Free exchange
Econometrics
It is not easy to compare the size of economies—even across the Channel
Jul 16th 2016 | From the print edition
FRANCE is renowned, fairly or not, for its long holidays and short working weeks, subsidised farmers and unionised workers, high culture and higher taxes. Less than two-thirds (64%) of its working-age population was employed last year, according to the OECD, compared with almost three-quarters (73%) in Britain. But is France’s well-lunched workforce of 26.4m now producing more than Britain’s harried 31.1m employees?
Many people seem to think so. France’s GDP in 2015 was about 2.18 trillion euros. Britain’s was a little over ￡1.86 trillion. On July 6th the pound fell below 1.17 euros
on the currency markets, rattled by Britain’s vote to leave the European Union (EU). Since 1.86 multiplied by the exchange rate of July 6th is less than 2.18, many commentators jumped to the conclusion that Britain’s economy had slipped overnight from fifth-biggest in the world to sixth. It was one more humiliation among many.
Comparing the size of national economies can be a frustrating exercise. The measuring tape is not always consistent from place to place or period to period. This week Ireland’s statisticians added over 19% to last year’s GDP after folding multinationals’ aircraft and intellectual property into its economy. Both China and India, two of the biggest economies in the world, have recently revised their methods for calculating GDP, bringing them closer to international standards agreed on in 2008. India’s controversial overhaul recalculated everything from manufacturing output (drawing on a new database of corporate e-filings) to the value of dung. (This latter revision added over 180m dollars to India’s GDP, assuming an “evacuation rate” of 0.3kg a day for goats and rather more for sheep.)
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China, for its part, last week added R&D spending to its measure of economic size (just as advanced countries already do). It also took the opportunity to revise its figures all the way back to 1952 (see chart). The new numbers suggest that China’s GDP was over 68 trillion yuan last year, compared with only 478 billion yuan in 1952 (at 2015 prices). The difference between those two numbers, however sketchy they may be, represents the greatest economic story of the modern age. But the statisticians keep fiddling with the earlier chapters.
When laypeople reflect on the size of their national economy, they may think of a vast inventory of productive assets: humming factories, gleaming skyscrapers, fertile lands, cosy homes and teeming workers, full of brains and brawn. Similarly, when they look at a chart of GDP, like China’s above, it may remind them of a pile of money accumulating steadily over time, like an unusually successful stock portfolio.
Viewed this way, it may seem natural to recalculate the value of an economy in the light of sudden currency fluctuations, like the yuan’s decline since August or the pound’s since June 23rd. Why not mark these economies to market? It seems unobjectionable to reprice Britain’s GDP at the lower July 6th exchange rate, just as a Frenchman in London might recalculate the diminished euro value of his sterling bank account or his Battersea flat.
But such an exercise betrays a misunderstanding of GDP. This deceptively familiar gauge of economic size does not represent a stock of assets but a flow of goods and services. It is more akin to the wages and interest someone earns during a year than to the money in an account at the end of the year. It cannot therefore be valued at a point in time, like a bank balance, dwelling or stock portfolio. It must instead be evaluated over a span of time.
Most often, this span is a year (which obviates the need for seasonal adjustment) or a quarter. Other periods are possible, both longer and shorter. From 1952 to 2015 China’s GDP amounted to over 809 trillion yuan (at 2015 prices), according to our calculations, based on the government’s revised figures. Incredibly, of all the goods and services ever produced by the People’s Republic of China, over half were produced from 2008 onwards.
Shorter timespans are also possible: Canada publishes a monthly GDP estimate. In theory, one could even calculate the output of Britain and France in the few weeks since the EU referendum. But weekly GDP figures do not exist and would be hideously volatile if they did.
Explore our interactive guide to Europe's troubled economies
Because GDP represents a flow of goodies over time, it makes sense to value it at the exchange rates that prevailed during that time. It seems odd, in contrast, to reprice what happened last year at an exchange rate that arose only last week. Many of the items that constitute GDP are perishable, disappearing shortly after their creation. Hot meals and long journeys, a stirring night at the theatre, a warm radiator on a winter’s morning—Britain produced many such necessities and conveniences over the course of 2015. But these items left nothing behind that could be marked to market in July 2016.
This is not to deny that the pound was overvalued. Its strength was rooted not in the international appeal of British goods but in the widespread appeal of British assets—including gilded homes and gilt-edged securities. Foreign purchases of these assets added little directly to British output (because GDP includes only newly built homes and factories, not financial securities or pre-existing properties or companies sold to new owners). But these buyers did bid up the currency in which GDP was priced.
Liberty, fraternity, purchasing-power parity
The size of Britain’s GDP, when converted into euros, thus reflected an uneasy amalgam of demand for its goods and services and a somewhat separate demand for the pounds required to buy British assets. The combination made Britain an expensive place to visit: all told, its prices were about 16% higher than France’s last year, according to the World Bank and the IMF. As it happens, if similar items were priced similarly in both countries (bringing their purchasing power into parity with each other), France’s GDP would have been almost the same size as its neighbour’s in 2015, even before Britain’s recent setbacks and indignities.
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From the print edition: Finance and economics
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