Economic indicators - summary

GDP

The metric commonly used to measure the quantity of goods and services is a country’s real Gross Domestic Product (GDP).

The idea of measuring ‘national income’ can be traced back to 17^th Century English economists Sir William Petty (1623-1687)^[i], who attempted the first assessment of national income, and to Charles Davenant (1656–1714)[ii], who suggested that England’s trade should be measured and recorded as on ongoing process. However, it was US economist, Simon Kuznets who developed the first ‘modern’ definition of GDP in a report to the US Congress in 1934 ^[iii].

GDP measures the market value of ‘final’ goods and services produced within a country, where gross means that any depreciation or capital consumption resulting from domestic (national) production is not considered – in other words gross figures are unadjusted for depreciation.

Given that asset values vary considerably over time - with some assets depreciating, and others appreciating - and with many assets difficult or impossible to value, figures for national wealth are usually crude estimates, and often unreliable.

Nominal and real economic growth

The ‘nominal’ value of GDP is the sum of all goods and services produced within a country in terms of the monetary value of output.

This contrasts with ‘real’ GDP, which tracks the quantity (or volume) of output.

Volume, price and value

The value of GDP (or any other monetary aggregate) is found by multiplying the volume of output by the market price of that output. This is a straightforward concept in micro-economics - the value of a firm's output is its sales volume times its selling price. For a whole economy, national income accounting uses the same principles, but at a much larger scale. Taking a simple example, if a hypothetical economy produces 10m apples in a year, which sell at $1 each (assuming no tax), the value of nominal GDP is $10m. The volume is 10m, the price is $1, and the value is $10m.

	Volume (apples)	Price [$]	Value [$]
Year 1	10	1	$10

Changes in GDP can, therefore, arise from three sources  – through an increase in output, through price, or through price and output. For example, if in the second year, 2 million more apples are produced (rising to 12m), but the price remains at $1, the nominal value of GDP will increase to $12 – a 20% increase. This is a real increase in GDP because it is the increase in volume that has led to the increase in the nominal value of GDP.

	Volume	Price [$]	Value [$]
Year 1	10	1	$10
Year 2 (volume increase)	12	1	$12
Year 2 (price increase)	10	1.20	$12

However, what if the increase in nominal GDP had come about from an increase in ‘price’? If the price of apples had risen to $1.20, and 10m apples are still produced, the nominal value of GDP would also increase to $12.

However, the ‘real’ value of GDP has remained constant at 10m apples.

Inflation distorts values

From this simple example, we can see that price rises, and general inflation, can distort changes in GDP, so we need to strip out the effects of inflation from nominal values to get real values.

For example, if nominal GDP rises to $15m (an increase of 50%) following a rise in the price of apples to $1.25, and an increase in output, to 12m, real GDP has increased by only 20%. The remainder of the increase in nominal GDP comes from the price rise. Hence, if we take out the effects of the price rise, we can then arrive at the real change in GDP.

Adjusting the nominal value to create a real value is referred to as ‘deflating’ the nominal value.

	Volume	Price	Value
	[Real GDP]	[Price level]	[Nominal GDP]
Year 1	10	1	$10
Year 2	12	1.25	$15

Using an index

To achieve the adjustment of nominal GDP values, we can convert the various changes into an index. In the above example, the nominal GDP increases by 50%, giving us an index value of 150. The volume change is 20%, giving an index value of 120, and the price change is 25%, with an index value of 125.

	Volume	Price	Value
	[Real GDP]	[Price level]	[Nominal GDP]
Year 1	10	1	$10
Year 2	12 [Index=120]	1.25 [Index=125]	$15 [Index=150]

However, we do not need to know the volume index separately. If we know two of the three indices, we can calculate the ‘missing’ index.

For example, if we know the price index (in this case, 125) and the nominal GDP index (in this case, 150), we can deflate (divide) the nominal GDP index by the price index, and multiply by 100, to arrive at the real (volume) index. Hence, 150/125 x 100 = 120 - real income has increased by 20%.

150 125	x	100	=	120

In the following example, we can deduce the real GDP:

If the index for nominal GDP is 160, and the index of inflation is 112, real GDP has increased by?

160 112	x	100	=	?

Real GDP has increased by 160/112 x 100 = 142.9.

160 112	x	100	=	142.9

So, while nominal GDP rose by 60%, when inflation is considered, real GDP grew by only 42.9%.

Total and per capita national income

Total income (GDP) is the total value of income produced in a year. However, for comparative purposes it is more useful to convert the raw GDP figures to GDP per capita (or per head). This is found by dividing total GDP by the population. Hence, if we take the example of Japan, GDP in 2019 was $5,082 trillion (that is $5,082,000,000,000), and its population was 126.3 million (that is 126,300,000), making a GDP per capita of $5,082,000,000,000/126,300,000, which is $40,237!

GDP per capital forms the basis of international and historical comparisons of growth and growth rates.

Gross National Income (GNI)

Gross national income (GNI) is GDP plus income received from other countries (including interest payments and dividends earned), less these payments made to other countries.

GNI measures the value added by a country’s residents plus payments to employees and income from ‘property’ from non-residents (called ‘primary income’). Hence, while GDP measures the value of final goods and services produced within a country, GNI measures the value of final goods and services produced by a country's citizens, wherever they reside.

In developed countries the GDP and GNI are often very similar, with, perhaps just a percent or two difference. However, developing countries often receive significant financial flows from abroad in the form of investment flows, and foreign aid.

Prior to 1993, GNI was called Gross National Product (GNP)^[1].

Measuring unemployment

Unemployment can be measured in various ways.

Those claiming benefit

One way to measure unemployment is to record those who claim to be unemployed, and seek government welfare benefits, which in the UK includes Job Seeker's Allowance (JSA) and Universal Credit. In the UK, this measure is called the 'claimant count', and most countries track the number of individuals claiming some form of welfare support as a result of being unemployed. However, the majority of countries have switched over to using a more standardised calculation for unemployment.

Those officially measured as unemployed

Most advanced economies use a standardised and internationally recognised measure of unemployment, which is based on a survey (the 'Labour Force Survey', and which takes its definition of unemployment from the Geneva based International Labour Organisation - ILO). Members of the EU are all required to use this standard definition, and most countries either adopt the definition, or modify it in minor ways.

For the Labour Force Survey, the unemployed are defined as:

Those individuals who do not have a job but have been actively looking for one in the four weeks previous to the measurement date, and who are available to work within two weeks of the measurement date.

The rate of unemployment, expressed as a percentage, is:

The proportion of the ‘economically active’ population who are jobless - that is, those who are in work, available for work and actively seeking work. The unemployment rate is NOT the proportion of the whole population, or the population of ‘working age’, who are unemployed.

The survey sample

The Labour Force Survey takes a sample from the whole population, (in the UK, some 40,000 households are included in the sample) who are then surveyed every three months -  20% of the sample is replaced each quarter ^[1].

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Advantages and disadvantages of using the claimant count

Advantages

Disadvantages

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Advantages and disadvantages of using the Labour Force Survey

Advantages

Disadvantages

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Both the Claimant Count and the Labour Force survey provide key information on the amount of slack in the labour market.

Measuring employment

Employment is defined as the number of individuals who are 16 years old and over who are in paid work, together with those who, on a temporary basis, are ‘away’ from their normal work.

The rate of employment is the proportion of these aged between 16 and 64 who are in employment.

In the UK, the employment rate is around 75% of the 16 to 64 year olds. Men have a slightly higher employment rate than women, at 78% and 72% respectively (as of February 2021).

Measuring economic inactivity

Economic inactivity refers to those who are jobless but have not been looking for work, or have been available for work. In short, the economically inactive are those between 16 and 64 who are not currently in the labour market. Examples of those who are inactive include students, carers, the retired, disabled and the long-term sick.

[1] https://www.hse.gov.uk/statistics/

Measuring Inflation

Inflation, which refers to a general rise in the average level of prices, can be measured in a variety of ways. Strictly speaking, there is no single 'measure' of inflation - only indicators of inflation.

By this we mean that the subjective experience of inflation will vary considerably between people and households. This is because no two individuals or families will consume exactly the same combination of goods and services. Hence, it is unlikely that a rise in the 'average' level of prices will be experienced in the same way. 'My' inflation rate is different from 'your' inflation rate.

So, is there any point to measuring inflation?

The most important reason to establish an accepted measure of inflation is that changes in the price level have fundamental and wide-ranging effects on all aspects of an economy, including living standards, growth, jobs and the balance of payments. While not perfect, it is essential that average prices can be tracked over time.

Levels and rates

Firstly, we need to distinguish between measuring the price level, and measuring the rate of inflation.

The price level

The price level is simply the average prices of all goods (or those measured) at a point in time. For example, if a family in Spain purchases 7 goods on a particular Saturday - a loaf of bread at €3, a bunch of bananas at €2, a kilo of rice, at €6, a newspaper at €3, some asparagus at €4, a bottle of water at €2, and an ice cream at €1, the price level they face is the average of all prices, which is €3 [total prices of €21 divided by 7 goods].

The inflation rate

The rate of inflation is the increase in the price level expressed as a percentage. The distinction between the rate and the level is important. Referring to changes in the price level is not the same as referring to changes in the inflation rate. While the rate of inflation could be falling, the price level is still rising, but at a slower rate. A falling inflation rate is still a rise in average prices - this is one of the commonest misconceptions regarding the measurement of inflation.

[1] More reading on the RPI from the Which Magazine, viewed June 5th 2021

[2] Publications - UK Parliament - https://publications.parliament.uk/pa/ld201719/

[3] Reported in: https://publications.parliament.uk/pa/ld201719/.html

The balance of payments

The balance of payments has two separate meanings in economics:

Flows of payments occur when a country makes and receives payments relating to international transactions. Payments relate to goods, services, investments, people working abroad, and official financial flows.

A country's balance of payments account

A country's official balance of payments account in broken down into two basic sections, the Current Account and the Financial Account, including a country's 'investment position'.

The current account, which includes:

Trade

Trade flows include payments for goods and services - imports and exports. Trade in goods is referred to as 'visible' trade and trade in services is 'invisible' trade.

Examples of visible trade:

Examples of invisible trade:

The trade account is often seen as the most important account for a country in terms of trying to achieve a trade balance.

Primary income

The primary income balance records income a country receives and pays on financial and other assets, together with compensation of employees.

Much of this relates to a country's previous investment abroad. For example, if a company purchases another company located abroad, the trading profits are included in primary income.

Secondary income

The secondary income account includes records of transfers;

General government transfers, which includes taxes and other contributions received from non-resident workers and businesses, bilateral international aid; social security payments abroad; and miscellaneous transfers.

Non-government transfers include taxes on income and wealth paid by a country's workers to foreign governments; insurance premiums and claims; and workers’ remittances, and private transfers, including gifts.

Capital and financial account

The capital account of the balance of payments records a country's transactions in fixed capital assets, such as the transfer of ownership of a factory in an overseas territory.

The financial account records flows of payments for financial assets, such as the disposal or acquisition of shares in businesses located abroad.

The financial account is laid out in several categories, including direct investment, portfolio investment, financial derivatives and reserve assets.

Official financing

The financial account also records official financing flows, which arise when a central bank buys or sells foreign currencies, or buys or sells other assets, including gold. It may be necessary to borrow from time to time, or to lend to other countries, and these transactions will be entered in this account.

The reason for this is that the overall balance of payments must balance. Hence, a deficit on a country's current account must be balanced by an equal surplus on its capital and financial account. A surplus on the capital account may not be sufficient to create an overall balance, hence the need for a country to engage in official financing through its central bank.

International investment position

The international investment position (IIP) looks at a country's balance sheet with the rest of the world, and measures the difference between the country's net stock of assets and liabilities.

Errors and Omissions

Although the balance of payment should, in theory balance, in practice there are various imperfections in how the data is collected and compiled. These errors and omissions are estimated and a 'net' figure is produced, which is included in the accounts in order to make the overall balance equal zero.

The importance of the Current Account

While the overall balance of payments must always equal zero, this does not mean that a country cannot run into trade difficulties. It is still the case for most advanced economies that the Current Account is regarded as an indicator of economic performance in the global economy. In other words, is the country 'paying its way' in the global economy?

Current account deficits and surpluses