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The Global Economy through a Different Lens

April 3, 2008


Most of the economic buzz at the moment is about whether the U.S. is in or headed towards recession and what that will mean for the rest of the world. The Economist asserts that, despite the gathering dark clouds, economic conditions around the globe are “by and large” not so bad [“Grossly distorted picture,” 15 March 2008 print edition]. The focus of the article is not on gross domestic product (GDP) growth rates (the normal economic metric) but on GDP per head. They explain why they use this metric by comparing what has happened in the U.S. and Japan over the past five years.

“Which economy has enjoyed the best economic performance over the past five years: America’s or Japan’s? Most people will pick America. The popular perception is that America’s vibrant economy was sprinting ahead (albeit fuelled by credit and housing bubbles that have now painfully burst), whereas Japan crawled along at a snail’s pace. And it is true that America’s average annual real GDP growth of 2.9% was much faster than Japan’s 2.1%. However, the single best gauge of economic performance is not growth in GDP, but GDP per person, which is a rough guide to average living standards. It tells a completely different story. GDP growth figures flatter America’s relative performance, because its population is rising much faster, by 1% a year, thanks to immigration and a higher birth rate. In contrast, the number of Japanese citizens has been shrinking since 2005. Once you take account of this, Japan’s GDP per head increased at an annual rate of 2.1% in the five years to 2007, slightly faster than America’s 1.9% and much better than Germany’s 1.4%. In other words, contrary to the popular pessimism about Japan’s economy, it has actually enjoyed the biggest gain in average income among the big three rich economies. Among all the G7 economies it ranks second only to Britain.”

While that may be good short-term economic news for the Japanese, as I’ve written before, Japan’s shrinking population bodes ill for Japan’s economy in the long-term [see Demographics and Robots]. That, however, is not the point of the article.

“Using growth in GDP per head rather than crude GDP growth reveals a strikingly different picture of other countries’ economic health. For example, Australian politicians often boast that their economy has had one of the fastest growth rates among the major developed nations—an average of 3.3% over the past five years. But Australia has also had one of the biggest increases in population; its GDP per head has grown no faster than Japan’s over this period. Likewise, Spain has been one of the euro area’s star performers in terms of GDP growth, but over the past three years output per person has grown more slowly than in Germany, which like Japan, has a shrinking population. Some emerging economies also look less impressive when growth is compared on a per-person basis. One of the supposedly booming BRIC countries, Brazil, has seen its GDP per head increase by only 2.3% per year since 2003, barely any faster than Japan’s. Russia, by contrast, enjoyed annual average growth in GDP per head of 7.4% because the population is falling faster than in any other large country (by 0.5% a year). Indians love to boast that their economy’s growth rate has almost caught up with China’s, but its population is also expanding much faster. Over the past five years, the 10.2% average increase in China’s income per head dwarfed India’s 6.8% gain.”

These statistics are interesting, but their larger implications need to be made clear. Given the choice between a reasonable population growth and a shrinking population, the latter is better than the former for the long-term health of an economy. Given the choice between a reasonable and rapid population growth, the statistics make it clear that the former is also better than the latter. The win-win scenario is reasonable population growth coupled with strong economic growth. Any other combination appears to create win-lose or lose-lose scenarios.

“Focusing on GDP per person also affects comparisons of economic health over time. During the past five years, world GDP has grown by an average of 4.5% a year, its fastest for more than three decades, though not as fast as during the golden age of the 1960s when annual growth exceeded 5%. But the world’s population is now growing at half of its pace in the 1960s, and so world income per head has increased by more over the past five years than during any other period on record. Mankind has never had it so good.”

Having laid out its case, The Economist proceeds to argue that the definition for what constitutes a recession should be redefined using their metric.

“Once you accept that growth in GDP per head is the best way to measure economic performance, the standard definition of a recession—a decline in real GDP over some period (eg, two consecutive quarters or year on year)—also seems flawed. For example, zero GDP growth in Japan, where the population is declining, would still leave the average citizen better off. But in America, the average person would be worse off. A better definition of recession, surely, is a fall in average income per person. On this basis, America has been in recession since the fourth quarter of last year when its GDP rose by an annualised 0.6%, implying that real income per head fell by 0.4%.”

The middle class in America certainly wouldn’t argue with the article’s conclusions. As I have noted before, wage stagnation has caused serious concern, and has been an issue during this presidential election season [see The Return of Protectionism?]. The Economist believes that U.S. politicians will take umbrage with its approach because it undermines many economic arguments they are fond of making.

“Many Americans will shrug this off, especially those politicians who believe that the prime goal of policy is to retain their economic and military dominance over the world. They see the size of a country’s GDP as the best measure of its economic clout, in which case the absolute rate of GDP growth matters more than growth in income per head. Europeans seem less bothered about global dominance—although they are sure to gloat about the fact that the weakening dollar means that the euro area could overtake America as the world’s biggest economy this year.”

The Economist indicates that it is understandable why politicians in America might not want to publish quarterly GDP/head figures, but it can’t understand why policymakers in Japan haven’t done so.

“If GDP per head is … a superior measure of people’s prosperity, why do governments not publish such figures each quarter along with their standard GDP figures? Population statistics tend to be less up-to-date than GDP figures and are generally not available on a quarterly basis. But that is a lame excuse: it should be much easier to count bodies than to put a value on diverse sorts of economic output. Not only do people have a right to know whether average living standards are rising or falling, but publishing such numbers could also benefit some countries. If Japan’s government had drawn attention to the sprightlier growth in income per head in recent years, in contrast to endless reports about its ‘underperforming’ economy, consumers may have felt cheerier and spent more—in other words, its GDP growth would have been stronger.”

The article eventually admits that Japan’s shrinking population has a down side and that investors and multinational corporations still find GDP growth rates useful in judging where they should put their money to work and where they should look for profits.

“There are several other reasons Americans can quibble over the use of GDP per head, especially with reference to Japan. Firstly, its shrinking population is also an ageing one in which the labour force will decline as a share of the population. Unless this is offset by more rapid productivity growth, this could make it harder to maintain the same growth in output per person in future and so harder to pay pension bills. Secondly, slower GDP growth makes it more difficult to reduce the ratio of existing public-sector debt to GDP, which stands at a hefty 180% in Japan. Last, but not least, investors care about GDP growth. Corporate profits depend upon the absolute rate of growth of an economy. And companies wanting to invest abroad will favour markets that are expanding more rapidly.”

While it is useful to know whether the economic conditions of the middle class are improving or declining, publishing statistics only confirms what families instinctively know. The Economist‘s metric is a good one for current conditions, but it could prove faulty in the long-term for those societies with declining populations. GDP/person also ignores income distribution which can distort the data to some degree. Unfortunately, the article never quite proves it case that “if you look at GDP per head, the world is a different—and, by and large, a better—place.” And it doesn’t prognosticate about how the current economic woes in the U.S. might yet affect the global economy. I daresay its worth watching.

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