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We are all better off than we think

Apple’s iPhone5 has already smashed sales records.  The first day on which consumers could make purchases over the web, more than 2 million online orders were placed.  Little wonder that JP Morgan has estimated that sales of the iPhone5 could add as much as 0.5 per cent to American GDP.  These numbers have attracted criticism. If consumers simply buy iPhones instead of other products, it is hard to see how output could be boosted by such an amount.

But there is a powerful case to be made that, thanks to products like broadband and mobile phones, the growth rate of the American economy genuinely has been distinctly higher than the conventional estimates suggest. Since 1992, the US economy has grown in real terms at an annual average rate of 2.6 per cent.   This figure could easily be 3.5 to 4.0 per cent.

The reason is the massive waves of technological innovation which have taken place.  The quality of the products which have become available has grown dramatically.  Smart phones, for example, have more computing power than many mainframes of the 1970s.  But how do we measure this increase in quality?

This is a very difficult problem for the Bureau of Economic Affairs (BEA) in America and the Office for National Statistics (ONS) in the UK.  The information they gather when they estimate GDP is based on information about the money value of what is being bought and sold.  So they have to deduct the part of any change which is simply due to prices changing. This then gives what it is known as ‘real’ GDP.

It is real GDP which gets the headlines, and it is real GDP which matters for how better off people are.  If the BEA or ONS are trying to estimate real Marmite output, say, the problem is easy.  Here is a product which has basically remained unchanged for generations.  Any change in its price is straightforward to interpret.  But a smart phone?  Just a few years ago, the product did not exist at all.   Even a new release in a product may represent a big increase in quality compared to previous versions.

In markets where innovation is rapid, we are simply not comparing like with like.  With a completely new product, top US econometrician Jerry Hausman at MIT has used the idea that a way of estimating the change in its price from the previous period is to assume that the price was then so colossally high that no-one bought it at all!  So the implicit drop in price this period is huge.

As a consequence, inflation has been systematically over-estimated and real GDP under-estimated.    Real GDP growth rates can easily have been 1 per cent higher a year than the standard estimates suggest.


by Paul Ormerod

As published in City AM on Wednesday 19th September

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