Tuesday, 19 April 2016

GDP — Treasury figures on brexit

This post was going to be on GDP and the North Sea, but some comments I made about GDP and household income in the previous post turned out to be more topical than I expected, so the North Sea will have to wait until tomorrow.

Today the treasury published a document on how Brexit might affect the UK economy. In the foreword, Chancellor George Osborne writes "families would be £4,300 worse off" and this figure has been widely repeated in various traditional and online media.

In actual fact, the figure is not a change in household incomes but the change in GDP per household. To be precise, what it is saying is that when two models of the UK economy are ran forward in time to 2030, one with the UK remaining in the EU, and another with it leaving, then the EU one ends up with GDP per household being £4300 higher. (This figure is rounded to the nearest £100 and inflation adjusted to be in 2015 prices.)

For the sake of argument, let's take the result at face value and consider what a £4300 drop in GDP per household might mean in Scotland.

Scotland's GDP for 2014 was £140 billion (excluding North Sea activity) and there are 2.42 million Scottish households. This means Scotland's GDP per household was £57,800 in 2014. So a drop of £4300 would be 7% in percentage terms. This is comparable to the drop in incomes caused by the 2008 financial crisis, as described in this post.

Of course, GDP does not simply get shared out amongst households, but we can get an idea of what does go to households by looking at how GDP is broken down in the Scottish national accounts, shown in this graph:

This shows us that about half of GDP goes to "compensation of employees" (which has been slowly declining since 2001, but that's a story for another time).

So if half of GDP goes towards paying employees, then it seems reasonable to suppose that the drop in an average household's income will be half of the £4300, ie £2150. Job done? Not quite, we also need to think about what happens to the rest of GDP.

About 10-15% of GDP goes on taxes on production and products, which is mostly VAT, and this goes to the government, not households. The remainder of GDP goes to "Gross operating surplus", and to explain that, allow me to digress for a moment.

In my younger days, I was the treasurer of a student astronomy society. When it came time to do the accounts, I noticed that my predecessors had entered surprisingly large amounts for "biscuits" in previous years. After asking why, it turned out it was a balancing item, ie if the accounts wouldn't add up, then the biscuits amount would be adjusted accordingly. In national accounts, the gross operating surplus is a bit like "biscuits", in that it's often used as a balancing item and so it's hard to say in detail how it breaks down. But a lot of it will be various operating costs of business and also their profits.

So what? If half the drop in GDP is spread across VAT, operating costs and profits, that's not going to affect household income, is it? Not directly, but it's still worth considering what effect it might have.

If you receive dividends from shares, then that contributes to household income in addition to your salary. So if a drop in GDP causes a drop in profits that will reduce dividends and some household income. But, admittedly, for most households, this will be a very small part of income.

However, if you have a private pension, then the contributions you pay into it are used to purchase shares, and part of the growth of the pension fund will be from dividends. So it's quite likely that a drop in GDP will, via the drop in company profits, reduce your household income in retirement. Private pension wealth is in fact the largest kind of wealth, as mentioned in a previous post.

But we're still not finished. VAT isn't the only tax going to government: income tax, national insurance and council tax come from household income, and corporation tax comes from company profits. According to the national accounts, Scotland's total revenues (again excluding the North Sea) are £51 billion for 2014, so if it drops in line with GDP this may fall to £48 billion. For comparison, Scotland's total public expenditure is £68 billion.

And this leads to the most important point, that a drop in GDP will mean lower public revenues and this could, depending on the government of the day, lead to cuts in public services. This includes benefits, which make up a significant portion of income to the poorest households, and also state pensions.

So, in summary, although the fall in household incomes will be nowhere near £4300, the reduction in GDP is likely to reduce pensions in the future and cause a fall in public revenue which could lead to spending cuts that hit low income households the hardest.

This is of course all dependent on whether the prediction of the £4300 figure is believable, but I'll leave that for others to assess.

In the next post, I'll turn my attention to how the North Sea is treated in the UK and Scotland's GDP figures, and I'll explain why I've been excluding the GDP figures so far.

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