Statistics: GDP underestimates the consequences of the proposed Brexit

Statistics: GDP underestimates the consequences of the proposed Brexit

Publication date: August 22, 2016

The most widely used measure of economic growth, GDP, is not without controversy. For example, the Interim Parliamentary Committee on the Broad Concept of Prosperity concluded in spring 2016 that GDP does not adequately measure prosperity and that a standard is needed that better reflects education, health, and the environment. Discussing this is very important from a policy perspective, but not for short-term economic development analysis. What will focus most of our attention in the coming months will be the economic impacts of the results of the British referendum on EU membership. What impact will increased economic and political uncertainty have on the UK economy? The International Monetary Fund expects a recession.

However, using GDP as an indicator understates the pain being experienced by the UK economy. The income effect of the relative development of import and export prices is not evident in GDP. If import prices rise sharply due to a fall in the value of sterling, real gross national income will fall (even if the size of GDP remains the same). This is because the volume of exports then represents a smaller volume of imports and thus the means of spending decrease.

Fortunately, business cycle researchers have another indicator at their disposal in addition to the size of GDP: real national income. The percentage change in RNI is equal to the percentage change in the volume of GDP corrected for the difference between the percentage change in import and export prices (terms of trade). This correction has been important for the UK on a number of occasions in the past (see figure). These were mainly years that saw a significant rise in oil prices (1973 and 1974) or a significant change in the pound sterling against other currencies (2008).

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After the referendum, the British pound fell by about ten percent, worsening terms of trade. This is similar to the exchange rate development in 2008. Even if the GDP effects are ultimately better than expected, this underestimates the extent of the damage and the National Reserve Index will develop unfavorably.

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