What’s behind the relatively large fall in UK GDP? (reprise…)

On Sunday, Labour’s Anneliese Dodds tweeted that the UK ‘had the worst recession and the worst growth of any major economy last year’, and that ‘Covid closed much of our economy, but the Conservatives crashed it’. Of course, this is just a tweet and almost all politicians try to score points in this way. Nonetheless, it was still pretty lazy.

The Shadow Chancellor was citing the latest IMF estimates for GDP growth in the G7 economies in 2020, rather than the actual data. The official numbers have either not been published (we have to wait until 12th February for the UK), or are slightly different. But the IMF probably wasn’t far wrong (UK GDP is indeed likely to have fallen by about 10%), so I’ll let that pass.

The real issue is how the data have been spun. For a start, rather than contrast the UK with the US or Japan, where the conditions are very different, it makes sense to compare the UK with its peers in the rest of Europe. Here, the economies with the worst recessions will probably turn out to be Spain (where GDP is already reported to have slumped by 11%), and possibly Greece.

Another important factor is differences in how GDP is measured. In the words of the official regulator of UK statistics, ‘the UK’s figures on GDP changes are not completely comparable with those of many other countries… because not all countries measure public services output in the conceptually sound way that the UK does’.

I first blogged about this back in August last year and David Smith was kind enough to quote me at the time. More recently, Ed Conway has picked up on this too.

In short, UK statisticians have put a lot more effort into estimating how much activity actually took place in sectors such as public health and education, rather than simply basing their numbers on how much money was spent.

The differences are huge. In the third quarter, UK government final consumption expenditure was estimated to be 17% higher in cash terms than the same period a year earlier, but the volume of goods and services that this money had bought was estimated to have fallen by about 9%. The biggest differences were in education and healthcare.

These big gaps imply that more money is buying fewer goods and services. In part this is because of genuine inflation (e.g. higher prices for PPE), and perhaps because some money is not being well spent (such as the early efforts at Test and Trace). However, it is mainly because the constraints of the pandemic mean that schools and hospitals need more money but are able to do less.

In particular, as the ONS itself has again explained today, the UK data attempt to reflect the impact of schools closures and the fall in output of the NHS as hospitals reduced elective and outpatient activity.

Economists and statisticians are still debating whether the ONS has gone too far. There are plenty of critics, including Mike Haynes and Simon Briscoe. I personally think the ONS has taken the right approach, but may have underestimated the overall output of the public sector during a crisis which changed the priorities. For example, diverting resources to treating Covid patients may have added more value in terms of protecting the nation’s health than continuing with elective operations (in the short term, at least).

However, there is no doubt that differences in the measurement of public sector output help to explain the differences in the official GDP data. After all, no other country has reported such a massive divergence between the nominal and real measures of government spending.

Nonetheless, this is still only part of the story (probably less than half). The UK has also seen relatively large falls in both consumer spending and business investment. This is presumably due to a combination of the more severe impact of the pandemic itself on the nation’s health, and how people, businesses and the authorities have responded. There is certainly no getting away from the fact that the UK has suffered a relatively large number of Covid deaths.

But to be fair, many of the variables which have influenced the impact of the pandemic are largely out of any government’s control. The UK was always likely to be hit relatively hard because of demographic factors, such as age and population density. These factors also help to explain the relatively high numbers of Covid deaths in countries like Italy and Belgium.

The structure of the UK economy has also played a part. As the OECD noted last year (and the Shadow Chancellor acknowledged at the time), ‘the UK has been among the most affected OECD economies by the COVID-19 crisis, reflecting the high share of services in output and its integration in the world economy’.

A key factor here is the greater importance of ‘social consumption’, which is discretionary consumer spending on activities (like eating out) which involve close contact with other people.

This can be overstated. The UK also has a high weight on financial services and real estate activities, which have weathered the pandemic relatively well. But the remaining differences still go some way towards explaining why UK GDP has been worse hit than economies like Germany and Japan, with their larger manufacturing sectors, and also why Greece and Spain, with their larger tourism industries, may have been hit even harder.

Given the doubts about the comparability of the GDP data, it also makes sense to look at other indicators. In particular, UK unemployment remains relatively low. The impact on jobs is surely a far better measure of the success or failure of economic policies, especially when economic activity is being deliberately constrained in order to save lives. In these circumstances, terms like ‘worst recession’ and ‘crashing the economy’ are much less meaningful – and a few percentage points either way is not such a big deal.

But if we are going to focus on GDP, let’s see how the more recent UK data compare to those in other countries. The UK probably avoided a contraction in the fourth quarter of last year, unlike the euro area. More importantly, the faster rollout of the Covid vaccines should mean a quicker and stronger recovery in 2021. (For consistency’s sake, I hope Anneliese Dodds tweets about this too…)

In conclusion, international comparisons of GDP need to be made with care. However, it is fair to say that the bigger falls reported in the UK partly reflect more accurate measurement, differences in the composition of the economy, and greater vulnerability to a pandemic in the first place. On the economic indicators that really matter – notably jobs – the UK continues to do relatively well.

PS. Some others are expressing these issues in terms of a jump in ‘inflation’ or a slump in ‘productivity’. While technically correct, I’m not sure this helps.

The jump in the deflator for government consumption partly reflects higher prices (e.g. for PPE) and therefore is ‘inflation’ in the sense that most people would understand it. But it also reflects the fact that many teachers and healthcare workers were simply unable to do as much as before, due to the constraints of the pandemic.

Similarly, the fall in the ratio of outputs to inputs could be described (accurately) as a collapse in ‘productivity’. But this term comes with a lot of baggage: it might be interpreted to mean the public sector has suddenly become much less efficient at doing the same things as before, or even reflect badly on the efforts and ability of people working in these areas. That would obviously be unfair.

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