Sir, On the front page of today’s (5 October) FT, you and Chris Giles have combined to present as headline news an account of events which is both out of date and misleading.
The alleged effect of the recent depreciation of sterling on the comparative situation of the UK economy is stale news. In The Guardian of 30 June, a columnist wrote that within 24 hours after the referendum, and as a direct result of it, ‘our currency was sufficiently decimated that we had fallen [from fifth] to sixth, behind France.’
Such language, as also the over-excited headline [‘Not so great Britain slips below France in ranks of economic powers’] that you gave to Mr Giles, reflects a basic misunderstanding. The size of an economy is correctly defined with reference to its output of goods and services, or real gross domestic product (GDP). Changes in a country’s real GDP are defined and measured in domestic prices, corrected for price changes. Exchange rate changes do not enter into such measures, and introducing them, as in this case (and in The Guardian three months ago) yields misleading results.
The latest IMF estimates of real GDP, ‘based on purchasing-power parity (PPP) valuation’ (which as Mr Giles rightly notes is the appropriate comparison) show the GDP of the UK as 1.018 per cent higher than that of France for 2016 and 1.016 per cent higher for 2017. These numbers [indicate that the UK has not ‘slipped below France’. More broadly, they illustrate how small a difference the prospect of Brexit has in all probability made, so far at any rate, to the relative position of the UK economy. They] give a wholly different picture from that shown in the unfortunate diagram that features so prominently on your Page One today.
How far even a correctly-defined comparative measure of real GDP is an indicator of ‘economic power’ is open to question, though your headline presumes it.
As Mr Giles notes, in her address to the Conservative Party conference on 2 October Theresa May described the UK as ‘the fifth biggest economy in the world’. Her use of this misleading routine formula indicates that no one among the Prime Minister’s circle of advisers understands the elements of national income accounting.
[On the following day, the same formula was used in his conference speech by the new Chancellor of the Exchequer, Philip Hammond, in the context of the UK’s supposed strength in negotiations with the EU27 countries. The Chancellor’s lapse puts in question the role and competence of Treasury officials.]
A further thought, as a former national and international civil servant:
Before the Conference, the PM and the Chancellor, though in the first instance their immediate advisers, should have been briefed as follows:
- Before the referendum of 23 June, it was often said, mostly by Leavers, that the UK economy is the fifth largest in the world; and this formula now occurs in the draft Conference speeches of both the Prime Minister and the Chancellor.
- This ranking is derived from a procedure which translates each country’s GDP into US dollars at the going exchange rate. Even accepting such exchange-rate-based comparisons as sound, when in fact they are highly questionable, it is no longer correct to say that on this measure the UK economy ranks fifth in the world. As a result of the recent fall in the sterling-dollar rate, it now appears as sixth.
- In using the term ‘fifth’ the PM and the Chancellor would expose themselves to the charge of making an elementary factual error. But to ‘say ‘sixth’ instead of the now-familiar ‘fifth’, though correct, would convey the misleading impression that the UK economy has shrunk, and therefore weakened, since the referendum. This is not the case. The fall in sterling does not translate into a fall in GDP.
It is recommended that, in this context, the PM and the Chancellor should simply refer to ‘the continuing strength of the UK economy’, without mentioning any specific ranking.
- Since comparisons of ‘economic strength’ are constantly made, often misleadingly, the following points are worth noting for future reference.
- The size of an economy is correctly defined with reference to its output of goods and services, or real gross domestic product (GDP). Changes in a country’s real GDP are defined and measured in domestic prices, corrected for price changes. Exchange rate changes do not enter into such measures, and introducing them can give rise, as in this current instance, to seriously misleading results.
- Cross-country estimates of real GDP, and consequential rankings of national economies by size, have to take proper account of differences in price levels.
- A long-established and carefully-made comparative set of estimates which incorporates such differences is readily available, though not widely known to the general public (and disregarded by a surprising number of economists). It is based, not on exchange rates, but on detailed estimates of ‘purchasing power parity’.
- On this basis, the UK economy currently appears as ninth in the world, alongside France. This ranking has not been affected by the referendum or subsequent events.
- Issues relating to the definition and measurement of changes in real GDP over time, and differences across frontiers, have recently been the subject of instructive exchanges in the journal Economic Affairs.