Making the invisibles in the economy visible

Lecture theatre Image copyright Thinkstock

Services such as banking, consultancy, law, education and retail make up around four-fifths of the UK economy. But output in these sectors is often invisible or intangible, and hard to measure.

And the UK sells a lot of services overseas. Ranked only after the US, the UK is the second biggest exporter of services in the world. But it is known as the invisible trade because it's hard to see exports and imports of services.

Could making the invisible parts of the economy more visible show us that the economy is in better shape than we thought? And that our trade position isn't as bad as it appears?

Mis-measured national output

Economists are arguing that better measuring of intangible assets would increase GDP (gross domestic product).

When research and development (R&D) and other intangible investment were included, US GDP was increased by 3%.

The OECD estimates that intangible investment, including in human capital (a person's education, training and skills) and software, is as important as investment in tangible machinery and equipment in the UK.

Jonathan Haskel of Imperial College Business School says that if investment in private R&D were counted in GDP, then national output would be increased by around £15bn. Along with better measurement of other intangible investment, he finds that UK GDP has been under-measured by about 1%.

Image copyright Getty Images
Image caption Prostitution is now included in GDP calculations but there are still many intangibles that are not

Last year, UK GDP underwent the most far-reaching changes in computation in decades, when counting drugs and prostitution raised GDP by 0.7%. But Haskel maintains that intangible investment is still hardly counted in the official data.

And intangible investment is what most firms in the services sector do. They invest in people. For instance, Sir Martin Sorrell, the chief executive of WPP, one of the world's largest advertising companies, says that they invest 25 times more in human capital such as training programmes than physical capital in the UK.

Productivity puzzle

The challenge is how to better measure the largely invisible output and input.

It's challenging to work out what's produced in an hour by a consultancy versus a factory. It's also hard to separate out the effects of a price increase or quality improvement.

For instance, Paul Ormerod of the consultancy Volterra Partners says that his firm could charge double the price for the same report. In the official statistics, output would look like it's doubled even though nothing has changed.

And we all know that there are certainly meetings that could be done away with, but there are also the meetings where things get done. No wonder estimating productivity is hard.

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Image caption How do you measure how productive a meeting is?

This is why it's difficult to know precisely how much of our national output is mis-measured.

But if intangibles were better measured, then that could help explain some of the productivity puzzle. I've written before about how low investment is one of the key reasons as to why the UK has had low productivity growth throughout this recovery.

Haskel believes that only tangible investment has dropped sharply while intangible investment has remained steady. If he is right, then better measuring this type of investment and services output could show that productivity growth is higher.

More of us work in the services sector than manufacturing, construction and agriculture combined. If the work of consultants and teachers were more accurately measured and productivity in the less visible parts of the economy proved to be better than thought, then that usually justifies higher wages and incomes.

That would be a welcome change from the years of stagnant wages that have characterised most of this recovery.

Trade deficit

Better measuring services output also affects trade. The UK has had a stubbornly high trade deficit despite the depreciation of sterling after the banking crisis.

Even if we can afford to buy more from abroad than we sell, the trade deficit shows that there is scope to boost exports of tradeable services, which would help pay for the imports of largely manufactured goods and commodities.

Image copyright PA
Image caption The UK imports more goods than it exports, but it is a different picture when it comes to services

Looking at the third quarter of last year when new records were made in trade, exports of services had reached a surplus of 5.1% of GDP. That certainly goes against the picture of a dire overall trade deficit, which is due to the manufactured goods trade.

Indeed, the UK's trade in goods hit a record deficit of 7.1% of GDP in that quarter. It has improved since then but is still squarely in deficit.

But trade in services is hard to measure. The economists Ricardo Hausmann and Federico Sturzenegger called services trade "dark matter", named after the physics concept, because both are invisible but very important.

If we promoted services better, then that could improve the trade deficit. The consultants, EY, even predict that the surplus in services trade will reach 6% of GDP by 2018 and could move the UK's current account back towards balance.

Pro-services policies

Perhaps because of the bad behaviour of bankers and the difficulty of seeing what is produced in the service sector, policymakers have focused on promoting manufacturing.

Rebalancing the British economy hasn't exactly worked: services have recovered to pre-crisis levels but manufacturing has not.

Yet there is huge scope for growth in services, particularly in exports. Emerging markets are increasingly becoming middle class and consuming more services, including the types of high-skilled professional services that the UK specialises in, such as education and law. But they're also producing competitor firms, so supporting services could help improve the trade position.

Of course, promoting the services sector abroad and at home depends on seeing it clearly.

By making invisibles visible, we may see that the economy is in better shape than we thought, and how we might make it stronger too.

For more on this story, listen to Analysis on the BBC iPlayer or download the podcast.

Linda Yueh is a Fellow in Economics at St Edmund Hall, University of Oxford and an Adjunct Professor of Economics at London Business School. She is also the BBC's former chief business correspondent.

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