HONG KONG — GDP is so 20th century. The measure has risen from humble beginnings during the Great Depression to be an essential gauge for governments and central banks the world over.
Long-term investors allocate capital based on its findings; traders buy and sell stocks, bonds, currencies and commodities in the blink of an eye after readings flash on their screens. One such closely watched report comes this Friday, when the US releases its revised estimate of second-quarter GDP.
The problem is — whether compiled by production, income or expenditure approaches — GDP is increasingly struggling to keep up with the pace of economic change.
In an age where $10 can buy one compact disc or a month of unlimited music streaming, it is getting tougher to put a price on economic output. And as an aggregate measure that ignores distribution effects, GDP has masked rising inequalities that helped fuel anti-establishment politicians like Donald Trump or the backlash that contributed to Brexit.
So as governments in the rich world and emerging markets alike struggle to reproduce the growth rates and productivity leaps of previous decades, a more urgent search is under way to make the economic yardstick fit for purpose.
“GDP is easy to criticize but rather difficult to replace,” said Paul Sheard, chief economist at S&P Global Ratings in New York. “If governments are managing the economy based on this metric, then there’s merit to saying we should take a broader measure.”
That search is binding such disparate endeavours as a stocks brokerage in Mumbai and a statistics conference in Dresden, Germany. The former, Ambit Capital, has created its own consumption index based on vehicle sales and electricity use as a hedge on India’s official growth numbers. That reflects a scepticism evident elsewhere that existing methods cannot consistently measure even traditional parts of the economy, and GDP is so subject to large revisions as to be of little use in making snap investment decisions.
That concern is coupled with the worry that statisticians are measuring the wrong things. This week, the International Association for Research in Income and Wealth meets in Germany, with a schedule dominated by papers probing questions of income equality, technological change and living standards — fields not easily read in GDP releases.
“The single focus on GDP or GDP growth in many policy discussions is misleading,” Olivier Blanchard, a former IMF chief economist who is now a senior fellow at the Peterson Institute for International Economics, wrote this month. “Distribution effects, or distortions that affect the composition rather than the size of output, or effects of current policies on future rather than current output, may be as important for welfare as effects on current GDP.”
Blanchard’s exhibit one: the increasing discussions around inequality in America. Exhibit two: China’s shift from investment toward consumption.
Adding to concerns about GDP and its relevance are widening revisions that threaten to send policy makers and investors off in the wrong direction.
Data are being revised more often and by larger margins, according to a July note from UBS Group AG Global chief economist Paul Donovan and analyst Sophie Constable.
That matters because the initial number that moves markets “is nearly always wrong,” they wrote. Given that asset-price swings feed back to the broader economy, “central banks should be very, very wary of overemphasising markets in their policy deliberations”.
In the US last week, Federal Reserve Bank of Atlanta President Dennis Lockhart questioned whether official data that showed growth of just 1.2% in the three months through June represented a true reflection of activity on the ground.
“If you look beyond the troubling headline GDP growth number for the second quarter and study real final sales, a more consistent picture of economic momentum emerges,” he said.
Fed Vice Chairman Stanley Fischer said on Sunday that he expects US GDP growth to pick up, signaling that a 2016 rate hike is still under consideration. “We are close to our targets,” he said.
In Japan, a new analysis by the central bank found that rather than contracting in 2014, the economy actually enjoyed robust growth. The contradiction between the government’s data comes as the Bank of Japan steps up its efforts to get better readings, such as by starting its own consumption index. Governor Haruhiko Kuroda has called for better numbers.
In the UK, an independent review in March by former Bank of England policy maker Charles Bean recommended a transformation of the nation’s data.
“We need to take economic statistics back to the future or we risk missing out an important part of the modern economy from official figures,” Bean said in a press statement accompanying the report’s release in March.
It is a similar story around the world. Yves Mersch, a board member of the European Central Bank, warned of the impact of technological change in a February speech. The New Zealand government has a well-being framework, while the European Commission has had a project for almost a decade to look beyond traditional GDP measures.
India’s outgoing central bank chief Raghuram Rajan has warned of the difficulty in measuring growth in the face of aging populations. GDP numbers there have come under scrutiny since a new methodology last year showed a booming economy outpacing China. Ruchir Sharma, head of emerging markets and chief global strategist at Morgan Stanley Investment Management, says such readings demonstrate “incompetence because the statistics bureau there is applying a new methodology not having tested it well”.
To get a better read, Edinburgh-based Stewart Investors is seeking research on the flaws of GDP accounting in Asia and to examine possible alternatives.
“Current ‘macro’ research from investment banks focuses solely on very flawed accounting techniques to ‘measure’ GDP,” the investment firm wrote on its website. “This is becoming increasingly important with the rise of factors such as extreme levels of environmental degradation, obesity levels that are approaching medical definitions of epidemics etc.”
The scale of change is fuelling the debate over whether activity on the ground is being accurately captured. One example: payments that were once made over the counter have now transitioned online, beyond the scope of traditional retail-sales indicators.
An Organisation for Economic Co-operation and Development (OECD) report in June found that while GDP metrics should be able to adapt to the digitising economy, many challenges remain. The report’s authors Nadim Ahmad and Paul Schreyer estimated that Airbnb has a market value close to that of Hilton Worldwide Holdings, yet the impact of Airbnb rentals on GDP is harder to quantify.
Ahmad and Schreyer pointed to hard-to-gauge but influential digital services such as Wikipedia and the free operating system Linux, with a “collective” global nature that makes their use and impact hard to fit within the traditional framework of GDP measurement.
What is more, digitisation has a long way to run, meaning the challenge to GDP is only going to increase. The US economy is only realizing 18% of its digital potential and could add as much as $2.2-trillion to annual GDP by 2025, according to the McKinsey Global Institute.
For all its faults, perhaps the best defence of GDP is that there is no convincing replacement.
“I haven’t found a smoking gun that suggests GDP is entirely off,” said Frederic Neumann, co-head of Asian economic research at HSBC Holdings in Hong Kong. Stagnant wages and tame inflation gel with weak GDP readings across much of the developed world, he said.
Indeed, if you fact-check GDP using measures of happiness, you get a very high correlation, said Justin Wolfers, an economics professor at the University of Michigan.
“We have this terrible measure that leaves a lot of things out — that’s the theory — but in practice, it turns out that countries with high levels of GDP are doing well on most of the things that people say really matters,” said Wolfers, a former Bloomberg View columnist. “This is one of those things that is broken in theory but it works in practice.”