This autumn, the United Kingdom’s GDP calculation will get an overhaul. It doesn’t sound particularly thrilling; some very mathematical people double-checking that their statistical tools and methods accurately reflect the state of the world.
This has been done before – 15 years ago, if you’re counting – and caused very little reaction. That may have had something to do with the tech boom at the time; investors weren’t particularly concerned about how GDP was measured when the FTSE 100 seemed set to break through 10,000 and Pets.com was the latest hot listing. Then of course, immediately following the revision, any GDP effects were swamped by the bursting of the bubble.
This time though, GDP figures are being much more closely followed, as investors (and indeed the general public) still don’t seem entirely convinced that the global growth recovery is here to stay. With so much weight (both financial and sentimental) placed on economic data releases, it is probably worth considering the potential impact of anything that affects the numbers.
First, let’s briefly look at the mechanics of GDP, to see why it needs updating at all. GDP is calculated by looking at the total output (i.e. spending) of a country in a certain period of time; which can then be compared against other periods. However, in order to allow for inflation, prices are fixed at a certain year – this means that a simple increase in price won’t change the GDP figure, but a genuine rise in amount produced will. Unfortunately, this means that as new products and industries develop, the base year may not have a comparable price, so any output in the form of these products is missed. Therefore, in order to capture the reality of our current world, occasionally the “price” year needs to be brought up to date to include things that weren’t around in 1999 – mobile apps for instance; all of those hard-earned Pounds spent on Candy Crush!
That logic seems reasonable. So the next point must be to consider what sort of impact these GDP re-calculations can have. The most recent example is Nigeria, which announced the results of this process at the beginning of April 2014. The headline (which you may have seen) is pretty impressive – Nigeria’s GDP jumped by 89 per cent. Eighty nine percent! The original GDP figure for 2013 was $270bn; the recalculation implies that Nigeria is a $509bn economy – the biggest in Africa and the 26th largest globally. Part of the explanation for the magnitude of this increase is that Nigeria’s base year was 1990, so the GDP calculation wasn’t just omitting iPods, it was ignoring both the Telecoms and Information Technology sectors entirely. Clearly these changes can be significant – Nigeria has been attracting investment for the last few years, but can now claim to be a truly important global market.
In 2010, Ghana performed a similar exercise, increasing GDP estimates by 60 per cent, and Kenya is about to do the same next month. It is not only African countries that make these kinds of changes though – last year, the US changed its calculation methodology slightly, and added $500bn to its economy.
So how is the UK likely to fare? A rise of the same size as Nigeria is very unlikely – the rapid development in Africa over the past twenty years has rendered the base years particularly obsolete. In the UK, the inclusions are likely to be more subtle – addressing the accounting treatment of pension rights and Research & Development costs, rather than adding entire industries. Nevertheless, estimates are for approximately £60bn being added to total UK output, an increase of around 4 per cent.
Will it matter to investors? Again, looking at Nigeria, these figures are important for investors. One simple metric, often focussed on following the financial crisis, is debt-to-GDP ratio. By almost doubling its GDP, Nigeria halved its debt-to-GDP ratio. For macro investors, that is the sign of a healthy country. Clearly, the UK won’t be in the same position, but any decrease, even if only superficial, is likely to be well-received. Where it might matter is in the comparison of one country’s economy with another if they are not calculated on a comparable basis and time horizon, where managers are deciding which securities offer better value in different country bases.
Will it matter to individuals? Unlikely – balance sheet tricks and recalculations are rarely directly observable – no one will have more (or less) money in their pockets than before. However, a confidence boost may filter through – good news tends to increase consumption as people feel more secure and headlines can be very influential!
Ben Kumar is investment manager at Seven Investment Management
