If it’s all about the data, a new way of measuring paints a completely different picture of growth
Every so often new evidence emerges to remind us how little we understand the economy. Not in terms of what the future holds, but the shape of the economy now. In recent weeks, there have been a couple of such double-take moments — reminders that we know even less about what’s going on than we thought.
The first of those surprises came from the European Union settlement scheme, under which EU migrants can apply to remain in the country permanently. During the Brexit negotiations, the plight of the three million EU citizens in the UK was front page news. When the deadline closed on Wednesday, 5.2 million of those three million had been granted the right to stay and another 500,000 were being processed.
That’s right. It turns out there are 2.7 million more non-Irish EU migrants in Britain than was thought during the referendum, and 2.2 million more than the Office for National Statistics’ estimate in mid-2020. The overshoot was so large that Jacob Rees-Mogg this week felt it necessary to pay tribute to deluged Home Office officials.
Where were they hiding? In plain sight. We just had not counted them. Speaking to the Resolution Foundation think tank on Thursday, Sir Charlie Bean, the former Bank of England deputy governor, said: “It’s always struck me as bizarre that we are an island yet we’ve never had a good handle on how many people are here because we’ve never really measured migration.”
Assuming no over-counting elsewhere, the discovery of these lost residents has big implications. For a start, questions may be asked about the economic benefits of migration if more were needed to deliver the same output. A larger total population means national income per person is lower. That would make Britain economically weaker than thought, with an even worse productivity record. Or perhaps we have a thriving shadow economy of crooks and money launderers.
The ONS says the two datasets are not comparable, that 5.7 million probably overstates the true figure as many left in the pandemic (informed estimates suggest 500,000) and that the ONS’s 3.5 million estimate was never the full picture. Either way, all we know is that the official estimate for EU citizens in the UK appears wrong by a factor of 50 per cent.
Measurement matters. Policy is guided by data, which is why the second revelation is even more important. This week, the ONS unveiled a new way of calculating GDP. The changes were technical but significant. What they showed was that Britain’s manufacturing sector, all too often unloved against services, has been a far stronger driver of the UK’s economic engine than thought.
In aggregate, the size of the economy is unaffected but the story of how we got to where we are today is different. Two decades of economic history have changed and the new methods raise the possibility of a better tomorrow.
To understand the changes, though, we first have to tackle the complex subject of “double deflation”. There are two main measures of national income — nominal, or cash, GDP and real GDP. Real GDP growth, which strips out inflation to reveal the volume increase in the economy, is what we all talk about.
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Say a car manufacturer makes £200 million one year and £220 million the next but sells the same number of cars in both. From a GDP perspective, cash growth would be 10 per cent but real growth would be zero as the extra revenue was only in the price. But if the manufacturer added a stereo to the cars in the second year, the quality improvement would be treated as an increase in volume. In economic terms, the £200 million cash GDP would translate into, say, £202 million in real GDP because the “deflator” would now be smaller. This hypothetical auto economy would now have seen 1 per cent real GDP growth.
What the ONS has done, in a painstaking but long overdue piece of work, is create a new set of deflators for each industry, both for their input costs and their output prices, to establish the real economic value they have added. This has transformed the telecoms services sector, the old phone companies that now supply superfast broadband.
Telecoms prices have barely risen but data has multiplied. The ONS has begun adjusting to reflect units of data. Imagine each of those cars had not just been fitted with a stereo but could also fly. As we get so much more for our money, the effective price has fallen, which conversely means the volume measure has exploded. This quality effect means real growth in telecoms has averaged 27 per cent a year since 1998, not the 6.8 per cent previously estimated.
Unfortunately, that vast growth does not mean the economy is bigger. What’s happened is that growth attributed to other industries under the old measurement methods has been shifted to telecoms. This is where double deflation comes in. As the telecoms deflator raises the effective input cost for companies using broadband, their volume growth falls. Architecture, for example, was thought to have grown at 1.9 per cent a year between 1998 and 2018. The new deflators now suggest the industry has not grown at all.
Like telecoms, double deflation has revealed hidden real growth in manufacturing, which accounts for a tenth of GDP and is now thought to have expanded at 3.1 per cent a year in the decade to 2008 rather than 0.3 per cent. Productivity between 1998 and 2018 has been upgraded sharply in manufacturing and downgraded in most services.
The economy is no longer what it was. Measurement changes mean telecoms, technology and manufacturing are the fast-growing industries. Services, still four fifths of national output, remain key but the balance has tipped a little.
It may be no coincidence that the UK is the only G7 country not using double deflation and is sitting at the bottom of the productivity pack. Previous analysis suggested Britain’s factories have been responsible for much of the productivity slowdown. With double deflation, they may become part of the solution.
Either way, pity the policymakers. They can only be as good as the data they are given.
Philip Aldrick is Economics Editor of The Times
