The UK Economy in a Global Context - Essay Example

? Managerial Economics Assignment GDP or gross domestic product is an economic indicator that can combine within a single figure the total market value of all the final goods and services that are produced within the country’s economic territory in a given period. It is the indicator that is most frequently in case of market activity and to denote the change in GDP over a specific time. GDP is the principal indicator for economic growth. GDP is at the top level of the entire System of National Accounts, and the methodology followed in it is rigorously defined and is highly standardized, which enables international comparison and in aggregation. Given the implicit link that is found between market growth and the elements of well-being (e.g. levels of employment and consumption), GDP is often regarded as a proxy indicator for human development and well-being. However, this relationship between economic growth and social welfare is not straight. Soon after the inception of GDP, the interpretation and its use as a proxy for social welfare received much criticism which included some of the most established thinkers in economics such as Joseph Stiglitz, Amartya Sen and Muhammad Yunus (Wesselink, et al., 2007, p.3). GDP is limited in the sense that it does not put in a number of factors that can determine the well being of the people and nature such as the value for non-market goods and services like an ecosystem services, for unpaid labor, and leisure or in distributional issues. Several measures like aggregated single number indicators, indicator sets, and satellite accounts have been formed that can act as the complements to GDP and in related economic indicators (Wesselink, et al., 2007, p.5). Standard of living and GDP GDP per capita is not a proper measure for the standard of living found in an economy (Economics, 1958, p.310). However, it is frequently used to be such an indicator based on the rationale that all people in a country would be befitting from their country's higher economic production. Similarly, GDP per capita is not an accurate measure for personal income (Eckes, 2011, p.7). GDP can increase while the real incomes of the majority decline. The major advantage of using GDP per capita to be an indicator for standard of living is that GDP per capita is measured frequently, widely, and consistently. It is measured frequently in several countries as they provide information on GDP on quarterly basis, allowing the trends to be understood by the analysts quickly. It is measured widely in the sense that some indicators of GDP are always available in almost every country of the world, which allows inter-country comparisons. It is measured consistently as the technical definition for GDP is relatively same or consistent among the countries (Muljadi, n.d, p.14). Despite of these features, it is not considered to be a good measure for the standard of living. The argument favoring the use of GDP as a proxy for the standard-of-living is not that fact that GDP of a nation is a good indicator for the absolute level of standard of living, but the fact that the living standard tends to move with the per-capita GDP, so that the changes in the living standards are easily detected by the changes in GDP (Muljadi, n.d, p.14). GDP versus real GDP GDP = consumption (personal + government spending) + business (non-financial) investment + net exports (exports - imports). It is essential to know the real definition of GDP which is that it is used to measure the total production in a country. It is a metric for economic activity. As such, the exact value of GDP has very little relevance. Instead, the economy of a country is interested mostly in the changes in GDP, or in the comparisons between countries or in different time periods. As the change in GDP over a certain time is important, one has to carefully consider the impacts of inflation. An inflation rate of say 5% would automatically lead to a 5% increase in GDP (assuming the inflation metric is a reasonably representative of the prices for the entire economy) even though no real increase in the economic activity might have occurred. Thus, GDP numbers are always corrected for inflation effect. This inflation-corrected form of GDP is known as the real GDP (Mack, 2006). But correcting inflation is still not enough. The population of a country changes over time. The general expectation is that more people would generate more economic activity. Thus, real GDP is divided by the population of a country to obtain the per capita real GDP. One of the most widely form of uses of the per capita real GDP is as an gauge for the standard of living. The general assumption is that for a 2% increase in the US per capita real GDP it would represents a 2% increase for the standard of living for an average American. While this assumption is considered reasonable in most cases, there are certain problems of using GDP as an indicator for standard of living (Mack, 2006). Probably the greatest difficulty while using GDP as a measure for standard of living is the obvious fact that the quality of life is ascertained by many things other than the physical goods whether economic or not. Unfortunately the attempts to bring in corrections for this type of problem such as in using the Genuine Progress Indicator, GPI tend to be rather arbitrary that defining the quality of life in a way which would rather displease more people than it could please. There are two approaches for measuring GDP: The Expenditures Approach and The Income Approach. The Expenditures Approach: The expenditures approach measures GDP to be the final expenditures by households, firms, the government and the foreign sector. This is represented by the following equation: Y = C + Ig + G + NX (1) Where, C = Personal Consumption Expenditures Ig = Gross Private Domestic Investment G = Government Purchases of Goods and Services NX = Net Exports (Gwartney, et al., 2010, p.150). The Income Approach: The income approach takes GDP to be the incomes that are generated in the economy that includes compensation of the employees, gross operating surplus (profits), gross mixed income and tax less subsidies (Australian Bureau of Statistics, 2008, p.694). The income approach calculates the National Income, NI. NI is the sum of the given components: Labor Income (W), Rental Income (R), Interest Income (i), Profits (PR) (Mukherjee, 2007, p. 997). Mathematically it is calculated as: NI = W + R + i + PR Labor Income (W) includes the salaries, wages, and the fringe benefits like health or retirement. This also takes in unemployment insurance as well as government taxes for providing social security. Rental Income (R) is the income that is received from the property received by households. Royalties from the patents, copyrights and the assets as well as the imputed rent are also included. Interest Income (i) is the income that is received by the households through the lending of money to large corporations and to business firms. Government payments and household interest payments are not calculated in the national income. Profits (PR) is the amount the firms have left after the payment of their rent, interests on debt, and all employee compensation (Mukherjee, 2007, p. 997). . Calculation of real GDP Nominal GDP versus Real GDP Gross domestic product or GDP stands for the monetary measure, for all commodities (goods as well as services) that are expressed in terms of its value. GDP is the value of all final goods and services and not the intermediate commodities. Nominal GDP also known as Current Dollar GDP or Unadjusted GDP is the GDP that is evaluated at the current market prices. E.g. for an economy that produces apples and oranges in the year 2002 the nominal GDP which is denoted by NGDP is calculated as NGDP 2002 = $(P apples * Q apples + P oranges * Q Oranges) where P stands for the price of the commodities and Q stands for the quantity of the commodities both in the current year (Kennedy, 2000, p.18). Now in order to arrive at the amount that is not impacted by changes in the price levels we use the real GDP measure (Mankiw, 2008, p.213). Real GDP is the GDP that is valued at some prices prevailing during a certain base year currently taken by statisticians and accountants to be 1992. For example if we assume the physical quantity of some goods produced in the year 1997 and add these together by valuing at the 1992 price level, we will get the 1997 GDP that is measured in 1992 price levels which otherwise would be known as the real GDP for 1997(Kennedy, 2000, p.18). For calculating the real GDP, a base year is chosen. Then the prices of the commodities in the base year are used to calculate the prices of the goods and services in the assigned year (Mankiw, 2008, p.213). Let us explain it using an example. Let us consider the base year to be 2002 and the goods produced to be hamburgers and hotdogs (Mankiw, 2008, p.213). Let us assume the following details: GDP Data for 2002 GDP Data for 2003 Item Quantity Price Item Quantity Price Hamburgers 100 $1.00 hamburgers 160 $0.50 Hotdogs 200 $0.50 hotdogs 220 $2.25 Then real GDP denoted by RGDP is RGDP 2002 = $(P 2002 Hamburgers * Q2002 Hamburgers + P2002hotdogs * Q2002 hotdogs = $(1* 100 + 0.50 * 200) = $(100 + 100) = $200 RGDP 2003 = value of the 2003 quantities at 2002 prices = $ (P2002 Hamburgers * Q2003 Hamburgers + P2002 hotdogs * Q2003 hotdogs) = $(1 * 160 + 0.50 * 220) = $(160 + 110) = $270 Advantages of using real GDP Real GDP is the nominal GDP which is adjusted for changes in inflation. By removing inflation rates, real GDP allows the economists to make accurate comparisons between two countries and across multiple years. Multinational corporations or MNCs use real GDP while deciding where to send the investment dollars or to headquarter their operations. National governments use real GDP in order to set currency exchange rate targets and to evaluate the effectiveness of the economic policy by comparing real GDP data of one year against another year. Central banks allow significant emphasis on real GDP data while determining interest rates and fiscal policy. Let us consider the real GDP of UK from 08/17/2007 to current fiscal year 08/17/2012 (UK Real GDP Growth, 2012). June 30, 2012 -0.79% 31-Mar-12 -0.18% Dec. 31, 2011 0.61% Sept. 30, 2011 0.53% 30-Jun-11 0.55% 31-Mar-11 1.36% Dec. 31, 2010 1.49% Sept. 30, 2010 2.35% 30-Jun-10 2.13% 31-Mar-10 1.23% Dec. 31, 2009 -0.87% Sept. 30, 2009 -3.34% 30-Jun-09 -5.42% 31-Mar-09 -6.12% Dec. 31, 2008 -4.16% Sept. 30, 2008 -2.39% 30-Jun-08 0.53% 31-Mar-08 2.71% Dec. 31, 2007 3.78% Sept. 30, 2007 4.57% Source: UK Real GDP Growth, 2012 The result arrived using the above chart is as follows: UK Real GDP Growth is found to stand at -0.79% as compared to -0.18% in the last quarter and 0.55% of last year. This is currently lower than the average long term of 2.57%. Weak UK output growth over its past has shown the effect of a number of factors. One factor that has its effect on UK activity has been the slowing global growth. The economical impacts arising from the above chart i.e. by using the figures of real GDP as deduced by the economists and analysts in UK are as follows: SERVICES INDUSTRY GROWS AT SLOWEST RATE IN 19 MONTHS According to the latest Markit/CPS survey, the UK services industry that accounts for around 75 per cent of the economy grew at the most slowest rate in more than 19 months (Straus, 2011).Growth came in at 51, down from 51.3 in May where as a reading above 50 represented growth in the country. The disappointing slowdown suggested the economy to have slumped down to its lowest ebb in more than three years since July. A worsening contraction in its manufacturing sector and the only little growth in construction and its services added up to a combined reading including all three sectors at 49.5, indicating a decline in the overall growth appearing for the first time since April 2009. Some of the fall in the service sector can be related with wash-out weather and disruption due to the run-up of the Olympic Games. However, even if the small factors are excluded, the economy, as per the survey conducted, is found to be still struggling for growth. The grim data has fuelled further fears that the country might have to struggle in order to pull out of this double-dip recession, which has already been reported to be the longest for the country in more than 50 years. CIPS chief executive David Noble had predicted most businesses to either expect things to become worse or remain the same for the next year (Straus, 2011). UK Economic Activity Contracts Economic activity contracted in UK for the first month in over three years in the month of July which was an indicator that the economic condition of the country will have to struggle to recover from its recession phase in the third quarter. The all-sector purchasing managers' index that is a gauge of the economy fell to 49.5 from 51.1 in June. This was based on the survey of construction, its manufacturing utilities and service firms according to the financial information firm known as Markit and the Chartered Institute of Purchasing and Supply. That means that the first reading which was below 50 indicated a contraction in its activity since April 2009. Some of the weakness for this dip can be attributed to the minor but relevant factors like the unusually wet weather which had affected construction and its demand for seasonal goods and its services, according to Markit. Some firms had also reported disruption in its orders and work flows due to the extra public holiday granted in the previous months to celebrate the Queen's 60th year on the throne, Markit said. The current weak data have in addition cemented the expectations where the Bank of England would have to increase its asset-purchase program at some time later this year after the same bank had raised it to a healthy GBP375 billion in its last month. The weighted average of the three vital activity balances that comprises of manufacturing, of construction and its services surveys is found to be consistent with the quarterly GDP growth which is about -0.3%. Vicky Redwood who is the chief U.K. economist at Capital Economics was quoted saying that Q3 has got off with a poor start (UK Economic Activity Contracts, 2012).     Chained Volume Measure GDP Total Production Construction Total Services     2009=100         2010 Q2 101.8 0.7 1.4 6.3 0.2 Q3 102.4 0.6 0.4 2.9 0.4 Q4 102.0 -0.4 0.1 -1.8 -0.4 2011 Q1 102.4 0.5 -0.1 0.5 0.7 Q2 102.3 -0.1 -1.2 0.9 0.2 Q3 102.9 0.6 0.0 0.1 0.8 Q4 102.6 -0.4 -1.4 0.0 -0.2 2012 Q1 102.2 -0.3 -0.5 -4.9 0.2 Q2 101.5 -0.7 -1.3 -5.2 -0.1 GDP at market price. % change: latest quarter on previous quarter. Source: (Gross Domestic Product, Preliminary Estimate, Q2 2012, 2012, p.2) UK standard of living drops below 2005 level The recession has further pushed the living standards in Britain at a level below the 2005 general election. GDP per person is now ?225 that is lower than in 2005. Oxford Economics have said that the gross domestic product per person has reduced to ?22,700 on an average in 2009, going down from ?23,000 in 2005 after the adjustment for inflation which showed a fall of 1.3% (UK standard of living drops below 2005 level, 2009). These instances show how the economic condition of a nation and its expected future can be derived by using the real GDP indices. The example mentioned above shows that as the economy of UK is forecasted to be sluggish in the near future it will directly deteriorate the standard of living of the people. However, real GDP indices cannot be used as true indicators for standard of living of the people. This has been discussed in details in the next section. Disadvantages of using real GDP as a standard of living indicator Real GDP cannot be used to be a good indicator for counting the standard of living. There are certain limitations of real GDP that sets it back. A few limitations are given below: Regional Variations in income and spending There can be situations where National GDP figures would not be able to disc lose significant regional variations in output, employment and incomes per head of population (Riley, 2005, p.58). Within each area there can also be domains of relative prosperity that would be in contrast with unemployment black-spots and the deep-rooted social as well as economic deprivation. Inequalities of income and wealth GDP figures themselves cannot show the distribution for income and the unequal spread of financial wealth. Incomes and earnings can be very unevenly distributed in the population and any form of rising national prosperity could still be faced with the problem of rising relative poverty (Riley, 2005, p.58). Economic growth and externalities Rising national output can have be effected by an increased level in pollution and other in negative externalities which can have a negative effect on the economic welfare (Riley, 2005, p.58). Output figures also inform little regarding the quality of the goods and the services produced. Leisure and working hours It can be seen that the rising national output had been achieved at the expense of the leisure time where workers are made to work longer hours. A report that got released in August 1999 and was entitled Six Days a Week, reported that greater than a million managers along with 656,000 professionals in the UK had been made to work at least 48 hours in a week. The study suggested that these people working greater than 48 hours in a week had increased from 2.7 million to four million since the past 15 years. British workers also had the longest period of working week in entire Europe, with full-time workers who used to put in on an average of 44 hours per week which was three and a half hours more than the European average (Riley, 2005, p.58). The black economy and non-monetised sectors GDP figures can understate the actual living standards of the people due to the existence and increase in growth of the black economy (Bamford & Grant, 2000, p. 95). The black economy involves the economic activity that is mostly unrecorded by the Inland Revenue and Customs & Excise. These non-monetised factors of the economy includes output which are not sold in the market prices but involves procedures known as barter trade as well as self-consumed products. CONCLUSION Gross domestic product (GDP) is not an accurate measure of personal income. Under economic theory it is stated that GDP per capita is exactly equal to the gross domestic income (GDI) per capita. Finally, GDP focuses on the current economic activities or the flows, rather than on the developments of natural, economic and social capital assets, which are important for a long-term perspective goal. An important aspect of overcoming a few limitations of GDP is by the adoption of a more inclusive framework for well-being. Extensive academic literature on such frameworks is available that includes approaches such as sustainable development like the United Nations, 1987, genuine wealth, capabilities and happiness, (Wesselink, et al., 2007, p.4). Real GDP is known to be the GDP that is correction of its inflation effects. It is considered to be a good measure for the standard of living but is not so as there are many loopholes in it. But indices showing the real GDP values can be helpful for the economists of a country in predicting the economic conditions of a nation. As has been shown in the graphs, the real GDP index of UK is showing a downward trend in its economy. Using these values analysts have been able to deduce the causes behind it as well as forecasted its future condition. But still real GDP cannot be regarded to be a good indicator for evaluating the standard of living conditions of the people as it often ignores conditions like the working hours, regional variations, spending levels and several non-monetised sectors that considerably affect the standard of living conditions of the people. The people while analyzing the real GDP of a nation need to incorporate these aspects too in their evaluation process that would depict the living standards which would be closer to reality. References 1. Bamford, C., G. & Grant, S. (2000). The UK Economy in a Global Context. Heinemann 2.  Eckes, A., E., Jr. (2011). The Contemporary Global Economy: A History since 1980. Wiley & Sons 3. Economics. (1958). University of Chicago Press 4. Gwartney, J., D. (2010). Macroeconomics: Private and Public Choice.South-Western College Pub 5.  Kennedy, P., E. (2000). Macroeconomic Essentials, 2nd Edition: Understanding Economics in the News. Cambridge, Mass 6.  Muljadi, P. (n.d). Economics and Banking.  Paul Muljadi 7.  Mukherjee, S. (2007). Modern Economic Theory. Wiley Eastern 8. Mankiw, N., G. (2008). Principles of Macro economics. Cengage Learning 9. Mack, C. (2006), Gross Domestic Product (GDP), available at: (accessed on 17 August, 2012)   10. Riley, G. (2005). European Economy in Focus 2005. World Scientific Publishing Company 11. STRAUS, R., R. (2011), Premature austerity measures 'may have cost Britain 16.5% in economic growth' warns leading forecaster, available at: (accessed on 17 August, 2012) 12. 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