june200882

L i e s , d a m n e d l i e s a n d L i e s , d a m n e d l i e s a n d b e f u d d l e m e n tb e f u d d l e m e n t

Alistair Darling says the output of the City of London is “absolutely critical”. The Chancellor is spot on.

China’s economy inspires awe owing to its industrial muscle, but the British economy is still almost as large as China’s. Our strength comes from the services sector, enabling goods to be designed, built, fi nanced, transport-ed and sold. We are especially good at business services, whose growth since 1992 has been stunning. Then, the Of-fi ce for National Statistics (ONS) says, the sector account-ed for just under a quarter of the economy. By 2004, it accounted for a third. The share of manufacturing dropped from 21% to 14% over the same period.

Even more impressive is the expectation that the share of business services will exceed 40% of the economy by the end of the decade. Its contribution has risen by an average of one percentage point a year since 1997 and next year the ONS will include in the national accounts a proper esti-mate of the value of banking services. That alone will add roughly 1.7% to gross domestic product (GDP).

But, for all the undoubted importance of lawyers, ac-countants, estate agents, architects, bankers and other employees of business services companies, we do not really know with any certainty what is going on.

The statistics on business services are rather like a cheap sausage; alluring on the outside, but the more you delve into the ingredients, the more queasy you feel.

Start with the cash fi gures for output. A quarter of the re-corded output of business services, 8% of GDP, is “letting of dwellings”. Anyone thinking that this is a refl ection of the buy-to-let phenomenon would be wrong. Most of the £83 billion contribution to the UK economy in 2004 is the ONS’s estimate of how much it would cost property owners to rent their own homes.

The reason that notional rents are included in GDP is to stop international economic comparisons being distorted by patterns of home ownership. Without the adjustment, Germany would appear richer and more productive than the UK simply because most people there rent their homes from others with a recorded cash transaction. But in es-timating this huge adjustment, the ONS has to guess the notional private sector rental value of every UK home using some heroic assumptions. The upshot is that if planning restrictions damage the UK economy and force rents up, measured GDP increases, improving Britain’s apparent pro-ductivity performance relative to other countries. Rental infl ation also allows the government to borrow more since one of its borrowing rules limits debt to 40% of national income. This is perverse. And at 8% of GDP, it matters.

New research by Professor Jonathan Haskel of Queen Mary College, London casts further doubt on how far we should take the statistics at face value. He argues that international rules on what counts as business investment

Why does a lawyer putting up his hourly rate increase our national productivity? Why does £83 billion of our GDP

apparently come from rents that are never actually paid, or even demanded? This article, by Chris Giles, was the

award-winner in the Print category of the 2007 RSS Statistical Excellence in Journalism competition. It fi rst ap-

peared in the Financial Times on July 27th, 2007.

Winner: RSS Journalism Competition

june2008 83

are outdated in a service economy. His research suggests that correctly measuring things such as research and development or development of new fi nancial products as investment—because the expenditure has a future value—would raise Britain’s GDP by 13%.

If these two examples suggest the measure-ment of the output of business services is dif-fi cult, even bigger problems lie in differentiating real growth from changes in prices.

The soon-to-be-introduced better measure-ment of fi nancial services is a huge step forward for the ONS. But it also has the worrying aspect that measured real GDP will often go up when interest rates rise. The reason: banks have tra-ditionally used interest rate rises to improve margins by jacking up interest rates on loans by more than on deposits. This is clearly infl ation, but the measurement of infl ation-adjusted inter-est rate spreads are so diffi cult that under the

ONS’s chosen methodology it will be recorded as an increase in banking activity and productivity.

Or take lawyers. A survey in Legal Week re-cently found that law fi rms had increased their hourly rates by 6–10%. That is infl ation. But it

will appear as increased output in the index of services, because data shortages force the ONS to adjust law fi rms’ turnover for infl ation using an index of the wages of estate agents, among

others. In other words, pay a lawyer 10% more and Britain’s output and productivity rises. But pay a doctor 10% more and it is infl ation, be-cause output in health services is measured by the amount doctors do.

I have no idea whether the real growth of business services is bigger or smaller than it ap-pears in the national accounts. But I am sure it is not as it seems and, at 40% of GDP, any errors in business services can paint a highly misleading picture of the economy. The ONS is aware of the problems and is working on improvements. We should give them enough money to do the job well. In the meantime, sensible people should not treat the national accounts as gospel. It is no wonder that the Bank of England’s Monetary Policy Committee is increasingly falling out and its members form their views from impression-istic surveys of businesses as much as from the offi cial data.

Winner: RSS Journalism Competition

Pay a lawyer 10% more and it counts as increased output. Pay a doctor

10% more and it counts as infl ation.