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The North East Economy and GVA Will Haywood Economic Intelligence Specialist Advisor Policy & Research Team 22 January 2007 Introduction The structure of the presentation is as follows: 1) 2) 3) 4) 5) The key points What is GVA (Gross Value Added)? Measuring the economy and GVA Economic growth and the North East The key points revisited Key points GVA measures the total value of goods and services available through economic activity GVA = Output = Income = Expenditure Regional GVA is measured using the income approach: North East GVA = NE wages + NE profits Economic growth is generated by: 1) More jobs = Additional wages = Higher GVA 2) Higher productivity = Higher profits = Higher GVA What is GVA? Broadly GVA is a measure of the total value of goods and services made available through economic activity – in other words, the size of the economy National Statistics GVA definitions: Company WRH Sales £100 Cost of Sales £30 Wages £40 Expenses £20 Net Profit £90 £10 GVA for Company WRH = £50 • Sales less CoS less Expenses = £50 or • Wages plus Net Profit = £50 —“GVA measures the contribution to the economy of each individual producer, industry or sector in the UK” —“The difference between output and intermediate consumption (the cost of raw materials and other inputs used in production)” GVA has now replaced GDP (Gross Domestic Product) as the measure of a region’s economy. However, at national level GDP remains the preferred measure The relationship between GDP, GVA and component parts 100% NIT G NIT P 80% Key GDP – Gross Domestic Product GVA – Gross Value Added GOS I 60% % of GDP GDP* GVA 40% Value added by sector GDP CoE C 20% 0% C – Consumers expenditure I – Investment G – Government spending NX – Exports less Imports NIT – Net indirect taxation - Taxes less subsidies on products P – Taxes less subsidies on production CoE – Compensation of employees GOS – Gross operating surplus *GDP measure not now used NX GDP* at Aggregate income factor cost GVA at basic prices Aggregate GDP at product market prices Aggregate expenditure Note that headline GVA figures are published at basic prices and that taxes less subsidies on production (P) are generally included as part of Gross operating surplus (GOS) Measuring GVA and the economy The size of an economy can be measured in three ways. The UK National Accounts are constructed so that these methods give (in theory) the same answer: i) The output or production approach • ii) The income approach • iii) Aggregate Output aka Aggregate Product aka Aggregate Supply Aggregate Income The expenditure approach • Aggregate Expenditure aka Aggregate Demand So: GVA = Output = Income = Expenditure Whilst this rule holds for any level of geography, availability of data means that Regional GVA estimates are presently only made using the income approach Output or production approach 1 How a loaf of bread’s value added is sliced up 0 10p 20p 30p 40p Farmer’s value added Farmer Value of wheat Miller Value added Intermediate expenditure Miller’s value added Final expenditure Baker Grocer Note that the sum of all value added is also equal to final expenditure. Total value added across all industry sectors gives total output based GVA i.e. aggregate product Grocer’s value added Wholesale value of bread Retail value of bread Final expenditure on bread Consumer 0 GVA Baker’s value added Value of flour 10p Farmer’s value added Miller’s value added 20p 30p Baker’s value added Gross output = GVA + Intermediate expenditure Grocer’s value added 40p ‘Double counting’ both the expenditure on final goods and intermediate goods will give gross output figures Output or production approach 2 How bread’s GVA adds up at each stage of production Intermediate expenditure (Purchases) Gross output (Sales) GVA (Sales less purchases) 0 10p 10p Miller 10p 20p 10p Baker 20p 30p 10p Grocer 30p 40p 10p Total 60p 100p 40p Farmer The point at which the final good (i.e. the bread) is traded is the relevant one in terms of economic accounting. At this point GVA is equal to income (i.e. the Grocer’s income from the sale of the bread) and expenditure (i.e. the Consumer’s expenditure on the bread) – all 40p Expenditure approach The expenditure approach calculates aggregate expenditure (aka aggregate demand or total spending) in terms of market prices i.e. inclusive of indirect tax such as VAT and therefore strictly a measure of GDP There are four main elements: Consumption expenditure (C) – approx 65% of UK GDP Investment (I) – 17% Government expenditure (G) – 21% Exports (E) less Imports (M) – (3%) UK GDP breakdown in 2003 C = £761bn I =£199bn G =£251bn UK GDP in 2003 = £1,177bn E = £299bn M = £334bn Income approach 1 This method is the one used to generate Regional GVA estimates Only income generated through the output of goods and services i.e. via the production process is included in the calculation of income-based GVA Therefore, the following are excluded: — — — Transfer payments – unemployment benefits and the state pension Private transfer of monies between individuals and income not registered with the Inland Revenue The Black or Shadow Economy Income approach 2 The main components of income-based GVA Major Components Source of data Approximate % of total NE GVA Compensation of employees Wages Employers’ social contributions IR tax returns Government accounts and ONS surveys 65% Gross operating surplus Company profits Rental income from property ownership IR and ONS/DTI inquiries and ONS estimates 28% Mixed Income Income of soletraders and the selfemployed Taxes less subsidies on production Total GVA Business rates IR and DEFRA HM Customs and Excise 5% 2% 100% Source: UK Gross National Income (ESA95) Inventory and DBS Regional Economic Model Economic growth and Real GVA Economic growth rate = Rate of increase of Real GVA Nominal v Real — — Nominal figures are expressed in current prices with no allowance made for inflation Real figures are expressed in constant prices with allowance made for inflation enabling year on year comparison to be made GVA Growth Example of derivation of Real GVA growth Nominal GVA Real GVA Real GVA GVA deflator 2005 2006 Nominal NE GVA growth rate 5% Inflation rate 3% Real NE GVA growth rate 2% UK Trend Growth A recession occurs when Real GDP falls – this was last observed in the UK (and the NE) in the early 1990s Real UK GDP Boom Below trend Bust Mid 1980s UK Trend Growth 2.5% p.a. Actual Growth Above trend (£s) Key Now Actual growth fluctuates around trend growth – aka the economic or business cycle. UK growth in the past decade has exhibited less ‘variation’ around trend than during earlier periods of rapid growth and decline or ‘boom and bust’ Drivers of GVA growth Productivity — is a measure of how efficiently factors of production (land, labour and capital) are used in the production process Productivity = GVA per job or GVA per hour worked “Higher growth in per capita incomes can only be sustained by raising the trend rate of productivity growth” Source: HM Treasury Participation — — Employment rate Population of working age Typical annual contributions to UK Trend Growth Productivity rate 2.0% Working age pop 0.4% Employment rate 0.1% Higher output growth and the role of the key drivers Increasing the productive potential of the economy enables more goods and services to be produced, leading to higher potential consumption. This is long-term economic growth The Production Possibility Frontier (PPF) indicates the limits of an economy’s productive capacity Goods c PPF2 Initially productive potential stands at PPF1 or ‘ab’ but can be shifted outwards to PPF2 or ‘cd’ through improvements in productivity as shown or through increased levels of capital stock Skills a Investment PPF1 Innovation Enterprise Competition 0 b d Services GVA, GVA per capita and the North East picture GVA v GVA per head Economic performance comparison - GVA per head — — UK v China North East v UK North East double-whammy — — Low productivity – concentration of employment in less well paid sectors and relatively low pay for the same occupation Less workplace participation – relatively low employment rates and an ageing population profile Ways to increase GVA per head Increase the following: — — — — Employment rate – more people in employment and earning Number of businesses – greater levels of enterprise and competition leads to higher productivity Skill levels – very strong correlation between higher skills and higher earnings Innovation and investment in the latest technologies – the highest returns flow from competing at the cutting edge of any sector Decrease the following: — Economic inactivity and benefit dependency – any work done by North East residents previously unemployed or not in the labour market will increase GVA per head Key points revisited GVA measures the total value of goods and services available through economic activity GVA = Output = Income = Expenditure Regional GVA is measured using the income approach: North East GVA = NE wages + NE profits Economic growth is generated by: 1) More jobs = Additional wages = Higher GVA 2) Higher productivity = Higher profits = Higher GVA