GDP as a measure of economic growth

GDP as a measure of economic growth Tera Allas Senior Fellow McKinsey Center for Government May 218 GDP as a measure of economic growth GDP is a useful aggregate indicator, despite its serious drawbacks The real problem is when it is misused, by decision makers or the media We need to both modernize GDP and complement it with other metrics McKinsey & Company 1

GDP as a measure of economic growth GDP is a useful aggregate indicator, despite its serious drawbacks The real problem is when it is misused, by decision makers or the media We need to both modernize GDP and complement it with other metrics McKinsey & Company 2 An improvement in measured GDP is not necessarily good Today s discussion Good things missing from measured GDP Consumer surplus Free goods (e.g., internet, recycling) Unpaid and volunteer work Leisure time Value of family, friends, community Health, well-being and happiness Bad things missing from measured GDP Pollution, noise, congestion Visual and landscape impairment Inequality Bad things that can increase measured GDP Unsustainable use of resources Unsustainable debt-fueled consumption War, disasters, crime, accidents, illness Good things that can reduce measured GDP Lower prices (if not captured accurately by deflators) Personal value of self-service (convenience, control) McKinsey & Company 3

GDP growth doesn t directly capture changes in people s well-being Impact of key variables on personal well-being in the UK Large Moderate Small Health Employment status Relationship status Age SOURCE: ONS, Measuring National Well-being - What matters most to Personal Well-being?, 213 McKinsey & Company 4 However, at a global level, GDP per head does correlate with health outcomes GDP per head and healthy life expectancy 2-215 Healthy life expectancy, years 77 76 75 74 73 72 71 7 69 68 67 66 65 64 63 62 61 6 59 58 57 56 55 54 3.4 3.5 3.6 3.7 3.8 3.9 4. 4.1 4.2 4.3 4.4 4.5 4.6 4.7 4.8 4.9 5. Log of GDP per head SOURCE: World Bank; WHO; McKinsey analysis McKinsey & Company 5

GDP per head also correlates with selfreported well-being across countries GDP per head and self-reported well-being 156 countries; 26-217 Cantril life ladder measure of well-being 8.5 8. 7.5 7. 6.5 6. 5.5 5. 4.5 4. 3.5 3. 2.5 2.6 2.8 3. 3.2 3.4 3.6 3.8 4. 4.2 4.4 4.6 4.8 5. 5.2 Log of GDP per head SOURCE: World Happiness Report 218 McKinsey & Company 6 In the UK, GDP growth is broadly in line with median disposable household income Average annual growth rate in GDP per head and disposable income Percent; reference year: 216 1.9 1.5 1.3 1.8 2.1 GDP per head Median equivalised disposable household income 1.8 1.5 1.7 1.8.2 1 year 5 years 1 years 2 years 4 years SOURCE: ONS; McKinsey analysis McKinsey & Company 7

But year-on-year changes in GDP are not accurate indicators of people s well-being UK GDP per head and well-being indicators Index; 212=1 15 14 GDP per head Median disposable income 13 12 Life satisfaction Happiness Life is worthwhile 11 212 13 14 15 216 SOURCE: ONS; McKinsey analysis McKinsey & Company 8 Consumer surplus is a significant component of economic value (1/2) Supply and demand curves for the UK natural gas market January 3, 26; estimated and simplified Supply Price, p/therm 15 1 5 1 33 2 46 6 66 43 3 135 4 5 Demand Price, p/therm 8, 6, 4, 2, 7,32 1 5, 2 27 65 3 5 4 5 UK North Sea Interconnector LNG Long-run storage Medium-run storage Short-run storage Power generation to keep lights on" Domestic and small Industrial customers Large industrial customers Power generation with oil substitute Power generation with coal substitute Volume, mcm Volume, mcm SOURCE: DECC, 26; McKinsey analysis McKinsey & Company 9

Consumer surplus is a significant component of economic value (2/2) Supply and demand curves for the UK natural gas market January 3, 26; estimated and simplified Price, p/therm 8, 7, 6, 5, Rough estimate of economic welfare Consumer surplus ca. 5,96 million Producer surplus ca. 4 million Total welfare ca. 6, million 4, 3, 2, 1, Rough estimate of market clearing GDP Price ca. 65 p/therm Volume ca. 4 mcm GDP ca. 5 million 1 2 3 4 5 Volume, mcm SOURCE: DECC, 26; McKinsey analysis McKinsey & Company 1 GDP growth doesn t always capture benefits of technological progress very well, either Human genome project 199-21 1 years Human genome sequencing 217 Retail price of $1, Time taken: 1 day $2.7 billion SOURCE: McKinsey Global Institute; Statista 218 McKinsey & Company 11

GDP as a measure of economic growth GDP is a useful aggregate indicator, despite its serious drawbacks The real problem is when it is misused, by decision makers or the media We need to both modernize GDP and complement it with other metrics McKinsey & Company 12 Changes in short-term GDP are often taken out of context in day-to-day reporting (1/2) The Guardian January 28, 214 UK economy grows by fastest rate since financial crisis as it happened The British economy expanded by 1.9% in 213 the fastest GDP growth since the first quarter of 28, after.7% growth in final three months Telegraph.co.uk January 26, 214 UK confirmed as fastest growing economy in Western Europe Official data this week will show that the UK economy grew 1.9% in 213, the strongest annual growth since 27 The Independent January 29, 214 UK GDP: British economy growing at fastest rate since 27 Official figures show UK economy grew.7% in the fourth quarter bringing the annual growth rate to 1.9% SOURCE: Google News McKinsey & Company 13

Changes in short-term GDP are often taken out of context in day-to-day reporting (2/2) UK quarterly GDP 1955-217 Chained volume measures, seasonally adjusted, bn 5 45 4 35 3 25 2 15 1 5 213 1955 Q1 1956 Q3 1958 Q1 196 Q1 1962 Q1 1963 Q3 1965 Q1 1966 Q2 1967 Q4 1969 Q3 1971 Q1 1972 Q4 1975 Q1 1976 Q3 1978 Q2 1979 Q3 198 Q3 1982 Q4 1984 Q2 1986 Q1 1987 Q4 1989 Q4 1991 Q2 1993 Q1 1994 Q3 1996 Q2 1998 Q1 1999 Q2 2 Q4 22 Q3 23 Q4 26 Q3 28 Q2 21 Q1 211 Q2 213 Q2 214 Q2 216 Q1 217 Q3 SOURCE: ONS McKinsey & Company 14 Countries with the same GDP per capita can have very different economic outcomes Employment as a share of 15+ population 1 Percent GDP per head 1 65 New Zealand Canada 6 55 Korea, Rep. Japan United Kingdom Israel Finland Germany Sweden Denmark 5 France Spain 45 63 64 65 66 67 68 69 7 71 72 73 74 75 76 77 78 79 8 81 82 83 84 85 86 87 88 89 1 Average for each country between 26 and 214 Italy Productivity 1 GDP per person employed, $ (211 PPP) 9 SOURCE: World Bank; McKinsey analysis McKinsey & Company 15

Averages hide important differences (1/3) GDP per head 214, current prices, thousand PPS Germany 35 United Kingdom 3 France 3 Italy 27 SOURCE: Eurostat McKinsey & Company 16 Averages hide important differences (2/3) GDP aper head by NUTS2 region 214, current prices, thousand PPS SOURCE: Eurostat McKinsey & Company 17

Averages hide important differences (3/3) Distribution of population across different bands of GDP per head 214, current prices, thousand PPS; percent of total population SOURCE: Eurostat McKinsey & Company 18 GDP as a measure of economic growth GDP is a useful aggregate indicator, despite its serious drawbacks The real problem is when it is misused, by decision makers or the media We need to both modernize GDP and complement it with other metrics McKinsey & Company 19

Manufacturing is over-represented in GDP statistics at the 4-digit SIC level Share of sectors in GVA and number of SIC 4-digit categories Percent, 215 1% = 1 1 Professional, scientific 2 13 and technical activities 14 Other services 23 5 4 5 7 Information and communication 11 Administrative and support services 1 2 Construction 8 Agriculture, mining, utilities 5 Wholesale and retail Manufacturing 17 14 44 Manufacturing is 14% of non-financial business GVA, but 44% of the SIC codes The average size of an SIC category was 67m in manufacturing but 4,9m in services Non-financial business GVA Number of 4-digit codes SOURCE: ONS Annual Business Survey; McKinsey analysis McKinsey & Company 2 Cross-border data flows are surging and connecting more countries Used cross-border bandwidth Regions NA United States and Canada 25 1% = 4.7 Terabits per second (Tbps) EU Europe AS Asia LA Latin America ME Middle East AF Africa OC Oceania Bandwidth Gigabits per second (Gbps) <5 5 1 1 5 5 1, 1, 5, 5, 2, >2, 214 1% = 211.3 Tbps 45x larger NA EU ME AS NA EU ME AS AF OC AF OC LA LA NOTE: Lines represent interregional bandwidth (e.g., between Europe and North America) but exclude intraregional cross-border bandwidth (e.g., connecting European nations with one another). SOURCE: TeleGeography, Global Internet Geography; McKinsey Global Institute analysis McKinsey & Company 21

AI is the new electricity Andrew Ng Adjunct Professor, Stanford University Co-founder and chairman, Coursera Former Chief Scientist, Baidu McKinsey & Company 22 GDP as a measure of economic growth Tera Allas Senior Fellow McKinsey Center for Government May 218