Friday, 30 May 2014

Measuring the Economy – A Knotty Problem

A change in focus is needed to make a real difference when measuring economic growth

Measuring the economy can be a bit like estimating the length of the proverbial piece of string.  Even pinning down what to measure before taking out your tape measure is tricky.  What is measured takes on even more importance when it is tied into government policy which aims to make us all better off.  This is a sobering thought at a time when improvements according to the traditional yardstick of GDP often fail to make a difference to the lives of many of us.  Changing what is used as a gauge for economic improvement can have significant consequences for the outcome of economic policy.

Being strung along by GDP

Rising inequality is a hot topic among economists at the moment.  Data shows that the wealth of the rich has increased considerably faster than for the less well-off over the past few decades.  Much of this can be attributed to the forces of globalization - a shortage of
skilled workers in the global marketplace has pushed up their pay while the opening up of countries such as China has resulted in a glut of low-skilled workers which has depressed their wages.  Technology has also added to this trend with computers reducing the clerical and administration work that had been a source of jobs for middle class workers.

Some see inequality as a necessary part of a capitalist economy with industrious people earning more due to their own hard work.  Others point to the social costs of inequality such as higher crime and more health problems and call for more policies to stem this trend.  The lack of advances in the earning power of a large portion of the population will inevitably have serious political consequences such as the rise of populist movements or a growing mistrust of capitalism among young people.  The issue is all the more urgent as it comes at a time when Western countries are struggling to maintain their place at the top of the global pecking order.

The combination of austerity measures and loose monetary policy in most countries is not doing much to address this issue and may be making the situation worse.  Cuts to government spending disproportionately hurt the less well-off while the wealthy have benefitted as quantitative easing has driven up stock prices.  These policies are based on the premise that creating growth in the overall economy will benefit us all.  But the data shows that, for example, while GDP in the UK is expected to reach its previous 2008 high this year, it will take a few more years for average earnings to recover lost ground. 

A different piece of string

The overall size of the economy is becoming increasingly difficult to measure.  So it might be better to focus more on the bit that matters most to people – what they earn and can spend.  Using median (real) earnings as a gauge of the economy would mean that economic growth would be more tangible for more people.  It is also a more simplistic measure which would require less manipulation although it would require some adjustments (to take into account changes in what we spend our money on and whether those goods change in price).

It would be a simple alteration that would have major implications for economic policy.  The welfare of normal people would be the central focus with other related issues such as unemployment also taking on greater importance.  Yet, this would not be a license for wages to rise inexorably as businesses would suffer and any artificially manufactured gains would only be temporary.  On the other hand, measures to help companies, such as lower corporate taxes, would also need to have a positive effect on wages. 

Increasing the median wage would have a more profound effect on the health of the economy and would involve more than simply boosting spending through an increase in debt.  Making progress on this goal would require more long-term policies such as investment in education and reskilling workers in declining sectors.  Lifting earnings would be hard work but the positive results would be genuinely worth the effort.

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