Credit: Christopher Furlong / Getty

November 16, 2018   3 mins

GDP stands for gross domestic product i.e. how much a country produces in goods and services every year. That would seem to be a reasonable measure of the size of an economy – and, by comparing one year to the next, its rate of growth.

However, as always, economics is a slippery business. For a start, there’s the practical challenge of measuring production. For various reasons, the most reliable way of doing so is at the point of purchase. Using this expenditure method, GDP is equal to personal consumption plus business investment plus government expenditure plus net exports. That, however, leaves the question of what to include under each of these headings.

In an article for the Global Poverty and Inequality Dynamic Research Network, Jacob Assa and Ingrid Harold Kvangraven point out that the standard methodology has changed in recent decades – and that the effect of those changes has been to make the western economies look richer (in comparison to non-western economies) than they really are:

“…changes made to GDP measurement over the past two decades have a bias towards countries traditionally in ‘the West’. As this has had a substantial impact on the assessment of comparative growth among countries in those two groups, we deem it as a form of kicking away the statistical ladder “

What changes are we talking about?

“Examples include the reclassification of financial intermediation services, Research and Development  activities (R&D) and owner-occupied dwellings as productive activities. This means finance has been ‘made productive’ (as Brett Christophers puts it), R&D is no longer considered an intermediate input and home ownership is now included in GDP in the form of the imaginary rent that homeowners would have paid to a landlord had they owned their home…”

The authors propose a new measure of “core GDP” that would exclude the funny money and focus “only what can be directly measured”:

“Such directly measured industries include agriculture, utilities, manufacturing, retail trade, transportation, and communication.”

In a fascinating paper they compare the official GDP figures to their “core GDP” measure and find that the choice of method makes a big difference to the relative sizes of the western and non- western economies. For instance, according to the official figures the non-West only overtook the West in the middle of 2000, but according to the core GDP figures the cross-over took place much earlier – at some point before 1990 (when the comparison starts).

Choice of statistical method doesn’t change how rich or poor people actually are, but the authors observe that the bias to the West does impact on “our perception of growth in the world” and also on the weight of western influence in global institutions like the World Bank and the IMF.

As well as this apparent unfairness to the non-West, I’d argue that the official measures of GDP are doing damage in the western nations too.

A key issue here is that of ‘imputed rent’ – which takes a bit of explaining. Official GDP figures include the rents that tenants pay to their landlords. They also include an estimate of what owner occupiers would pay if they too rented their homes instead of owning them – these are the imputed rents. It is as if owner occupiers were paying rent to themselves. This might seem fanciful, but the justification is that though owner occupation doesn’t generate an actual transaction, it still has a measurable financial value.

Assa and Kvangraven argue that including imputed rents in the measurement of GDP has “the peculiar effect of making countries with housing bubbles appear to grow more rapidly”. Well, fair comment, but on that basis one shouldn’t include any kind of rent in the GDP figures – imputed or actual.

In fact, taking rent out of GDP would remove some deeply perverse incentives for policy-makers. Ever wondered why government does such a bad job of solving the housing crisis? Well, if it did a better job, and rental values came down, GDP would take a corresponding hit.

In the longer term, I think the real productive economy would benefit hugely from lower, more stable rents and land values – but that’s not the sort of thing factored into the models of bean-counting finance ministries.

Peter Franklin is Associate Editor of UnHerd. He was previously a policy advisor and speechwriter on environmental and social issues.