In the UK, GDP is stagnant. At the same time the employment and labour-hour counts are rising. Stagnant GDP with rising labour-hours means that measured productivity has fallen. Declining productivity has engaged economists who have named the phenomenon of falling productivity as the “productivity puzzle”. Two main explanations have been put forward to account for this puzzle.
Incorrect employment count
The first explanation holds that the employment statistics published by ONS mask a significant amount of disguised unemployment. There has been a large rise in self employment over the very recent period and it is suspected that many of the newly self-employed have been pushed into this category by DWP. Frances Coppola deals with some of the reasons for the rise in the newly self employed in her blog. Coupled to the rise in self-employment are claimants on out-of-work benefits who have been placed on government work-for-your-benefit programmes. Claimants on these programmes are counted as employed. The productivity of those pushed into self-employment and those on work-for-your-benefit programmes is likely to be lower than for paid employees recruited via conventional channels.
Incorrect measurement of GDP
Some commentators assert that GDP cannot be stagnant if there are more people working, There is therefore an assumption that ONS’s measurement of GDP is incorrect and the productivity puzzle would be solved if GDP was measured correctly.
This strand of thought asserts that intangible fixed assets are being created as a faster rate than are tangible fixed assets. Moreover, these intangible assets are being self-constructed (made in-house), as distinct from being purchased from outside suppliers. Self-constructed fixed assets, whether tangible or intangible, would not (nor should not) feature in the calculation of gross value added and hence, so the argument goes, a significant amount of economic activity is not being captured in the GDP figure. Hence the stagnation.
Below are value added statements for a hypothetical 2-firm economy which have been consolidated in the third column of numbers. The row shown in red represents a self-constructed fixed asset built by Firm 2. This item does not properly belong in a value added statement and has been included to illustrate the impact its inclusion has on measured GDP.
The GDP Code column contains a letter code to denote where each item in the national value added statement would appear in the expenditure equation of national income so beloved of economics textbooks. Below the value added statements appear two tables, the first showing GDP calculated with self-constructed assets included, the second with GDP calculated under conventional principles. The figures in these tables have been taken directly from the consolidated value added statement. You will see that the method that includes self-constructed assets increases national income by the amount of the work applied in the period to the self-constructed asset
Value Added Statements
|Sales||Firm1||Firm 2||Combined||GDP Code|
|To UK consumers||£30||£170||£200||C|
|To UK firms: goods & services||£40||£40|
|To UK firms: capital equipment||£100||£100||I|
|Change in inventories||£5||£5||I|
|Change in self constructed fixed assets||£50||£50||I|
|Gross value of output||£200||£315||£515|
|From UK firms: goods & services||£40||£40|
|Gross Value of inputs||£30||£90||£120|
|GROSS VALUE ADDED||£170||£225||£395||Y|
|Distribution of value added|
|To Labour : wages and salaries||£20||£100||£120||L|
|To shareholders : dividends||£13||£22||£35||F|
|To government : tax||£15||£50||£65||T|
|To the firm: retained profits||£122||£53||£175||P|
|GROSS VALUE ADDED||£170||£225||£395|
|GDP measured with self constructed assets included|
|Y = GDP||C||I||G||X||M|
|GDP measured in the conventional manner|
Although the example provided is simple, it does allow a clearer examination of the assertion that GDP is being understated due to the exclusion of self-constructed intangible fixed assets from computations of value added and hence national income. Such exclusions may well understate GDP but then they will always have done so.
More importantly though, a value added statement is merely a recasting of a traditional income statement. If self-constructed fixed assets were to be included in the calculation of value added and hence national income then a fundamental distinction between capital and revenue expenditure would be violated which would presumably be extended to income measures for firms.
So my message to the proponents who hold GDP measurement is wrong because it excludes intangibles and self-constructed fixed assets is, “Nice try but the productivity puzzle is more likely to be resolved by looking at the labour market”.