GDP - The Value of Drugs and Prostitution

The Office for National Statistics (ONS) has just increased the size of the British economy by nearly £10 billion, a figure equivalent to around 0.7 per cent of the economy as a whole. George Osboren has not waved a magic wand. We have not suddenly become more productive. The reason is that, for the first time, estimates of the value added by drugs and prostitution have been included.

These activities are included in an economic sector called 'miscellaneous goods and services', which, as an indicator of its diversity, already contains things like life assurance and post office charges.

All the member countries of the EU are being encouraged to include the value of drugs and prostitution in their estimates of GDP. Italy led the way. But the impact on the estimated size Italian economy pales into insignificance compared to the event known as 'il sorpasso'.

In 1987, the Italian government announced that their economy was now bigger than that of the UK. The simple reason for this was that GDP estimates had been upgraded by nearly 20 per cent to allow for the substantial amount of black market activity in Italy.

It is easy to be cynical about such revisions to data. In a fundamental sense, nothing changes. The Italians did not suddenly become 20 per cent richer. All that happened was that the estimates of how much income the country generated were revised to try and give a more realistic picture.

The ONS has already been criticised for the size of its estimates of drugs and prostitution. Its task is even trickier than might be imagined.

What matters for national accounts, for the estimate of GDP, is not the total amount of sales in any particular market such as prostitution, but how much value is added in that particular market. In other words, the revenue of the suppliers minus all the costs they incur in providing the service.

Perhaps an apprehensive member of the ONS was assigned to go and visit Miss Whiplash to form a view on the value of her equipment.

National accounts statisticians such as those at the ONS face challenging decisions every day. The economy cannot simply be put onto a pair of scales and weighed, as in a scientific experiment.

A whole series of judgements is required in order to estimate GDP, and the ONS often has to exercise considerable imagination and creativity to work out the contributions of a wide range of factors.

The more one delves into how the ONS arrives at its numbers, the more incredible it becomes that they have any meaning at all. Yet they do. GDP is a rough and ready measure, but it works. When the ONS estimate that it is falling, as it did in 2008 and 2009, employment falls and people feel the squeeze. When it is rising sharply, as in the mid-2000s, the mid-1990s and during the Nigel Lawson boom of the mid and late 1980s, almost everyone feels well off. Respect to the staff of the ONS!