How the Knowledge Base Assesses the Real Trends

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Introduction

Most statistics covering a range of years are expressed in "real terms", net of price changes. The statistics presented here show how particular price indices have changed over time, and provide data to convert a given time series to a different reference year (such as index 2000 = 100 rather than index 2010 = 100), or measuring the percentage change in an index over a given period of years.

Implicit Deflators

Table 1

Statistical measures ("metrics") show changes that are due to two influences: real progress or decline in a market or activity, and changes associated with what are usually rising prices — inflation. The convention is to use an "implicit deflator" to isolate the real change. The Australian Bureau of Statistics produces a wide range of such deflators as part of its national accounting work, which aims at estimating real economic growth, net of inflationary trends.

International standards for national accounting are defined by the United Nations System of National Accounts (SNA), which ensures maximum comparability between countries. The dominant component to date has been the current accounts, in which the total product of an economy is calculated in three different ways and reconciled in the national accounting process.[1]

  1. Production accounts record the value of domestic output and the goods and services used up in producing that output. The balancing item of the accounts is value-added, which is equal to GDP when expressed for the whole economy at market prices and in gross terms[2]
  2. Income accounts show primary and secondary income flows — both the income generated in production (for example wages and salaries) and distributive income flows (predominantly the redistributive effects of government taxes and social benefit payments). The balancing item of the accounts is disposable income — National Income when measured for the whole economy
  3. Expenditure accounts show how disposable income is either consumed or saved. The balancing item of these accounts is saving.[3]

The most inclusive implicit deflator relates to the total Gross Domestic Product, but the ABS publishes 38 implicit deflators in its main statistical table, going into some detail on types of gross fixed capital expenditure and other main GDP components. Ultimately, the definition of GDP in the production account comes to just five[4] components, C + I + G + (X - M), where:

  • C is private consumption expenditure (by households)
  • I is private fixed capital expenditure ("investment")
  • G is government expenditure, comprised of general government consumption and government fixed capital expenditure
  • X is exports of goods and services, and
  • M is imports of goods and services.
Chart 1

GDP is the total annual (or quarterly) value-added of all final goods and services produced in a country (after deducting goods used up in the process of production). It therefore includes exports but excludes imports of goods and services. In contrast, Gross National Expenditure, or GNE, is total expenditure on goods and services, including imported but excluding exported goods and services.[5]

The virtue of having a range of implicit deflators to choose from is that more specific indices suit more specific markets. In practice, this doesn't take us too far in the analysis of the music sector. No deflator is specific to the music sector or even the arts and general cultural activities. The main choice is between obvious items of consumption (such as household expenditure) and more general indicators (such as time series of industry- or sector-related activities). Table 1 shows annual observations for the two most general indicators since 1989-90: expenditure on GDP, and household expenditure (final consumption expenditure by households).

How Related Are the Individual Implicit Deflators?

The ABS implicit deflators go back much further than 1989-90 which was included in Table 1. This is reassuring because it provides an opportunity to compare the trends in different deflators — since none is culture-related we can gain some confidence in the use of these more general indicators if they behave in at least roughly similar ways. Chart 1 shows that since these indices were first published in 1959-60, the two included in Table 1 have shown similar movements. Another reason for showing this long period is that it includes the time of rapid development in arts management and funding from the 1960s culminating in the founding of the Australia Council for the Arts in the mid-1970s — it took place in an unusually turbulent economic period for Australia. The logarithmic scale (sometimes called a ratio scale) used in Chart 1 visualise percentage rates of change through the slope of the line — in this particular case in the implicit deflator showing inflationary influences. The chart shows that the index has moved through three main periods:

Chart 2
  • In the thirteen years before the first oil crisis hit in 1973, and many other social factors disrupted what was temporarily regarded in the sixties as stable and predictable long-term growth with relatively low inflation, both GDP and household expenditure moved very much in parallel, at comparable growth rates.[6]
  • Between 1972-73 and 1990-91, inflationary pressures became very much higher, with a more than 9% annual growth rate in both indices
  • Over the past twenty years to 2011 inflation became closely monitored by the Reserve Bank which sets a tight band below 3% for consumer prices, but the gap has widened between the two indicators on Chart 1 with the GDP deflator showing 2.9% annual growth and household expenditure 2.4%. This increased discrepancy is most likely due to increasing external forces causing growing structural change in the Australian economy.
Table 2

This view is supported by Chart 2, which presents the annual change in the two indicators over the same period from 1959-60. Again, the main initial impression is that the GDP and household expenditure indices have followed similar paths, the rate of inflation peaking for both at around 17% in 1975, and falling from there until the early 1990s. Since then, however, household expenditure has been the more stable indicator, while the annual change in the GDP deflator has become more erratic. Since 2003-04, with the exception of 2009-10, the growth in the GDP deflator has consistently outpaced the growth in the household consumption indicator. As hinted above, it is difficult to escape a hypothesis that something in the Australian economy — beyond the narrower household expenditure area — is undergoing structural change.

Table 2 compares the various main components of the economy — via Gross National Expenditure (GNE) — across the three main time periods defined above. The components of GNE are private and government consumption and fixed capital expenditure, including imported goods and services but excluding exports. These components show parallel developments across the three periods, and amounted to annual rates in total GNE of 3.9% in the thirteen years to 1973, followed by 9.5% in the period to 1991, before reducing to 2.2% in the final 20 years to 2011.

The remaining implicit deflators, of exports and imports of goods and services and total GDP, were also roughly parallel with the others in the first two periods, but since then the export price index has kept moving up whereas import prices have been generally static or falling. In GDP terms, which includes exports but excludes imports of goods and services, the rate of inflation (2.9% pa) deviated significantly not only from household and total final consumption expenditure but even more from total Gross National Expenditure (2.2% pa). The discrepancy between GNE- and GDP-based inflation is striking, and contrasts with the experience in the previous time periods.

The distortions are brought even more to the fore when comparing the 2010-11 indices with 1990-91: GNE inflation showed a total increase of 54% compared with 76% for GDP. Export prices in 2010-11 were 73% above the level 20 years previously, while the erratic import price index was 8% lower in 2010-11 than in 1990-91. Closer inspection of the two time series shows that the main boost in export prices is of fairly recent origin (since 2004), whereas the import price index has been higher than the 2010-11 level ever since the late 1980s. Around 2000 it was 22% higher and as recently as 2008-09 17% higher than in 2010-11. In short, export prices have increased (as well as the volume of exports with the mineral boom), while the volume of imported goods and services have increased by more than shown nominally since the price effect has been generally negative.[7]

In terms of our discussion of how reliable the implicit deflators are for correcting for inflation, the expenditure components (including total Gross National Expenditure or GNE) are generally preferable to the use of Gross Domestic Product, especially in the most recent period. GDP has been used as an implicit deflator in some parts of the knowledge base, but must currently be regarded as slightly inferior to GNE.

Limitations of the National Accounting Approach

The past few years have seen growing concern with the way the conventional national accounts epitomised by "GDP" have dominated the debate on what makes a nation successful. This is the topic of another paper planned for this knowledge base, but while it goes beyond the subject of the current article which is to provide estimates of "real" change over time, a brief reference is appropriate. We add that there is little chance of substituting a more general index for those derived from the national accounts for the time being, but just querying the very basis of these accounts in their conventional form does complicate the interpretation in ways not yet fully defined.

In 2009, the former French president Nicolas Sarkozy expressed dissatisfaction with the way GDP measures progress, and hired two eminent Nobel-prize winning economists, Joseph Stiglitz and Amartya Sen, to report on the problem. The resulting report was widely debated, discussing how concepts going beyond GDP, such as quality of life and sustainable development and environment, could be incorporated.

The United Nations for two decades has researched how the conventional statistics could be expanded to incorporate the depletion of natural resources associated with the generation of wealth, traditionally measured by the national accounts. In June 2012, the International Human Dimensions Programme on Global Environmental Change (IHDP) launched a major report on "inclusive wealth" at the Rio+20 Conference in Brazil. The Australian Bureau of Statistics in May 2012 published Completing the Picture — Environmental Accounting in Practice (ABS Cat 4628.0.55.001) along the lines of the IHDP report. It provides a framework for the development of statistics, though not surprisingly most items in the tables making up the ABS effort have yet to be collected as actual statistics.

In 2011, the Better Life Index was launched by the Organisation for Economic Cooperation and Development (OECD) to measure the world's well-being beyond "cold GDP numbers". This alternative measure includes 20 different indicators across 11 topics OECD has identified as essential. Designed as an interactive tool, it allows users to compare well-being across the OECD's 34 member countries by changing the weight of each sector according to their own view of its importance. Sophia Wistehube commented on the OECD effort: "GDP measures everything — except the things which make life worthwhile."

The Happy Planet Index takes a radical approach to balance current use of environmental resources against the needs of future generations. It is based on three variables:

  • Life expectancy, L, a universally accepted measure of health
  • Experienced well-being, based on a question called the "ladder of life" in the Gallup World Poll
  • the ecological footprint, a measure of resource consumption developed by the environmental charity WWF, bringing the interests of future generations into play.

The formula for the index is (Experienced well-being x Life expectancy)/Ecological footprint. The ranking of countries according to the index is radically different from those sources mentioned above, in giving low ranking to technologically advanced economies like the United States and placing some other nations (led by Costa Rica and other Central American nations) at the top.

These efforts — and others to be explored — all indicate a groundswell of opposition to the conventional GDP approach. At this stage, the proposed additional indicators are social and environmental in nature, while cultural indicators are absent. There is a need to establish, in the ideal case, how indicators of culture and the arts can be convincingly demonstrated to contribute to a nation's well-being in line with environmental and social indicators, or at least to demonstrate how culture and the arts correlate with the indicators that are shown to make such contributions. We are researching these aspects in 2012.

Author

Hans Hoegh-Guldberg. First entered 3 July 2012. Additions on 6 July 2012 concerning the import and export price indices.

References

  1. Based on Wikipedia, [[1]], accessed 2 July 2012.
  2. Value-added is also an important concept for individual industries and sectors; the sum of all industry values-added, Gross Value-Added or GVA, plus indirect taxes less subsidies, equals GDP.
  3. The three other components of the SNA system are (1) capital accounts, which record the net accumulation of non-financial assets and their financing; (2) financial accounts, which show the net acquisitions and losses of financial assets; and (3) balance sheets, which record the stock of assets, both financial and non-financial, and liabilities at a particular point in time. Net worth is the balance from the balance sheets. There have been growing efforts in recent years to ascertain net losses of capital, especially natural capital. See further under "Limitations of GDP" towards the end of the current article.
  4. Six, if the consumption and capital components of government expenditure, G, is counted separately.
  5. That is, GDP - X + M = GNE, and GNE + X - M = GDP.
  6. That the sixties were exceptional is supported by the Consumer Price Index (CPI) which goes back even further, to 1948-49. The compound annual growth rate of the CPI in the first eleven years to 1960 was 6.3%, quite a high rate of inflation, before reducing to 3.3% in the subsequent period to 1973. The movement in the CPI closely parallels total household expenditure from 1960, increasing to 9.5% in the eighteen years to 1991, before reducing to 2.6% in the final period to 2011. The CPI is not as general an indicator as total household expenditure but is obviously closely related to it.
  7. Further analysis confirm that export and import prices are the most irregular — this is particularly so for imports because different components of that index move in very different directions, but total export price trends also have two distinct periods as shown at the end of this note. Regression analysis shows that the implicit deflator for total imports of goods and services declined by 0.3% per annum between 1990-91 and 2010-11, but the fluctuations around the trend are very wide and the coefficient of determination, R2, which in effect shows how well future outcomes are likely to be predicted by the data, is low (.141). For the exports of goods and services deflator, the trend in the over full period to 2011 was 2.8% per annum (R2 = .711), but the index hardly increased between 1991 and 2004 (annual growth 0.4% pa) before shooting up to 7.5% pa over the 2004- 2011 period, as the mineral boom rolled on.
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