Mind your Business - 02 February 2004
Statistics and National Income Accounts
Statistics and National Income Accounts:
The ONS are constantly looking at refining the techniques they use to collect such data to provide its users with more accurate information. In addition, the government may instruct them that it intends changing the way in which they measure key economic data. One of the more widely publicised has been the change from using the Retail Price Index (RPI) as a measure of inflation to the Consumer Price Index (CPI). There are often suspicions as to why the government might do this - during the 13 years of Conservative government in the 1980s and 90s, the measure of unemployment was changed around 16 times - on each occasion it delivered a lower level of unemployment than previously. Cynics might point to a deliberate massaging of the figures to put governments in the best light, but it is also important to realise that governments need information to be as accurate and reliable as possible and in some cases changing the measure gives then 'better' information upon which to rely in making important decisions.
Apart from inflation measures, what else has changed? Over recent years, the work of eminent economists has provided the basis for refinements to statistical methods. One such example is the work done on time-series data by Engle and Granger. Both received the Nobel Prize in Economics for their work, which has enabled those who work with such data to be able to develop techniques that produce more reliable information.
In September 2003, the ONS announced that it was applying a new method to its calculation of figures for Gross Domestic Product (GDP). GDP is vitally important for all sorts of reasons - it gives an indication of the wealth of the country, how that wealth is growing (or not as the case may be), provides clues as to the likely revenue streams for the Treasury from tax revenue and thus helps to assess the impact on government borrowing, gives clues about the levels of employment and unemployment, consumer spending, investment and the levels of trade between the UK and our foreign trading partners. Because it is so important, it is essential that the government, the Monetary Policy Committee of the Bank of England and business can rely on the data as being an accurate representation of what is happening in the real economy. In addition, the GDP figures are used to help generate other important data such as the Gross National Income (GNI), Gross National Disposable Income (GNDI), and Real Gross Domestic Income (RGDI).
The Bank of England
So the ONS is constantly seeking to revise its methods and the data it produces. In some cases, this is as a result of research carried out into statistical methods that shed new light on producing accurate and reliable data, and in others, it is because new information comes to light that was not available when the data was first processed that gives a different and more accurate picture. Recently, the National Statistician, (the Head of the ONS) wrote an article defending the performance of the ONS and explaining why the organisation needs to consider revisions to data. This is an attempt to head off criticism that if you constantly update or revise statistical data they cease to have meaning when first published. The ONS, for its part, point to the efficiency of its operation and the respect the service receives from users worldwide.
The theory section will look at some of the definitions used by the ONS in generating its statistics. It is important to know the basis on which data is generated because you will often be presented with tables of data in examination papers, case studies and so on. Knowing something of the basis on which the data was produced can be important
GDP is a measure of the amount of wealth generated by an economy during a specified time period. The generation of that wealth can also be viewed as the amount of economic activity - production and exchange (buying and selling) that goes on during the time period. The ONS uses three measures to produce such data - in theory these measures should be identical, but in reality they are not. The reason is that the information on which the data is collected may come from different sources and inevitably contains inaccuracies and 'rounding' leading to what are called 'error terms'. The statistics are adjusted to take account of such errors.
The ONS has to make sense of millions of decisions and actions every day. In order to do this, it groups activities in the economy under the following headings:
- Households - This covers all individuals who are engaged in transactions with another sector of the economy.
- Financial Corporations - All legal business entities and companies.
- Government - All the transactions carried out by the UK government.
The three methods of measuring the national income are as follows:
- Expenditure Method - This measures the amount of spending on goods and services by all the sectors of the economy as outlined above. This will include government spending on all the services it provides, business spending on equipment, machinery, raw materials, advertising, and other investments, and household spending on goods and services such as food, clothing, household goods, furniture, entertainment, insurance, vehicles and so on.
- The Income Method - If you go to a shop and buy a bar of chocolate, the money you hand over for that item represents your expenditure but for the shopkeeper receiving it, that represents their income. This is why measuring the GDP through either the expenditure or the income method should give the same figure. The income method records all the incomes received by each sector as a result of transactions that take place over the period of time under consideration. This will include incomes received as wages and salaries of employees and the self employed, money earned by corporations, money received by the government from its activities, interest payments received, payments from rent and so on.
- The Output Method - The chocolate bar used in the example above has a price. That price represents the value of the inputs that went into the production of that item - land, labour, capital and enterprise. At each stage of the production process therefore, the value of the output carried out can be recorded - this is the value added. The total value added to the chocolate bar is the price at which it is sold - how much the consumer has to pay (expenditure) and how much the shopkeeper received (income). We can now see that the output method is another way of looking at the same thing. In theory, therefore, the output method should give the same figure as either the income or expenditure method. The output method is invariably shown by industry - construction, agriculture, financial services, manufacturing and so on.
Electronic Christmas spending.
The measure for GDP is essentially what is called a 'volume measure'. In other words, it is measuring 'how much' has been produced. The ONS has to produce a single measure of GDP and does this by using the three approaches above and balancing the final figure in relation to the three measures. Remember, we said that in theory they should all be the same but the process of collecting information from millions of transactions means that in reality they would never be exact.
Imagine a situation, for example, where someone has some work done on his or her house - say some plastering of a room. The total price for the work paid by the owner of the house might be £1500 - this should represent the sum of the resources used in the job. The plasterer may declare to the inland revenue that the work represented income of £1200 (to avoid paying income tax - illegal, but nevertheless it happens!) and the resources used might have included the plasterboard, plaster, electricity, buckets, nails, water, trowels and hawks, the vehicles to get to and from the builders merchants, etc. It is easy to see how, even in such a simple example that it becomes incredibly difficult to keep track of every item involved!
The figures produced can be in various forms:
- Current prices (CP) - Transactions valued at prices that exist in the current time period. These are also called nominal prices.
- Constant Prices (KP) - The number of transactions can be viewed as the effect of rising prices has been taken out and all transactions are expressed in a common set of prices. For example, these could be the prices that existed in 1999 - termed the 'base year'. These are what are called 'real ' figures.
To illustrate this let us take a simple example:
Assume that we are measuring the output of the economy through the production of cheese sandwiches. Each sandwich is priced at £1.50. In 2002, the economy produced 1000 sandwiches, so total GDP would equal £1500. In 2003, the economy produced 900 sandwiches, but prices rose to £2.00 each. This would give a 'nominal' GDP of £1800. It looks as though the country is better off following a £300 rise in GDP but we are actually producing less. If we use the constant prices method we could express both 2002 and 2003 output at the same price level. So if we used 2002 as the base year, then output in 2003 would be recorded as 900 x £1.50 = £1350. This would more accurately reflect what happened to economic activity. Alternatively, we could record the measure in 2003 prices. This would give us a measure in 2002 of 1500 x £2.00 = (£3,000) compared to £1800 in 2003.
The choice of which base year to use is important - up to now, the ONS has used a method referred to as 'fixed base aggregations'. For example, they might have compared the data using 1995 as the base year. However, as with any statistical data which uses a base year in its compilation, the base year can lead to inconsistencies in the data because circumstances change. Goods, for example, that were common in 1995 may not exist anymore and there might be some products that were not available at that time - DVDs, for example? In general, the more you can update the base year, the more accurate the statistics will be. Fixed base aggregations in GDP statistics was used as follows. The growth of the different parts of the economy is given weights when trying to arrive at the final figure for GDP. This takes account of their relative importance in the economy and a base year of 1995 was used to help determine these weights. These base years were updated every 5 years but as we have seen, this can lead to problems.
The method known as 'annual chain linking' helps to overcome these problems. Rather than updating the base years every five years, this method does it every year, calculating the prices in previous years prices (PYPs). In future therefore, you might see GDP tables expressed as 'GDP (CVM)', where CVM means Chained Volume Measures, as opposed to 'GDP in constant prices'.
In terms of analysis of the data it should make little difference but you could comment that the data is more likely to be accurate and reliable compared to the previous measures!
Data / Facts / Figures
UK GDP - 1999-2002 - Market Prices, Current Prices (£ million)
UK GDP - 1999-2002 - Market Prices, Chained Volume Measures (£ million)
Source: Adapted from ONS data (http://www.statistics.gov.uk/articles/economic_trends/ETApr03Soo.pdf)
Source: ONS, reproduced under licence. (http://www.statistics.gov.uk/cci/nugget.asp?id=255)
Look at the data in the tables and the graph above.
- Describe the differences in the data in the two tables. (10 marks)
- Look at the information provided in the graph. What implications would this have for decisions made prior to the new methods being adopted in September 2003? (16 marks)
- In each table, calculate:
- The proportion of each component of aggregate demand to GDP. (8 marks)
- The percentage change in GDP for each year. (6 marks)
- Use your calculations to comment on the likely direction of macroeconomic policy in the light of the government's key economic targets. (20 marks)
Total = 60 marks
Related Web sites for research
- GDP - Measuring the UK's economic activity (http://www.statistics.gov.uk/CCI/nugget.asp?ID=56)
- The application of annual chain-linking to the Gross National Income system (http://www.statistics.gov.uk/articles/economic_trends/ETApr03Soo.pdf)
- Office for National Statistics (http://www.statistics.gov.uk)
- TimeWeb - Time Series Data on the Web (http://www.bized.co.uk/timeweb/)
- Time Series data analysis (http://www.bized.co.uk/timeweb/crunching/crunch_analysis_illus.htm)
- Virtual Economy - General advice on economic management (http://www.bized.co.uk/virtual/economy/policy/advisors/general.htm)
The aim of the questions are to get you to do a bit of data analysis and thinking about how the accuracy of data can influence economic decision making.
The first question is asking you to recognise that there are differences in the data when calculated through current prices and through the chain volume measure. Here you will be expected to say what is happening to the components within each table - whether they are rising or falling and crucially, how quickly they are rising and falling. To do this it is useful to be able to calculate percentage changes quickly - they allow you to be able to demonstrate more effectively the rate of change. To calculate a percentage change, take the difference in the two figures, divide by the starting figure and multiply by 100. For example, to calculate the percentage change in consumption in the first table between 1999 and 2002, take the difference between 692896 and 592509 (100387), divide it by the figure for 1999 (592509) and x 100 (16.9%).
The basis of this question is the use of the difference in the information outlined in question 1 in terms of policy making. The basic point is that accuracy of information is important in making informed decisions. If, for example, the Chancellor is assessing the options available to him in his annual Budget, and is given information telling him that the annual growth rate is 3.0%, this might suggest that tax revenues will be quite high. If however, the true figures (whatever they are) give a growth rate of only 2.0%, then tax revenues will be much lower than anticipated and if plans for expenditure have been based on the likely tax revenue, then government will have to fund the gap through increased borrowing! Trace through the effects on other key targets such as inflation, unemployment and the balance of payments. By doing so, you will improve your understanding of the relationships between these key variables and economic activity.
The calculations here are the same as those highlighted above. To calculate the proportion of consumption to GDP in 1999, for example, divide 592509 by the total GDP figure (909636) and multiply the result by 100. Calculating the percentage change of GDP is the same process as outlined in question 3, above.
Question 4 is encouraging you to look into the economic crystal ball and think about what has been happening and what the figures tell you might happen in the coming years and the policy decisions that might be taken as a result. Again, you are being assessed on your understanding of the relationships between the factors influencing aggregate demand and your knowledge of how the whole economy behaves - the moderating effect on increases in aggregate supply, for example. You are not expected to come to definitive answers here but would be expected to make some judgements at least supported by reasonable economic theory and using the data provided. The policy options will cover tax policy, government spending, possible changes in interest rates and supply side policies. The high marks for this section imply an assessment of higher order skills - analysis and evaluation - and so you need to think about developing an argument, showing an understanding of the theory and an ability to apply it appropriately within a coherent and logically developed and structured answer. Plan it out first - know what you are going to say when and in what order. A summary paragraph highlighting your main conclusions will help to tie up the piece.