GDP
National
Income is a metric of the flow of money in an economy represented by its goods,
services, and wealth in a given period of time. It is essentially the same as
National Output and National Expenditure, and is sometimes used as equivalent
to Gross National Product (GNP.)
In
most economic discussions, GNP is adjusted twice. Firstly, economists tend to
strip out net income earned abroad from GNP. This gives a figure for Gross Domestic
Product. This is useful for economic studies because it focuses the
analyst on what is going on within the economy. Secondly, economists usually
adjust the nominal, ‘raw’ GDP figure for price changes, which leaves ‘real GDP’
as the key figure.[1]
Change in Real GDP
is therefore the most used and important indicator economists use. It tells the
examiner about growth and allows for assumptions about the economic
cycle.
Real GDP tells economists about the
accumulated flow of money around an economy but it does not really give an
indicator of the relevance of the national wealth to the population. A small
country with a moderate GDP is in a better position in many ways, for instance,
than a country with a large population which has what seems to be
a high GDP. This means that many economists find Real GDP per Capita (Real
GDP divided by population) as a more useful metric than GDP itself.
Equally, GDP figures are based on taxation
and legal surveys. A country with a large illegal ‘shadow’ economy has of
course more income and wealth in it than the official figures would suggest. GDP
figures are also not representative of purchasing power parity when
compared between countries, and so any comparison based on an exchange rate of
currency has to be dealt with carefully. Finally, comparisons of GDP over
time can be made but become more difficult as the time period is extended.
This is because of different social structures, expectations, and outcomes over
time, and is a more complicated version of the problem that arises when income
inequality or comparisons between countries are taken into account.
The Price Level, Inflation, Deflation,
and Disinflation
The
ability to calculate the price level is essential to the economy. The price
level represents the average price of goods and services in the economy. In the
UK, the Consumer Price Index is used to measure the level of the most
popular consumer items. It is calculated by a central exercise every month in
which the Office of National Statistics asks some 20,000 consumer outlets for
the price of a representative ‘basket’ of 700 goods. The basket is regularly
checked for how representative an item is—for instance, there is no sense in
tracking goods that are obsolete or out of fashion, or not tracking items which
people are buying. Within the basket, each item is given a weighting
which reflects the importance of that good to consumers. So, if, for instance,
consumers spend on average 5% of their income on clothing, the weighting of
clothing is 0.05. A 10% change in clothing prices will therefore result in a (10*0.05)
.5% change to the price index.
CPI
is calculated as a geometric mean and, sometimes, housing costs like
council taxes and mortgages or rents are added to it, giving a CPIH
figure (the H is for Housing costs). This is different from an older
calculation, which looked at households rather than individual consumers
call the Retail Price Index. The RPI was also calculated using a
weighted basket of goods and services, but did not cover all consumers, or
tourists, and was generated as an arithmetic mean. This made it
(usually) higher than the CPI, and not always as reliable. Sometimes, housing
costs were added to it to make RPIX, and, occasionally, attempts were
made to exclude taxes from it too. From 2021, the Office of National Statistics
does not use RPI, but HM Government and the Courts do, for a few calculations.
There
are other measures of the price level, but these are usually much narrower and
much more a tool for analysts in addition to the CPI. These include producer
price indexes and House Price Indexes.
It
is important to remember that, when politicians and economists talk of deflation
and disinflation, or use terms such as ‘reflationary policy’ or ‘deflationary
policy’ they have specific meanings. For instance, deflation means a fall in
average prices and is usually a bad thing. If an economy was in trouble,
with unemployment rising and GDP falling, a fall in the price level might occur
because consumer demand fell, and because stores went for permanent sales and ‘dumping
stock’ to achieve revenue maximisation at cost or below cost prices.
This is not a good thing.
Disinflation,
on the other hand, refers to a situation where the CPI is low or falling
compared to previous levels, but still positive. It tends to occur when new
technology or economic growth, or lower energy or food prices, or global trade
gains, lower costs for producers, even though consumers feel richer and therefore
spend more.
Deflationary
Policies are not connected with the price level
directly. Rather, they seek to lower Aggregate Demand to take
inflationary pressure out of the system. Similarly, Reflationary Policies
exist to try to raise AD at times of depression or recession when Demand has declined
or suffered a shock.
Unemployment,
Employment Levels, and Patterns of Employment.
Not
having a job is an obvious normal definition of being unemployed. In economics,
there are several metrics. The two most important ones are The Claimant
Count and the Labour Force Survey (sometimes known as the ILO
measure.)[2] The first metric counts
the number of people taking unemployment benefits. This is flawed since not all
people do, or can, because of savings or background. The ILO measure surveys a
representative sample of the workforce every three months. The sample is
normally composed of around 85,000 people from an economy, and the standard to
define unemployment is that they have been out of work for four weeks and are
seeking, and able to commit to, work within the next two weeks.
Two
separate metrics are the number of people in jobs, known as the employment
level, and the number of job vacancies. Taken together with the Unemployment
measure, they give a good indication of the direction of the economy, the size
of structural unemployment, and any indications of technological or
frictional unemployment. Unemployment measures are seasonally
adjusted and lagged so they should not be relied on as a ‘snapshot’
of the economy right now, but rather, of what was happening several months ago,
and of the direction of growth.
There
is also a problem in economies when counting the illegal economy (or the
Shadow economy), which means that unemployment is often an estimate. In
addition, underemployment, when people are working jobs that do not
reflect or pay for their abilities, or part-time, and regional unemployment
are problems in unemployment figures. This means that figures can vary, wildly;
the United States has six official measures of unemployment (from U1 to
U6) and they are often separated by ten to fifteen percentage points.
If
the ILO measure and the Claimant Count are very similar, this is a bad sign
that unemployment is widespread throughout the economy and that there is little
frictional unemployment. It normally suggests that a deep cyclical downturn
is in progress.
Investment levels
and the relationship between capital investment and national output.
Equality
Economics
is a social science which does not often acknowledge the normative nature of
some of its assumptions and explanations. Most observers, and many critics of ‘mainstream
economics’ would suggest that economists should develop a measure that explains
what it is like to live within an economy, and whether an economy works for the
people within it. A picture of this could be compiled, as detailed below, from
measures like a compounded ‘happiness index,’ a ‘misery index,’ and by
non-quantitative opinion polls. Growth, jobs, steady inflation, low real interest
rates, social mobility, and stable home ownership as well as stable population
growth and the empowerment of women are also measures.
Two
key indicators of the health of an economy, however, are the distribution of
wealth and the distribution of income. These are normally measured
by the same tools—Lorenz Curves, Gini Coefficients, and Quintile or
Decile Analysis.
Wealth
and income are different things. Wealth is a stock and represents the
accumulated fixed assets of an economy. It is not liquid, and can be borrowed
against or shared in ownership. The role of land, buildings, and property
rights in an economy is very much conditioned by the law and culture of the
country, but no economist would question its importance. If one group, individual,
or group of companies or people own the vast majority of the wealth, it is very
difficult for those who have none to achieve social mobility, to gain property
of their own, or to escape debt.
Income
is a flow and is best represented by money, though digital alternatives
which function like money are emerging. Income in kind is a term for
being paid in commodities, just as barter and service exchanges can represent a
kind of income. Economists just tend to estimate the money value of these
things.
People
can be wealth-rich and income poor, and live from rents and borrowing against
assets, or occasional sales (like British aristocrats in the later twentieth
century, who owned great palaces but who had little income in many cases.)
Similarly, a worker in a financial centre who had a high income but didn’t own
their flat or save their money would be income rich and wealth poor.
Lorenz
curves plot the income or wealth of all
households on a cumulative basis against a ‘line of equality.’ This line shows
what would happen if everyone had equal wealth and income; fifty per cent of
the households would own fifty per cent of the wealth or income and so on. A second
line, showing the real distribution is then drawn onto the graph. The bigger
the area between the real distribution and the line of equality, the bigger the
gaps between rich and poor. A Gini Coefficient can then be calculated,
in which the area between the lines in A, the area between the lower line and
the axes is B, and the coefficient is A/(A+B). If the Coefficient is 0, absolute
equality reigns; if the Coefficient is 1, there is absolute inequality. Most
developed economies come in around 0.3.
Quintile
and Decile analysis are the same sort of thing. Quintile analysis ranks
incomes between highest and lowest, and then divides the population into five equal
groups of 20% each. By looking at the share of income the bottom 20% of the
population have, and what share the top 20% have, and the gap between them, an
economist can get a sense of inequality. Decile analysis does the same thing,
but with 10% bands.
Inequality
tends to hold societies back. It creates externalities in health, crime, and
pollution, encourages the bulk of the population to buy inferior goods, makes
it difficult to accumulate and spread capital across society, depresses middle-
and working-class investment, and encourages debt rather than savings.[3]
Unequal societies also tend to be ones associated with monopolies and
oligopolies based on vast economies of scale, low quality products, or labour
exploitation because, once established, no one can compete except other large
companies and individuals.
Levels of Debt
Economists are concerned with different
sorts of debt. National Debt is the stock of debt owed by all government
bodies, including local and regional governments, as well as the national one.
It is usually raised by selling bonds to market entities like banks and pension
funds. The important figures are not just the level of the debt alone, and the
interest owed on it, but the ratio of National Debt to GDP.
If the market believes that governments are
not exercising discipline over budgets and that they will cause inflation, or
that they are relying on rolling forward debt rather than balancing budgets,
markets will demand a high interest rate on the government bonds.
Markets might also drop the currency, and
remove capital from the country. All of these actions could in theory cause a
balance of payments crisis or a budget crisis in which living standards dropped
and the options available to government became very limited.
National
debt or ‘public sector debt’ is therefore a major problem for governments. The interest
on the debt alone, even at low levels, is often a problem—in the UK, for
instance, interest payments on the national debt are currently running at
levels equivalent to all spending on the police or education. Very few countries
have ever run large national debts, and persistent budget deficits (different
things) and not suffered a large fall in living standards and pressure to raise
taxes and cut spending. Worse, if Government is borrowing from the markets,
banks and individuals will find that the interest rate on private debt rises
because of crowding out. In this process, the amounts of money available
for the private sector decline, leading to the remaining money becoming more
expensive to borrow—‘crowded out.’
In
western societies, and the UK and USA in particular, private debt is
both a response to, and a cause of, inequality. Mortgage debt, which is taken
out to purchase housing, is very vulnerable to interest rate rises and, if restricted
to those with existing money, tends to concentrate property in few hands whilst
excluding the young and poor, who are forced into rental or emigration. Student
debt is a serious cause of malinvestment and restricted growth in the USA, and
increasingly in the UK.
The
US and UK have also developed a ‘precariat’ of people on previously good salaries
in professional jobs who, without credit, overdrafts, or loans, would be within
a matter of months of homelessness. This in turn would increase the burden on
the state and represent a waste of resources and underemployment. There is
substantial evidence that private debt also fuels consumption of imports and an
overreliance on service industries.
There
are great benefits to a flexible system of debt based on public and private
borrowing, not least of which is a tendency of the availability of debt
initially to allow people to try to ‘even the playing field’ of life by
allowing for property purchases and higher education. If the debt is not repaid
by higher future earnings, and accompanied by gains in productivity, however,
it becomes a social constraint which eventually starts to choke off innovation,
mobility, and enterprise, to drive up interest rates, and to impoverish
society.
Other
Economic Metrics
Economists
can use other metrics to assess levels of national income and the health or
direction of economies. Some of them are tied to the indicators above. Terms
of Trade, for instance, measure the ability of a country’s exports by value
to pay for its imports. They are defined by an index of output prices over an
index of import prices over time. It used to be thought that, if a country
invested in service industries over industrial ones, or industrial ones over
agricultural ones, its productivity would rise. This would mean that it
earned more from its exports, which would improve in competitiveness
against other countries, and therefore that its terms of trade would improve.
There is now dispute over this idea.
Saving,
Levels of Saving, and the Ratio of Savings to Household
Disposable Income are usually seen as important things. This is because
savings are translated into investment by functioning financial institutions. Investment
is by definition a sustained addition to Long-run Aggregate Supply which
allows for more GDP, disinflation, and higher living standards. This process
leads to improvements in the terms of trade if capital gains become
productivity gains. Societies which prioritise saving also tend to be less
prone to demand-pull inflation because household saving is ‘negative
consumption,’ and they are also able to cope with health or employment shocks,
or the need to provide pensions in the future, more easily in theory than those
societies which do not prioritise saving.
There
is a quirk of societies like the USA, the UK and Australia, which is that
savings tend to increase during bad times and to be run down during odd ones.
Large parts of the world, including many EU societies, can be said to take the
opposite approach, and to save during good times, which is more logical.
Societies with high levels of household saving are also less prone to
dependence on credit, and less unequal.
Exchange
rates, whether adjusted for Purchasing Power Parity or
not, are rarely used as a metric of economic health or analysis. If they are fixed,
pressures on the exchange rate have implications for fiscal or monetary policy,
and if they are floating, they are not central to the economy but reflect other
things, like trade, the balance of payments, or overall foreign investment.
They become very important if a country has a structural deficit in the balance
of trade because of an inelastic demand for imports, or if it owes other
countries or international banks money in a foreign currency. Similarly, the components
of the Balance of Payments—the current account, or Balance of
Trade, and the financial and capital accounts—tend to show the effects of
policies or other factors, rather than to be causes of issues.
Wider Measures: The Human Poverty Index,
the Human Development Index
The
United Nations, and various bodies interested in international development,
often prefer an HDI over GDP as an initial marker. HDI is an indicator of human
development. It multiplies three indexes-- life expectancy, income, and years
of schooling (real and expected)—and then finds the geometric mean. This figure
is then used to compare societies. An HPI uses education indices, nutrition and
child mortality, and a number of ‘deprivation factors’ relating to things like
access to clean water, sanitation, housing, and media, to generate a figure for
a society. Both HDI and HPI are very valid figures, but neither can be
generated for all societies yet as they rely on efficient and rigorous data
collection.
[1]
Remember, anything with ‘real’ in front of it in economics has been adjusted
for inflation. The best alternative example is maybe real interest rates.
These are nominal interest rates minus inflation; for instance, 5%
interest rate with a 3% inflation rate leaves a (5-3) 2% real interest rate.
This is useful with GDP because anyone can make it look as though GDP has grown
by simply printing more money or raising prices. In real terms, however, this
is worse than useless, so the ‘real’ figure is used.
[2]
The ILO is the International Labour Organisation, based in Geneva, Switzerland.
All EU members use the ILO measure.
[3]
Poorer people cannot afford cleaner technologies or lifestyles and may, if
their own life is shortened by poverty, not see the point of them anyway.
Unequal societies also tend to have lower average life expectancies, which is a
waste of human resources, more dependency, and, by definition, less social
mobility. This then places an emphasis on productivity through lower wages and
costs, rather than the improvement of output, leading to a decline in
efficiency, exports, and competitiveness. A ‘vicious circle’ then emerges in
which people and economies become too poor to break out of poverty whilst a
small group of rich people and companies disassociate themselves from the
society and tax revenues.
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