When she came home from school with her heavy economics textbook I had to browse through the opening chapters covering the basics of economic theories from supply and demand onwards.
I observed: "Darling, in the real economy, things are not so black and white. There are definite shades of grey!"
A simple measure
Politicians and policy makers agree. They also know that economies are complex structures with many variables beyond their control. Despite their acceptance of this, all governments focus upon one simple measure as the best indicator of the health of an economy – Gross Domestic Product.
It is the main measure used by the UK government in planning economic policy and by the Monetary Policy Committee in setting interest rates. It is also used globally by various financial bodies such as the IMF and the World Bank to compare economies.
The lack of GDP growth has concerned leaders since the global financial crisis and subsequent recession in 2008. In the long term, the theory is that economies grow with more efficient production through technological advances. However, short-term growth can stagnate if resources are not being used effectively and in the current environment labour is being under-utilised.
With a growing population, it is generally accepted that GDP has to grow annually above 2% to stop unemployment from rising. With the UK economy back in recession, unemployment remains above 8%. If more people are out of work then that means the government spends more on benefits and receives less in taxes which leads to more borrowing.
Government debt has to be paid back and a healthy growing economy obviously makes repayment a lot easier. If an economy stagnates and growth in GDP stalls, then the situation is made more difficult as unemployment rises and labour efficiency falls.
A generational problem
With this recession in the UK, it is young people especially that have found it difficult to find employment and this has placed further burden on the country’s debt-to-GDP ratio which has risen to one the highest in the developed world. In fact three members of the G7 have debt-to-GDP ratios greater than 100%.
Japan, at over 200%, is the example that leaders in the US and Europe so desperately want to avoid.
Recently the US Federal Reserve announced the launch of QE3, shortly after the ECB said it had the tools necessary to defend the euro at all costs. Those ‘tools’ are not only monetary, but also potentially social and environmental, deployed by governments primarily to increase GDP in the belief that the benefits far outweigh the costs.
The focus on a single ‘black and white’ metric of a country’s health and success can often hide the complex mechanics driving their economies. However, GDP is currently the globally accepted measure of a country’s success and there is no indication that it is about to be replaced any time soon.
