Even Mark Carney does not believe ONS data now

In a speech to the House of Commons Treasury Committee yesterday, Mark Carney, Governor of the Bank of England, admitted publicly something which many of us have suspected for a long time – see ‘Mark Carney criticises quality of ONS data’, Daily Telegraph, 27 November 2013There are very serious problems with some of the data published by the UK Office for National Statistics (ONS). My blog post today on Save our Savers gives examples of how the GDP deflator produced by ONS is exaggerating the apparent size of the economy in the UK. A more detailed version of the article is presented below.

saveoursavers 27 Nov 13

The economy is growing – or is it?

Carney is right to challenge ONS data

The latest revisions to the GDP figures today apparently confirm economic growth is now running at an equivalent annualised rate of over 3%. Moreover revisions to previous GDP figures now show the UK avoided any double dip recession and the economy is back to where it was in early 2007 (although still slightly below its peak in Q1 2008). 

But should we believe these numbers? The Bank of England clearly has its doubts about the data produced from the ONS. Mark Carney’s said yesterday to Treasury Committee, he trusted them less than those produced by the Canadian statistical office – see Daily Telegraph ‘Mark Carney criticises quality of ONS data‘ (27 November 2013[i]). As we’ll see in this article, he should have good reason to doubt the official GDP growth story too.

Does it feel like economic recovery?

When the initial Q3 GDP figures were released last month George Osborne tweeted that ‘we are firmly on the road to economic recovery‘.  Does this make sense and stack up with the reality we all see around us?

We are still in a period of austerity. Savings income has been slashed as interest rates have been cut. Government expenditure has been reduced.  Unemployment is more than 50% higher than in 2008. Disposable income has shrunk by 10% over the last 4 years, as average wages have risen just 7% whilst inflation (RPI) has increased 17%.  Food prices alone are up over a quarter in the last five years since the recession started.  So how can it be that the overall UK economy has managed to almost recover?

The ‘Alice in Wongaland’ recovery

The official explanation for economy’s bounce is that consumer is borrowing and spending again and this is leading to businesses starting to invest again. There is some evidence for this. The government is pouring money into the housing market via schemes such as Help to Buy. However more importantly, unsecured lending is up by 4%[ii].  To meet the gap in their disposable incomes noted above, people are now having to borrow on their credit cards and from payday lenders. This led economist Ann Pettifor to describe it recently as more like an ‘Alice in Wongaland’ recovery[iii].

However there is an alternative explanation. Maybe the economy has not recovered. Maybe, like Mark Carney possibly fears, it is only the official statistics that appear to show a recovery, while the real economy has been languishing in a recession? Although this might sound far-fetched or Orwellian, there is unfortunately some evidence to support the view. To appreciate why, you need to understand a bit more about GDP first.

GDP and how it is calculated

Calculating GDP is actually very complicated, not least because it is calculated in three completely different ways i.e. from income, expenditure and production statistics. These measures are combined (as they all approximately give the same answer), and one GDP figure is published.

One of the simplest ways to understand GDP is in terms of the countries’ expenditure. It is the total everything that people spend, everything that government spends and everything else that is spent by others (such as capital investments by companies)[iv].

However statisticians publish the change in spending each quarter to determine GDP growth, they first need to take inflation into account. Therefore two figures are calculated each quarter – the actual (nominal) amount spent and a (real) inflation adjusted amounts.  If you look at the difference between these two, you can work out what is called the GDP deflator, i.e. the effective rate of inflation the government is assuming in the calculation.

The deflator

Naively you might assume the deflator is pretty much the same as something like the Retail Prices Index (RPI). This makes sense as nearly two-thirds of GDP is household expenditure. RPI measures inflation for this group pretty well. Of the remainder, nearly a quarter of GDP is government spending, much of which involves purchasing many things that consumers buy, but on a bigger scale. The main other element is capital expenditures (usually building things), which are influenced by material prices – which also correlate with RPI.

That naïve logic held true for about half a century until the late 90s, as the graph below shows.

Source: ONS

However that that historical relationship has now changed.  The deflator is now consistently lower than RPI[v].

Moreover the divergence between them has grown even greater in the last three years to just under 2% on average.

Year Deflator RPI Difference
2010 3.2% 4.6% -1.4%
2011 2.3% 5.2% -2.9%
2012 1.7% 3.2% -1.5%

Source: ONS

The implications for actual GDP

This has major implications. If we were still calculating GDP as we used to (when it approximated to RPI), the stats would have shown the UK in recession for almost the whole period of the current government since 2010 – see table below.  The countries’ real GDP would still be over 10% less than what it was in 2008.

Year Official GDP GDP adjusted by RPI
2010 1.5% -0.3%
2011 0.6% -2.1%
2012 0.3% -1.4%

 

I would contend that the RPI adjusted figures accord much closer with the man in the street’s perception of the economy than the official statistics do.

Conspiracy?

As you’ll see below, I will argue that this is probably not a conspiracy but is mainly the effect of a succession of changes made to the way GDP is calculated. On the face of it, some of these appear well intentioned. Though as we’ll see, most were introduced for political reasons. However it is quite probable that those directly introducing them may not have fully anticipated what implications they would then have for GDP today.

Reason 1: Deflating government expenditure differently

One of the main reasons why GDP appears so high is related to the way government expenditure is now deflated.

If you look at the deflator stats for 2012 spilt by category, this highlights that something appears very odd with the inflation assumptions for government expenditure. The ONS is assuming there is outright deflation going on:

Component of expenditure

Deflator/ inflation rate

Household expenditure

2.7%

Capital formation

1.6%

Government expenditure

-1.6%[vi]

CPI

2.8%

RPI

3.2%

Source: ONS – Second Estimate of GDP, Q2 2013 at: http://www.ons.gov.uk/ons/dcp171778_322665.pdf – Annex D.

The reason for this goes back to a progression of changes that were made to the system after 1998.

Prior to then, government expenditure was deflated assuming that changes in outputs were the equivalent to changes in expenditure i.e. assuming productivity was constant. Other countries (i.e. the USA) had switched to a system where the quality of outputs were being taken into account and this had led to enhancements in their apparent GDP levels. As Tony Atkinson (key Government advisor in this) wrote[vii] retrospectively about it in 2005:

“In the report we pointed out between 1995 and 2003 the US economy grew ½% per year faster than that of the UK…But half of this difference is due simply to the difference in how we measure Government output. If we had used the same method as the USA, then the UK growth rate would have been 3% per annum [vs 2 ¾%]. These are not simply statistical conventions, but they materially affect how we view our performance.”

The report being referred to is Measurement of Government Output and Productivity for the National Accounts (2005). This highly influential government sponsored document resulted in the formation of the UK Centre for the Measurement of Government Activity (UKCeMGA) which then brought in further changes in the GDP calculation which we have seen the results of in the recent statistics.

The basic essence of all these changes is that we are no longer using inflation in government costs (like wages, fuel and catering bill rises) but instead deflating them by measures of quality (such as the number of children getting a GCSE grades A-C or the number of patients treated in A&E in four hours).

There is a big problem with this concept.  Over recent years when spending has been capped, apparent productivity (as measured by blunt instruments like GCSE grades) has carried on improving. Therefore it looks like government is getting more productivity for each pound spent. This means they have to assume a negative deflator (-1.6% in 2012 for example), to make the books balance.

This change has significantly contributed to making GDP look a lot higher than it really is over the last 2-3 years.

Reason 2: Replacing RPI with CPI

The other major change to the GDP calculation recently was the decision in 2011 to stop using RPI to deflate certain expenditure measures and to switch to CPI (Consumer Prices Index). This matters because CPI is almost always lower than RPI. This is primarily due to the way prices are averaged in CPI using a so called ‘geometric mean’. This methodological change can trim a staggering 1% off CPI. Moreover as I have written elsewhere[viii], the justification for such statistical manipulation, is dubious at best.

However it does now have direct implications for GDP estimates, which will always be higher now as a result of it. Note though, the pattern of prices in the shops has not altered, nor has the amount of money we all spend altered. It is just the GDP growth statistic that has changed and will now appear to be up to 1% higher each and every year now.

1984 revisited

If this were not bad enough, the ONS have taken the opportunity of this change to not just change the way we calculate GDP after 2011, but have used it to rewrite the whole GDP history back to the Second World War in a very Orwellian fashion.  Even though CPI did not exist before 1996 in the UK, they have still used it to justify somehow enhancing all our historical growth figures. The effect was highlighted in a recent blog post on EconBrowser[ix].  and the chart below summarises the way our history has been rewritten:

Decade

Average GDP growth per year

Before CPI change

After CPI change

1950s

2.7

3.0

1960s

2.8

3.2

1970s

1.9

2.1

1980s

2.7

3.1

1990s

2.6

2.8

2000s

1.6

1.8

 

To make matters worse in my view, if you try and go back and find the old GDP data (e.g. in the 2010 Blue Book) you’ll find that all the spreadsheet numbers now have been replaced with ‘new numbers’ in what looks like an example of Orwell’s Ministry of Truth in action[x].

So has the economy recovered?

The answer as you can see from the above is very difficult to tell. However if you view the economy through a lens of a statistician living in the 1990s, the answer is most probably that we’ve been a recession for most of the last three years. On the other hand, according to the latest Newspeak of the ONS, the economy grew 0.8% last quarter.  I wonder which opinion Mark Carney believes?

 

 

[i] http://www.telegraph.co.uk/finance/bank-of-england/10476050/Mark-Carney-criticises-quality-of-ONS-data.html

[ii] http://www.bankofengland.co.uk/publications/Documents/other/monetary/trendsoctober13.pdf

[iii] http://www.theguardian.com/business/poll/2013/aug/15/britain-alice-in-wongaland-economy

[iv]The GDP expenditure model also includes a measure of imports less exports.

[v] The only exception was in 2009 when house prices plummeted causing RPI to go negative. CPI, which excludes housing, did not go negative and remained above the deflator.

[vi] These 2012 figures are derived from the ONS report published in August 2013. In the latest report published on 27 November 2013, the deflator for government expenditure was changed to -0.5%. See: http://www.ons.gov.uk/ons/dcp171778_335900.pdf.

[vii] Atkinson, A.B.(2005), Editorial: Measurement of Government output and productivity, Journal of the Royal Statistical Society, 169, Part4, pp659-662.

[viii] Comley, P. (2013), Inflation Tax: The Plan To Deal With The Debts.

[ix] http://www.econbrowser.com/archives/2013/01/guest_contribut_30.html

[x] Luckily the data still does exist from those who copied it before 2011 and in old ONS publications which are paper documents/PDFs e.g. http://www.ons.gov.uk/ons/rel/elmr/economic-trends–discontinued-/2005-edition/economic-trends-annual-supplement.pdf

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