Investors need to be aware that in Europe revisions in how to calculate GDP (Gross Domestic Product) are about to take place. The transformation will take place in September of this year. The end result is to make the individual economies of European nations larger then is presently reported. The same effort was achieved in the United States last year. If the politicians don’t like the economic statistics as reported then just change them. The objective is to magnify the wealth of Europe by changing how economists will calculate the GDP. The initiative is required by law for the 28 members countries in the European Economic Community. However, it is quite likely that additional nations within the region will soon follow suit.
The upward revision in GDP will increase the size of all European economies. How can an investor make informed decisions when the rules of the game continue to change. In the United States the way inflation, unemployment and as of 2013 GDP is measured has already been rewritten. The revision there added between 3% and 4% to the overall size of the economy. Now the Europeans are going to join this charade in numbers.
If the numbers look bad just lie about them. Why does it matter? Well, if you can convince the public that the nation is wealthier than reported, it allows political leaders to increase taxes and spend more money on government programs. This in turn permits greater regime control over a larger proportion of the economy. It will also allow the government to run up more debt.
How will this endeavor in changing the GDP be achieved? If you change the inputs you can change the results. In Europe this will modify how one calculates the size of an economy. The rules as exist today were last changed in 1995. The elites in Europe will simply argue that they are just adopting the new global standards.
The greatest change in how GDP is arrived at will come from the sector of research and development. If one reclassifies this facet of the economy from being consumed as part of production, to a portion of the investment side it ends up padding the overall size of the economy.
The increase matters enormously to the individual countries in Europe, especially those that invest a sizable portion of their economy towards this task. If one takes this revision into account it raises the GDP overall and in some cases quite a bit. In southern Europe where research and development is much lower nationally it will add just 1% to 2% to the size of the economy. In the north of Europe nations like Sweden and Finland, will see an increase of 4% or even higher. Ireland is most likely to see an uptick of 3.8%. In the middle of the continent will be the nations of France and Germany, which will see increases of 2.1% and 2.3% respectively. The increases will be revised retroactively of course, which will change the dynamic of size and strength of the economy for all the individual nations in Europe. The end result is that smaller nations will grow proportionately in relation to larger ones.
This is just the beginning of the rewrite. Extra wealth will be generated by integrating new data and supposed improved methods of collection. In a number of countries this will give a major addition to the GDP. In France and Germany it will be close to 0.8%. In the Netherlands this will add almost 2%. In the United Kingdom it will be close to 1%.
National accounts will also add previously uncounted activities that are deemed unsavory or illegal. These would include smuggling of alcoholic beverages, cigarettes, cigars, drugs and other products. Even prostitution will be included. In countries where it is already legal it will have less of an impact. In countries where it is illegal like the United Kingdom and Ireland it can add nearly 0.7% to the GDP.
The amount attributed to these activities is considerable. In the United Kingdom it is estimated to be worth 10 billion pounds. This is the equivalent of 12.64 billion Euros or $16.60 USD (United States Dollar). In Italy it is figured that the increase in GDP will be between 1% and 2% as a result. In Spain prostitution alone is calculated to add 18 billion Euros ($23.6 billion USD or 14.2 billion British pounds) to the national economy. To make things even more complicated is that the commerce in sex is somewhat wrapped up with travel and the tourist trade in general.
Various agencies will be charged to find the most accurate information possible. Since some of the aforementioned activity is illegal in countries within the Euro-zone fully accurate numbers will be problematic.
Charitable contributions are also due to be included in the new GDP numbers.
As the fix is enacted it will in many cases soften the blow of poor or even negative growth. The is because the weight allocated towards various sectors of the economy will be modified as well. The final result will not allow a complete rewrite of the poor performance of the European economy in general, because you can only hide a portion of that reality. Since the revisions are retroactive one can still observe trends in general, despite the manipulation in numbers.
The new computations will matter because GDP determines how Europe will determine wealth. In the European Community it will determine all of the national contributions to the Union budget. It will entitle less advanced areas of the organization to larger transfers of money. If the GDP is higher it will allow countries to claim lower debt in relation to the size of the economy. Remember European governments as a whole are obliged to do this by agreement within the Euro-zone. It will also allow a lower calculation in annual deficits. Together it will likely lead to more spending and a false reading of greater financial stability in numerous social programs. It obviously reduces the public debt to GDP ratio. France for example can reduce this relation by 1.6%. Technically some nations may actually see an increase, but most will find a way to wiggle out of this result if it occurs.
The total increase in GDP will be large in some cases. In the Netherlands investors will see a nearly 8% gain. Germany the biggest economy in Europe will see an expansion of 3.3%. France is not far behind with 3%. The United Kingdom and Ireland will see increases of over 4% each. Italy on the other hand is struggling to not enter a triple dip recession. An increase of GDP there by as much as 2% might make all the difference between low economic growth and negative growth. Spain’s economy which grew at its fastest pace in six years (0.6%) during the second quarter, will be able to report at least a 2% increase in the GDP. The same will be true in Portugal which also reported growth of 0.6% in the second quarter of 2014.
Accuracy will be a major issue even if one agrees that the new rules make economic sense. When Italy revalued it’s GDP in 1987 to include the black-market or underground economy, it increased the total size by 15%. The inclusion of supposed tax evaders and undocumented workers allowed Italy to claim that the total size of the country’s GDP had surpassed the United Kingdom overnight. Italy went from the 6th to 5th largest economy in the world at the time.
An additional problem in some nations is how the revisions will be done. France up to this point for example is resisting the movement to include drugs and prostitution. The official reason given is that the sex trade often stems from slavery and should not be given even the veneer of economic legitimacy.
It is going to be increasingly difficult in Europe and elsewhere to measure the various facets that measure economic growth or decline. As economists use more sophisticated and dubious methods of data collection it is likely to skew the real figures even further. Too many of the new statistics are being estimated, especially in the areas of illegal economic activity. It will make the job for investors that much more arduous and challenging.