Hi Ray, I have not know much about John Kay, although I was just over at his website.
johnkay.com
His article can be used to make an interesting argument that many metrics that were used to quantify and value things over the past 100, 50 and even 30 years may be changing somewhat due to major structural changes. ???
he has some interesting information on the origin of National income accounting:
johnkay.com
History of GDP and National Accounting
The practice of national income accounting was developed during the Second World War, in particular by Richard Stone and James Meade under the tutelage of Keynes (Stone, 1986, Weale, 1993). Some aspects of national accounts conventions – particularly the emphasis on gross rather than net measures and the emphasis on the real flows corresponding to the circular flow of income rather than the financial flows important to private sector accounting – seem to be the product of a perspective based on war conditions and Keynesian economics.
Suggested reading:
BEA, 2000, GDP: One of the Great Inventions of the 20th Century’, Survey of Current Business, (January)
Stone, R., 1986, ‘Nobel Memorial Lecture 1984: The Accounts of Society’, Journal of Applied Econometrics, Vol. 1, Issue 1 (January), pp5-28
Weale, M., 1993, ‘Fifty Years of National Income Accounting’, Economic Notes, Vol. 22, No. 2, pp.178-199.
Defining GDP
A basic glossary item usually describes GDP as “the total market value of goods and services produced in a given year within the borders of a country (whether or not they are sold)”.
An economist would not deviate too much for this definition by defining GDP as the sum of firms’ gross value added. (Gross value added is the extra a vale a firm adds to raw materials in order to make output.) And because gross value added is used to pay employees’ wages and shareholders’ dividends national accountants can estimate GDP by looking at peoples’ incomes, as well as what they spend on goods and services.
GDP is strictly defined as the sum of consumption (C), investment (I), government expenditure (G) and net exports (Z). However, defining which fall under the term ‘investment’ can be a subjective matter. In particular, whilst investment goods are included in GDP because they enhance future output, any intermediate goods (or current inputs) are ignored as they form part of the vale of final output. Recently this has caused many to argue that a greater proportion of computer software should be included as investment because it may enhance production beyond the current year. Indeed this caused the US national accounts to be retrospectively altered.
There are two important things to remember about this definition:
(i) GDP is a gross measure. Investment that firms undertake in order to replace worn out equipment is added to GDP. Even if all investment is used to replace obsolete machines GDP still rises.
(ii) GDP is measured in constant prices. The total market value of a particular good or service can increase (a) if the price rises, and/or (b) if more units are produced. To calculate economic growth in terms of the volume of output national accounts try to eliminate (a) by valuing all output in the prices that existed in some arbitrary base year (1995 in the UK at present).
So GDP growth is just output growth, right?
Wrong. Whilst it seems intuitive that growth in the sum of all individual firms' output (defined as value added) should equal aggregate output and income this is not the case. See John's paper on National Accounting for the New Economy(section 2).
GDP is GDP. It is not aggregate income or aggregate output.
Whilst this system has been fairly robust up until the 1990s, the introduction of new goods and technology has posed a few problems for national accountants (and users of the data they produce).
Suggested reading:
Office for National Statistics website: ‘Gross Domestic Product: A brief guide’ explains the circular flow and the different methods of calculating GDP. Links to more detailed information provided.
THE PROBLEMS:
(i) Estimating price changes: new goods and rapidly changing technology
Measuring the price fall of standardized goods is easy. A barrel of oil is a barrel of oil in whatever two time periods you look at it. Comparing prices is child’s play. But what happens when we compare the price of a computer or a car, whose characteristics and quality may vary dramatically even over short periods of time? A base-level PC costing £700 this year offers far greater power than a machine costing £700 in 1995.
Economic statisticians have two main estimation techniques at their disposal:
(i) Matched-model approach. This simply tracks the falling price of the same computer over time.
(ii) The hedonic pricing approach. This involves carefully estimating the value each characteristics of goods. For computers this would involve estimating the market prices of the amount of memory, the processor speed the hard disk size, and so on. By comparing old and new models a price differential is calculated using regression analysis. This differential can be positive or negative and, for computers, this is normally negative – reflecting some fairly dramatic falls in prices.
Suggested reading:
BEA, 2000, A note on the impact of hedonics and computers on real GDP, Survey of Current Business, (December)
Hausman, J.A, 1994, Valuation of New Goods under Perfect and Imperfect Competition, NBER Working Paper No.w4970. Also published in Bresnahan, T. and Gordon, T. (eds.) The ‘Economics of New Goods’, Studies in Income and Wealth 58: 209-237. University of Chicago Press for the National Bureau of Economic Research.
Lequiller, F., 2001, The new economy and the measurement of GDP growth, INSEE working paper
Schreyer, P., 2000, "Computer Price Indices and International Growth and Productivity Comparisons" for an international perspective.
(ii) The distortion of base prices.
As mentioned above, real GDP attempts to disentangle the volume growth of output from the increase in prices and, to do this, all output is valued in the prices that exist in some base year. The problem is the results can be very sensitive to the base year we pick. This is because relative prices (and therefore consumer tastes) change over time. A good that was relatively new and expensive in 1995 may become quite cheap and have gained serious sales momentum in 2000. The good’s contribution to real GDP growth will be upwardly biased if it’s increased production is valued at its high introductory price.
This is precisely what has been happening with computers and communications technology because the price of these investment goods has fallen so fast.
As a result of these concerns the US real GDP is now constructed under a system called “chain linking” which uses the prices of adjacent years rather than one fixed base year. [So, for the year 2000, the prices of 1999 and 2000 will be used and for 2001 the price of 2000 and 2001.] See BEA (1997) for more details. The UK’s Office for National Statistics is planning to follow suit.
Suggested reading:
BEA, 1997, BEA’s Chain Indexes, Time Series, and Measures of LongTerm Economic Growth, Survey of Current Business, (May)
See the ONS Chain-linking project web page for more details of the ONS plans to introduce chain linking and the effect on GDP.
(iii) Depreciation
GDP is measured gross and is therefore insensitive to counting investment that simply replaces old and obsolescent equipment and investment that enlarges the capital stock (bringing fresh productive capabilities). National accountants do produce a version of GDP – Net Domestic Product – that does take account of such depreciation. But, up until recently, the growth in GDP and NDP has been sufficiently similar to warrant a focus GDP growth as the main indicator of economic growth.
Computers, software and communications technology have upset the balance somewhat. Whilst land and industrial equipment may depreciate at around 2% and 15% per cent per annum respectively, computers depreciate far faster than rest of capital stock, perhaps at a rate of over 30% (Lequiller, 2000). So, whilst a greater proportion of firms’ investment spending is on computers much of this spending has merely replaced computers of a slightly older vintage. The diverged between NDP and GDP growth has become even more pronounced.
The impact on growth figures
John’s paper looks at the impact of these issues on rates of economic growth.
Suggested reading:
Jorgenson, D.W. and Stiroh, K.J., 2000, ‘Raising the Speed Limit: U.S. Economic Growth in the Information Age’, Brookings Papers on Economic Activity 1, pp125-211.
Oliner, S.D., and Sichel, D.E., 2000, ‘The Resurgence of Growth in the 1990s: Is Information Technology the Story?’, Journal of Economic Perspectives, Vol.14, pp2-22. |
