Join our community of smart investors

Underestimating growth?

Difficulties in measuring inflation pose the question: has growth been faster than statisticians claim? The answer is: probably not.
January 23, 2018

Are we better off than official figures tell us? This is the possibility raised by a recent report from the Economic Statistics Centre of Excellence. It shows that prices of telecoms services have fallen far more since 2010 than official statisticians estimate. This means the Office for National Statistics (ONS) has overstated inflation.

Now, in itself this is only a tiny effect. But it’s part of a wider question: how do we measure inflation when there is technical change?

One problem here is the introduction of new goods. A few years ago, you couldn’t get an Amazon Echo, tablet or smartphone at any price. Now you can. There has been in effect an infinite rate of deflation for such goods. How can CPI statistics accurately capture that?

A second issue is quality change. A laptop today costs as much as it did a few years ago. But it’s faster and has more memory so you get more computer for your money. That’s a price fall. In principle, statisticians measure this by hedonic pricing. Rather than take the price of a laptop, they consider it as a bundle of attributes: processing speed, screen resolution and so on. If the same money buys you more of these, the price of a laptop is deemed to have fallen.

These problems mean it’s possible that inflation has been lower than the ONS says. Growth in nominal incomes – which is measured separately – isn’t affected. It follows that real growth might have been higher than the ONS says. If so, we’re better off than official figures claim. Or are we?

I’m not sure. First, it’s not clear that this is a new problem. It’s as old as technical change. The replacement of standpipes with running water in the home, and later the mangle with the upright washing machine, posed exactly the same issues. Maybe inflation has always been overestimated and real economic growth therefore under-recorded. It doesn’t follow at all that growth has been faster recently relative to what it was in the past.

Secondly, there are some ways in which technical change has genuinely reduced GDP. GDP, remember, is paid activity. But the internet has caused a shift from paid to unpaid activity. If you watch cat videos on Youtube rather than TV; use Wikipedia rather than buy an encyclopaedia; or buy something second-hand off Ebay rather than new from a shop then you have depressed GDP. You might be happier reading a newspaper online than paying for the physical product. But newspaper owners, journalists and advertisers are worse off. The drop in GDP is not just a statistical artefact. It’s real.

Thirdly, progress is not the only story. Many journey times for cars and trains are longer now than they were a few years ago. This means that prices of train tickets or cars have in effect risen more than their prices would suggest. To this extent, inflation is understated and so real growth has been overstated.

We have a rough check here. Just look at real people. If inflation has been overstated and real growth understated, we’d expect to see that people are happier. But they are not. The vote for Brexit and rise of Corbynism are both signs of discontent with the established order. This tells us the economy hasn’t been performing well.

What is clear here, though, is that official statistics give us only a rough idea of what’s really happening. When reports say (for example) that inflation was 3 per cent in 2017 or real GDP grew 0.4 per cent in the third quarter they are precise, but not accurate.