Monday, November 9, 2009

Constant Prices or Share of GDP or ....

The question of how to represent economic structures will be an ogoing discussion in this blog but one of the key aspects of this issue are the methodologies adopted for comparisions.

So for example current prices are virtually useless for anything other than comparing economic phenomena for a single time period for a single nation because it has the same currency. This is because inflation, exchange rates etc cause serious difficulties for anything more than this. You can use calculations like purchasing power parities (PPP) which are better than exchange rates for cross currency comparisons to improve the analysis. By way of example, Nordhaus uses current PPP dollars in his economic geography project. This is fair enough for a single year but once you have a time series this doesn't work.

Constant pricing methodologies improve the utility of time series but they don't capture quality changes or technological changes limiting the benefits;. They are also difficult to use in cross country comparisons.

Typically then, share of GDP has become the standard for international analyses. Publications emerging from organisations such as the OECD almost exclusively use share of national GDP. This is an excellent approach for revealing differing relative specialisations. For example industry X might represent # % in Sweden or ## in the USA. You can even use these comparisions for time series analyses comparing the share of GDP acoss time. This is often done, for example, to highlight the rise of services relative to manufacturing.

But there is a problem. GDP isn't some absolute measure (and there isn't one), obviously GDP can rise and fall and the rates at which it does so differs between economies. The implication is that although this doesn't damage the measure's status as useful for relative specialisations it hides from readers (or blinds them) to the significance of growth. So using our example above in time 1 Sweden's industry represents # % but perhaps the whole economy grows fast but relatively evenly so at time 2 it is still # %. But in comarison to the USA that perhaps grew slowly during the same period - the Swedish industry has actually caught up to some degree on the scale of the industry in the USA.

This is particularly important for our analysis of East Asian economies over the last twenty years and comes to the forefront as we consider how to analyse the BRICS (Brazil, Russia, India, Chin and South Africa) over coming years. We need a complementary measure that captures change better.

What, I have been thinking about is creating a measure based on a basket of economies. Data on the world economy is too problematic, but a basket of economies (say approx 15 or so) where we have good data reaching back to the early 1960s would be workable. Your measure of interest - R&D, industry output etc could then be calculated against this basket of economies. If you wanted to, by the same logic you could create sectoral groups - something that is currently not possible. Over time you would be able to capture the changing dynamics of the world economy. For example, if you created a sectoral group (perhaps auto), in the early 1960s you would probably find that a small group of countries (mostly inside your basket of economies) accounted for a high share of the sectoral bechmark G15 Gross Sectoral Product. However, today, by keeping the basket of economies the same, you would probably find that fewer economies (inside the basket) account for a high share of G15 sectoral product but a significant amount of sectoral product would fall outside the basket.

In this methodology, if a sectoral product basis was calculated we would find that over time "shares" would grow beyond 100%. To me this is not a conceptual but a communication problems in terms of teaching people how to interpret the new measure. For the forseeable future using a basket of GDPs measure wouldn't have this problem, but it will eventually emerge.  We could call the measure something like the Benchmark International Product.

The only genuine challenge to this measure is that of perceived 'western bias'. The first benchmark group would have to have a western' OECD economy bias, which governments in China and East Asia may not like. However if the measure is to be really useful it has to reach back in time to a point where there are only few economies with really good data.

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