation, shows a considerably lower growth rate. Whereas in 2015 GDP in current prices increased by 32.4 %, nominal growth of NNI amounted to “only” 6.4 %.
Going one step further, one could also look at household disposable income, a key measure of average material well-being of people. In 2015, Irish households’ disposable income grew by 4.6 % when adjusted for price changes. And while Irish GDP per capita is well above the OECD average, by 24 percentage points in 2014, Irish household disposable income per capita is 22 percentage points below the OECD average.
When looking at the economic performance of a country, it is therefore important not to focus solely on GDP. The system of national accounts is a complete and consistent framework for the description of an economy. From this system, a variety of indicators can be derived, depending on what exactly one wants to monitor or analyse. If one wants to look at the material well-being or the purchasing power of a country’s resident population, it is much better to use data on, for example, household disposable income or household final consumption (see the OECD Dashboard of Household Statistics). An even broader perspective on the well-being of a society, which goes well beyond income developments, and also takes into account other aspects affecting well-being such as health, education, security, housing, etc., is provided in the OECD Better Life Initiative.
The Irish figures help to illustrate the limits of GDP and in particular the care needed in its interpretation, particularly in the domain of material well-being. It also highlights the importance of focussing on additional aggregates including those defined within the system of national accounts, and not exclusively on GDP.
To read the full story, go to: www.oecd.org/std/na/Irish-GDP-up-in-2015-OECD.pdf
Calculate this country’s GDP OECD Insights article on the System of National Accounts
New standards for compiling national accounts: what’s the impact on GDP and other macro-economic indicators? Peter van de Ven, OECD Statistics Brief, February 2015
Today’s post is by Lucas Chancel, researcher at the Institute for Sustainable Development and International Relations (IDDRI) and lecturer at L’Institut d’études politiques, Paris and Damien Demailly, programme co-ordinator at IDDRI.
When a French MP recently decided to draft a law for the adoption of Beyond GDP (BGDP) indicators in France, she was told that such a law wasn’t necessary because BGDP indicators already existed and were published annually in the country. The MP replied that nobody in Parliament or government was aware of it. The reason was simple: the new set of indicators was published in the annex of a very technical administrative report – in a place where nobody would even bother look at them. This example sheds light on an important dimension of the BGDP indicator debate: measuring and publishing indicators is not sufficient, it is essential to reflect on how they can be used practically in policy making processes.
Today, several countries have already officially adopted dashboards of BGDP indicators. These pioneers are interesting cases to look at in order to see how BGDP indicators are used in practice: are they left in technical annexes of government reports, used as communication tools or mobilised effectively in the making of public policies?
Australia set up Beyond-GDP indicators as early as 2002, developed and supported by the Australian Bureau of Statistics and its statistician in chief. The dashboard comprises 26 dimensions grouped around four headline themes: society, economy, environment and governance. The dashboard has been published frequently and holds particular interest for the media and the general public. Indicators were initially designed to help citizens consider progress in a more integrated way, and not to evaluate government actions – however, the dashboard is regularly used by political staff in their media interventions.
Belgium ratified a law, early 2014, aimed at developing indicators to complement GDP. These indicators are currently being developed by the Belgian Federal Planning Agency and could include some of the indicators already adopted at the regional level by Wallonia: six indicators, including GDP, on three dimensions: environment, society and the economy. Interestingly, a review of BGDP indicators progress is planned to be included in the annual report of the Banque nationale de Belgique and the indicators’ progress will be debated in parliament each year. Contrary to what was initially planned in Australia, indicators are to play a very political role in Belgium.
The United Kingdom has produced a comprehensive dashboard of Beyond-GDP indicators since 2011 under a national programme for measuring well-being which was supported by Prime Minister David Cameron. The dashboard of indicators in the UK contains more than thirty indicators. Some are objective (e.g. income level) and others are subjective (e.g. percentage of anxious people in the population). The British would like to use their dashboard to measure the before and after impacts of public policies. This is not yet done systematically, but monthly reports are published to comment on how the country is performing on different dimensions of well-being and some indicators have been used to inform decision-making.
These case studies provide three interesting lessons.
First, in terms of methodology, it stands out clearly that “replacing” GDP is not an option any more in the countries which adopted new indicators. The choice that was made was to complement GDP rather than replace it. This choice can be understood by the fact that it is difficult to simply get rid of an indicator as emblematic as GDP but also because, despite its many limitations, GDP retains several powerful features (i.e. standardisation, part of a wide system of national accounts, etc.). In addition, GDP is not complemented with a single indicator but a dashboard of indicators – seen as a better way to represent different dimensions of well-being which cannot be merged into one single metric.
Second, initiatives to complement GDP were supported at the highest level. The executive power supported the Well Being Programme in the UK, the legislative power in Belgium and the administrative in Australia. In addition, indicators are not supported by one political party or sensibility: all sides of the political spectrum support beyond-GDP indicators. In the UK, it is the Conservative government, in Belgium, the Greens-Socialist majority. However, all political parties do not support similar sets of indicators. It may be anecdotic, but the UK does not have an objective measure of income inequality in its dense dashboard of indicators, while Belgium will very likely have one.
Finally, these examples showed three possible types of use of indicators. They can play a symbolic role, as initially planned in Australia: the indicators are supposed to represent progress in a different way but are not developed to measure government’s performance. Indicators can also play a political role, like in Belgium where they are developed precisely to assess government’s performance via an annual debate in Parliament. And new indicators can also be developed in order to play an instrumental role: when they are used to measure the impacts of specific public policies. Clearly, BGDP indicators are rarely used in this way currently, partly because of a lack of statistics and theory to understand how they are impacted by different types of public policies.
However, it should be reminded that, just like BGDP indicators, GDP did not always exist and has not always been used in an instrumental way. It took several years and decades, with developments in economic theory and statistical methods, as well changing socio-economic expectations, to make of GDP a symbolic, political and instrumental indicator. BGDP indicators are following this path even though it will undeniably take time and – indeed- political will.
Last 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 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”.
Is GDP a satisfactory measure of growth? François Lequiller, co-author of Understanding National Accounts talks to the OECD Observer
Today we publish the first in a series of articles on the OECD’s contribution to the RIO+20 UN Conference on Sustainable Development
Here’s one of the best ever openings to a paper in any academic discipline you care to name: “The economic changes that occurred in this country during recent years are sufficiently striking to be apparent to any observer without the assistance of statistical measurements. There is considerable value, however, in checking the unarmed observation of even a careful student by the light of a quantitative picture of our economy.” That’s Simon Kuznets in his unremarkably entitled 1934 paper National Income, 1929-1932. Three years later, he would present a report to the US Congress that formulated such a “quantitative picture”: GDP, a single measure of the size of a nation’s economy.
Before GDP was invented (and it seems such an obvious, natural measure it’s hard to believe both that it was invented and invented so recently) governments did have some objective data on the state of the economy on which to base policy. In the 17th century already, William Petty established the bases of national accounting, essentially for tax purposes, although his Political Arithmetick also has many other lessons that are still relevant today, for example on how “a small Country and few People, by its Situation, Trade, and Policy, may be equivalent in Wealth and Strength, to a far greater People and Territory”.
Despite the centuries separating them, Petty and Kuznets were responding to a similar need to understand a changing situation. Petty’s concern was that although money rather than barter was starting to dominate economic transactions, national wealth was still counted as it had been for centuries in terms of gold and silver. In Kuznets’ time, the US government’s role in the economy was growing after the Great Depression, but as Richard T. Froyen points out, its interventions were being guided by a sketchy set of indicators such as freight car loadings or stock price indices.
The beauty of GDP was that it included so many different things in a single figure, and despite the suspicion and even outright hostility any innovative approach attracts, it became the standard measure of national economies following the 1944 Bretton Woods conference. The main criticism was, and still is, that it is not a measure of well-being since production can increase while leaving most people no better off in any way. Kuznets himself insisted that GDP was a quantitative measure and not meant to describe the quality of growth.
Speaking to the OECD Observer in 2005, François Lequiller, head of National Accounts work at the OECD, also defended GDP as doing very well what it was designed for, but admitted that it left out a number of key topics such as environmental degradation. However, as he pointed out, it’s probably impossible to design a single GDP-like figure for a wider application that would reflect the many different aspects in any meaningful way, and including them in GDP would damage its usefulness as a measure of output. A suite of indicators is more appropriate in these cases.
The OECD’s Better Life Index follows this logic to allow citizens to establish their own measure of well-being. Users “weigh” 11 topics – community, education, environment, governance, health, housing, income, jobs, life satisfaction, safety, and work-life balance – to generate their own Index from a collection of 20 indicators. But even if growth is what’s being measured, a single figure may be misleading or too vague.
When OECD governments asked the Organisation to develop tools to support policy analysis and monitor the progress of green growth strategies, it was clear that by its very nature green growth is not easily captured by a single indicator, and a set of measures would be needed as markers on a path to greening growth and seizing new economic opportunities.
A database of green growth indicators has just been launched by the OECD, structured around four groups to capture the main features of green growth:
- Environmental and resource productivity, to indicate whether economic growth is becoming greener with more efficient use of natural capital and to capture aspects of production which are rarely quantified in economic models and accounting frameworks.
- The natural asset base, to indicate the risks to growth from a declining natural asset base.
- Environmental quality of life, to indicate how environmental conditions affect the quality of life and wellbeing of people.
- Economic opportunities and policy responses, to indicate the effectiveness of policies in delivering green growth and describe the societal responses needed to secure business and employment opportunities.
Colombia, the Czech Republic, Korea, Mexico and the Netherlands have already applied the OECD’s preliminary set of green growth indicators to assess their state of green growth, and Costa Rica, Ecuador, Guatemala and Paraguay are now doing so.
Apart from providing data on what we know, compiling the database also reveals a number of gaps in our information relevant to green growth, for instance on biodiversity, what’s happening at industry level, or monetary values to reflect prices and quantities of stocks and flows of natural assets.
Even where enough data exists, it may be difficult to combine them due to differences in classifications, terminology or timeliness, to allow cross-country comparisons for example. The system of national accounts pioneered by Petty allows such comparisons for national economies, and provides the inspiration for the System of Environmental-Economic Accounts (SEEA), internationally agreed standard concepts, definitions, classifications, accounting rules and tables for producing internationally comparable statistics on the environment and its relationship with the economy.
We can only guess what William Petty would have thought of such an exercise. As for Simon Kuznets, he anticipated it in his 1971 Nobel lecture, pointing out over 50 years ago that “the conventional measures of national product and its components do not reflect many costs of adjustment in the economic and social structures…” going on to cite “clearly important costs, for example, in education as capital investment, in the shift to urban life, or in the pollution and other negative results of mass production.”
Why measure subjective well-being? Richard Layard, Director of LSE’s Wellbeing Programme, argues in the OECD Observer that the search for measures of progress that might replace GDP is a timely and necessary one, but only a single metric will do the trick.
In your baseline scenario, GDP growth across the OECD countries is projected to slow from 1.9% this year to 1.6% in 2012, before recovering to 2.3% in 2013. In some economies, especially the euro area, a mild recession is projected in the near term. Why are you so pessimistic?
The global economy has deteriorated significantly since our previous Economic Outlook. Advanced economies are slowing and the euro area appears to be in a mild recession. Concerns about sovereign debt sustainability in the European monetary union are becoming increasingly widespread. Recent contagion to countries thought to have relatively solid public finances could massively escalate economic disruption if not addressed. Unemployment remains very high in many OECD economies and, ominously, long-term unemployment is becoming increasingly common.
Emerging economies are still growing at a healthy pace, but their growth rates are also moderating. In these countries falls in commodity prices and slower global growth have started to mitigate inflationary pressures. More recently, international trade growth has weakened significantly. Contrary to what was expected earlier this year, the global economy is not out of the woods.
What factors underpin this assessment?
Deleveraging in the financial and government sectors remain with us. Likewise, imbalances within the euro area, which reflect deep-seated fiscal, financial and structural problems, have not been adequately resolved. Above all, confidence has dropped sharply as scepticism has grown that euro area policy makers can deal effectively with the key challenges they face. Serious downside risks remain in the euro area, linked to the possibility of a sovereign default and its cross-border effects on creditors, and loss of confidence in sovereign debt markets and the monetary union itself.
Another serious downside risk is that no action will be agreed upon to counter the pre-programmed fiscal tightening in the United States, which could tip the economy into a recession that monetary policy can do little to counter.
If this is the “baseline” scenario, are the others?
Alternative scenarios are possible, and may be even more likely than the baseline. A downside scenario would be characterised by materialisation of negative risks and the absence of adequate policy action to deal with them. An upside scenario could arise if policy action were successful in boosting confidence and no significant negative events occurred.
In the downside scenario, the implications of a major negative event in the euro area depend on the channels at work and their virulence. The results could range from relatively benign to highly devastating outcomes. A large negative event would, however, most likely send the OECD area as a whole into recession, with marked declines in activity in the United States and Japan, and prolong and deepen the recession in the euro area.
Unemployment would rise still further. The emerging market economies would not be immune, with global trade volumes falling strongly, and the value of their international asset holdings being hit by weaker financial asset prices.
What would be required for an upside scenario to materialise?
A credible commitment by euro area governments that contagion would be blocked, backed by clearly adequate resources. To eliminate contagion risks, banks will have to be well capitalised. Decisive policies and the appropriate institutional responses will have to be put in place to ensure smooth financing at reasonable interest rates for sovereigns. This calls for rapid, credible and substantial increases in the capacity of the European Financial Stability Facility together with, or including, greater use of the European Central Bank’s balance sheet. Such forceful policy action, complemented by appropriate governance reform to offset moral hazard, could result in a significant boost to growth in the euro area and the global economy.
An upside scenario also requires substantial and credible commitment at the country level, in both advanced and emerging market economies, to pursue a sustainable structural adjustment to raise long-term growth rates and promote global rebalancing. In Europe, such policies are also needed to make progress in resolving the underlying structural imbalances that lie at the heart of the euro area crisis.
Deep structural reforms will be instrumental in strengthening the adjustment mechanisms in labour and product markets that, together with a robust repair of the financial system, are essential for the good functioning of the monetary union. By raising confidence, lowering uncertainty and removing impediments to economic activity, rapid implementation of such reforms could raise consumption, investment and employment.
If combined, stronger macroeconomic and structural policies might raise OECD output growth by as early as 2013. The largest benefits would be felt in the euro area, though these could take some time to emerge. Stronger activity and trade, and the consequent rise in asset values in the OECD economies, should boost activity in the emerging market economies as well.
What is your advice to policy makers?
In view of the great uncertainty policy makers now confront, they must be prepared to face the worst. The OECD Strategic Response identifies country-specific policy actions that need to be implemented if the downside scenario materialises. The financial sector must be stabilised and the social safety net protected; further monetary policy easing should be undertaken; and fiscal support should be provided where this is practical. At the same time, stronger fiscal frameworks should be adopted to reassure markets that the public finances can be brought under control.
The difference between the upside and the downside scenarios reflects the impact of credible, confidence building policy action. Such action, as we have seen, requires measures to be implemented at the euro area level as well as at the country level throughout the OECD, especially in the structural policy domain. In the case of a downside scenario, policy action would clearly be needed to avoid the worst outcomes. But then the question arises of why policy efforts are not taken to deliver the upside scenario even if the worst case does not materialise. Why, in other words, should we settle for less?