Tuesday, February 14, 2006

Has Sweden Really Outperformed Australia?

The Swedish Social Democratic government gloated over PPP-adjusted GDP per capita numbers from the OECD for 2005 which showed (or claimed to show) that Sweden have moved up from a shared 12th place (with Belgium) to a shared 11th place (with Australia).

Yet there are several strange things about these numbers. First, how can the OECD already publish 2005 numbers when most countries haven't published fourth quarter numbers? And the few that have done so ( like the US, the UK and South Korea) published only highly preliminary estimates which are likely to be revised. And there can be a lot of revisions expected for the numbers of the three first quarters. The OECD have, it would seem then, published numbers based on their forecasts, forecasts which are likely to differ somewhat from the actual numbers.

A even bigger problem however is that the OECD do not seem to have adjusted their numbers for changes in terms of trade, which is why they have come up with the false result that Sweden have outperformed Australia in the latest year. As fourth quarter numbers are not available yet, I used the numbers for the first three quarters of this year.

During this time, the volume measure of GDP rose by 2.5% in Sweden and 2.35% in Australia. And as Australia have a far higher population growth than Sweden, 1.2% versus 0.4%, this means that GDP per capita seemingly increased 2.1% in Sweden versus 1.1% in Australia. This, it seems, is the basis for the OECD's claim that Australia's GDP per capita fell from 114% of OECD average to 113%, while Sweden held steady at 113%.

But, these numbers are based on the faulty methodology of deflating nominal GDP increases with the GDP deflator, a price index that includes export prices but not import prices. To see how absurd this methodology is, imagine a self-employed barber who for the sake of simplicity is assumed to have no fixed costs and who live in a country with zero inflation . Say that he cuts his price by 50% and that this means that the number of customers increase 60%. Even though his nominal income falls by 20% and his cost of living is unchanged, the absurd volume measure of GDP would have us belive that he really is 60% better off! Pure common sense tells us that in reality he is 20% worse off. The common sense measure takes terms of trade changes into account and deflates nominal income changes with the price changes of the goods the producer buys, not the price changes of the goods he sells.

And if we take terms of trade changes into account and deflate nominal GDP increases with the price indexes for domestic demand rather than the price indexes for domestic production, the relative economic performance of Australia and Sweden changes dramatically. If you look at the Australian numbers more closely you could see that domestic demand in Australia rose 3.9% in real terms and that the 2.35% number assumes a sharp increase in the trade deficit. But if you look at current (actual) prices in the same release the Australian trade deficit actually shrank from A$18.3 billion to A$15.3 billion, as opposed to the increase from A$22.4 billion to A$32.3 billion assumed in the volume numbers. The reason for this discrepancy is that the volume numbers do not take into account the vastly improved terms of trade for Australia. During this period, export prices rose no less than 11.2% while import prices rose a mere 0.2%. Taking terms of trade into account, Australia's GDP rose by 4.35%. That in turn translates into a 3.1% increase in GDP per capita.

For Sweden, the effects of adjusting for terms of trade is less dramatic, but it is negative. Nominal GDP rose 3.4% during the first three quarters of 2005, which deflated with the GDP price index increase 0f 0.9% means a 2.5% volume growth. But if you deflate the nominal GDP increase with the more relevant price index, that for domestic demand which increased 1.3%, real GDP growth was only 2.1%. And with a 0.4% population increase, real GDP per capita increased 1.7%.

So, far from being the case that Sweden had 1% higher GDP per capita growth, the terms of trade adjusted numbers show that Australia had 1.4% higher GDP per capita growth. As Australia was already ahead, that also means that Australia's PPP-adjusted GDP per capita is higher than Sweden's.


Anonymous Anonymous said...

Thanks for another interesting post!
Have you seen any "official" (OECD, SCB, ...) motivation for not taking terms of trade changes into account when computing the PPP adjusted GDP per capita numbers?

9:48 AM  

Post a Comment

<< Home