The Great GDP Growth Lie - why the economy isn’t healing
By Viral Shah
This April, the British economy grew for the fifth consecutive quarter and by 0,8 percent this quarter (from January to April), leading to the Chancellor of the Exchequer George Osborne to declare, “Britain is coming back.”
This is despite the nation’s GDP (Gross Domestic Product – i.e. the total its economy is worth) being 0,6 percent lower than the pre-2008 peak. While once again, the actual growth was 0,1 percent lower than the estimate made by the UK’s Office for National Statistics (ONS). Such optimistic predictions of economic growth have frequently happened since the ‘Global Financial Crash’ of 2008.
So is the UK, along with the global economy, finally over the financial crash – or is someone fibbing?
Predicting growth
In 2012, Jonathan Jones of The Spectator magazine calculated that “in the past 51 years, just 12 of the ONS’s 205 first stabs at quarterly growth have survived later revisions.”
The ONS is becoming more accurate, but 11 of the past 21 initial predictions for annual growth have been too high (albeit by smaller margins). Only six did not require a revised estimate.
Yet, the ONS are hardly the worst of the forecasting organisations. Others have also admitted an overestimation of economic growth for European countries, with the International Monetary Fund admitting that “In particular, significant over-predictions of GDP growth tended to occur during regional or global recessions, as well as during crises in individual countries.” The Paris-based OECD also admitted to over-estimating growth between 2007 and 2012. In addition, the UK’s Office for Budget Responsibility (OBR), set up by George Osborne (and housed in the UK Treasury building) to provide an ‘independent’ analysis of the UK economy also admitted the same.
So why does this happen in a variety of institutions and what are the consequences of it?
ONS spokesman Rob Doody told us: “The methods for producing the preliminary GDP estimate use monthly data for the first two months in the quarter and forecasts for estimating the third month. The forecasts are reinforced by early responses to the ONS Monthly Business Survey (MBS) but the monthly response rate is generally lower at the time of the preliminary estimate (typically between 30-50 percent).”
However, Doody refuted suggestions that there was a tendency to overestimate GDP growth, at least at the ONS: “Revisions to GDP between the preliminary estimate and the third estimate (made around 90 days after the end of the quarter) are typically small (around 0,1 to 0,2 percentage points), with the frequency of upward and downward revisions broadly equal.”
Methods vary between countries but the ONS combines the three main ways to measure UK GDP: by adding up all the money spent each year by households and government; by adding up all the money earned each year by all parts of the economy; or by adding up all the value added to the economy each year.
In addition, according to Warwick University Professor Robert Skidelsky, there were two major problems with the forecasts: “The models used by all of the forecasting organisations dramatically underestimated the fiscal multiplier: the impact of changes in government spending on output. Second, they overestimated the extent to which quantitative easing (QE) by the monetary authorities – that is, printing money – could counterbalance fiscal tightening.”
Another boom?
So what effect do these statistics, released four times a year by various forecasting organisations, have on the global economy?
For this, we have to look at the stock market and the actions of the banking industry. So, we spoke to Himesh Patel, a Public Sector Analyst: “The trend for lending this year has been that banks are willing to lend more at cheaper prices; this coincides with better market sentiment due to growth prospects improving in the west.”
“Growth in the economy and forecasts means that credit decisions on clients are easier and bankers are able to provide a better credit case to the committees within banks to say, ‘Look, we can afford to give a five year loan to this client because their revenue will increase due to better growth in America, or Central Europe’.”
The banks and markets basically take these relatively imprecise early GDP growth forecasts as a solid indicator of how the economy will grow (or contract), leading to greater banking and trading activity. In fact, a 2012 report from BNY Mellon Asset Management found that “stock market movements in a given quarter are somewhat more correlated with GDP developments in the following quarter, even if this relationship is slight.” Of course, most in the industry know that such forecasts aren’t bulletproof, and that they’re essentially betting that this is exactly the case.
A case in point is the current year, as Patel notes: “The start of 2014 had great amounts being lent on the back of a good forecast for 2013 in the economy. This didn't materialise initially but started to at the end of 2013, hence banks realised the prospects for growth were correct, albeit delayed.”
History also seems to be repeating itself when it comes to the real bear pit – the stock market.
According to Patel, “What you see is that the short term equities or stock market are a bit more bullish and investors flock to these first. Growth forecasts will increase trading volumes in stocks and bonds,” Patel tells us, “while the other market is risk and hedging markets where you do derivatives and swaps.”
Many types of derivatives and swaps, such as the infamous Credit Default Swap (CDS), were the very financial instruments that led to the crash of the 2007-2008 global financial crash. Despite this, Patel tells us that, with a forecast of economic growth, “companies will enter more of these to hedge against potential interest rate changes and potential knock on foreign exchange changes.”
The increase in trading has led to a boom in the FTSE index, which is comprised of the UK’s 100 largest companies (with financial services comprising a fifth of these) floating on the London Stock Exchange. In May, the FTSE 100 reached a 14-year-high of 6.895, higher than the peak before the 2008 crash. In the United States, the Standard & Poor 500 stock market index reached an all-time high.
Based on this, it would seem the global – or at least western – economy is recovering pretty impressively. But really, these indicators are oases of boom in an economically fragile desert.
Aside from the optimistic GDP forecasts, “share prices are high mainly because of the huge amount of money sloshing around thanks to quantitative easing (QE), not because of the strength of the underlying real economy,” according to Cambridge University economist Ha-Joon Chang.
Quantitative easing is when a government’s central bank purchases assets, normally bonds, from either commercial banks or insurance companies, using money it has created from thin air. The intention is to pump cash into financial institutions in an effort to promote increased lending and liquidity to the wider economy – except this lending to businesses and individuals to restart the circulation of money didn’t materialise – it mainly stayed with the big financial institutions. They bought new assets to replace the ones sold to the central bank. This raises stock prices on such assets and boosts investment, which in turn, would boost GDP forecasts.
We spoke to Austrian heterodox economist Jakob Kapeller, from the Johannes Kepler University of Linz, about the current mode of thinking in central banks: “Given the current institutional setup of the US Federal Reserve and the European Central Bank, the monetary authorities act in a very Keynesian way by expanding the monetary base to induce investment activity. However, this approach largely fails since the additional money does not end up supplying real investments but is rather used for speculation or even hoarding.”
A dangerously virtuous cycle
Of course, this trend has led to another massive rise in private debt, something the Australian economist Steve Keen has been pointing out for some time in previous interviews: “With sustained positive growth in credit comes a tendency to positive economic news as well, and out of that a tendency to take on more credit too – after all, that’s what gave us the previous boom, isn’t it?”
Keen has pointed out in previous interviews that the level of private debt being created by this increased trading activity is rarely discussed in the mainstream media: “Conventional economics fantasizes that private individuals are always sensible in what they do, and therefore private debt is good, while governments are reckless, hence government debt is bad. The politicians latch onto this simplistic tale and also appeal to the electorate on the basis of being ‘responsible’.” Yet public debt, where the taxpayer effectively foots the bill, only rose massively in 2008 after the banks couldn’t pay off the massive private debt and governments had to step in.
The same story is unfolding once again after the initial 2008 crash, with the situation far more volatile in the UK than in the USA.
Dr. Kapeller, who studies alternative schools of economic thought, provides a slightly different take: “I think governments, and even mainstream economists to a very small part, have recognized the importance of rising private debt. However, they have both not yet recognized that the rise in private debt shares a source with the continuous rise in public debt: both increases are driven by a redistribution from the lower and middle class as well as the taxpayer to the upper classes, most importantly, the richest percentile.”
Yet, the message from politicians like George Osborne, relying on a GDP growth forecast forged by a massive rise in public and private debt, is that the economy is healing. While the inaccuracy (and relatively frequent over-estimation) in GDP growth forecasts is a problem in how the economy works, it is minor compared to the economy’s totally inadequate economic management and acceptance of the repetitive boom-bust tendencies.
Kapeller concurs: “I have the feeling that mainstream economic thought surely paved the way for this crisis mainly by academically legitimising a lot of policies which in turn led to increased instability [...] alternative economic ideas are mostly dismissed out of hand, without being fully understood.”
Even those who have been directly involved in setting economic policy are damning in their judgement. The respected macro-economist William White, formerly of the Bank of England and the Bank of Canada, said of his profession: “People are making it up as they go along.”
Though the global financial system doesn’t look like it will change anytime soon, improvements are being made in how GDP is being calculated, at least in Europe.
According to their spokesman Robert Doody, the ONS is taking part in a “European task force [which] is currently looking at the feasibility of producing an EU estimate around 30 days after the end of the quarter.” Furthermore, from September, the UK will join EU standards of calculation by including drugs and prostitution in its GDP calculations, adding an estimated 9,7 billion pounds (0,7 percent of total GDP) to the 2009 estimate of the UK’s GDP, with recent years yet to be calculated.
For the politicians like Osborne, for whom that quarterly GDP figure of economic growth is everything - however misleading it may be in the long-term - this must be welcome news.
