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History tells us that GDP estimates are unreliable
Britain's economy grew by 0.3pc in the first three months of the year. But past experience suggests that the true figure could be even higher.

Norman Lamont knows a thing or two about hindsight.

Back in October 1991, the former British Chancellor declared that he could see "the green shoots of economic spring appearing once again". Unfortunately for him, those green shoots never sprouted, unemployment carried on rising, and the year ended with Britain being booted out of the Exchange Rate Mechanism.

Although Lord Lamont, as he is now known, may have regretted uttering those words at the time, it was his foresight that was proven right. Later revisions to the data showed that UK economic growth was flat during the first half of 1992, but turned positive over the second half of the year.

It was not the first time that revisions have painted a different picture of the UK economic landscape. In fact, history suggests that many of the ONS's estimates of GDP are unreliable.

Simon Ward, chief economist at Henderson Global Investors, has long doubted the accuracy of gross domestic product (GDP) figures. He points out that the cumulative contraction in GDP between Q4 2011 and the first quarter of 2012 was initially reported to be 0.6pc.

In less than a year, the ONS revised the figure to -0.2pc, with falls of just 0.1pc over both quarters. If later revisions show that the economy did not contract during the first three months of 2012, the double-dip recession that caused so many jitters at the time would be no more.

Mr Ward, who points out that ONS growth figures have been revised up by an average of 0.15pc since the beginning of 2009, argues that it takes "at least five years" to get reliable GDP data.

With this in mind, Mr Ward says that “true” growth in the first quarter may have been "0.5pc or more".

"My personal view is that the ONS shouldn’t publish this preliminary estimate. I don’t think they’ve got enough information, so I would be in favour of waiting at least another month," says Mr Ward.

Another volatile part of the economy is Britain's construction sector, which drives 7pc of UK economic activity. The way construction output is calculated was changed in early 2010, and though the ONS claims that the new figures are better than the old ones, it admitted there was "a tendency for upward revisions of between 1pc and 2pc".

Recent labour market data, which suggest the UK economy is much stronger than headline GDP figures show, have also proved perplexing for economists. Employment levels have already returned to pre-crisis peaks, while productivity is some 14pc below where it would have been had the pre-recession trend continued.

As one commentator put it, that's the equivalent of an extra eight-minute cigarette break for every employee, every hour.

Analysts at Oxford Economics highlight that some of the sectors that have seen the strongest rates of job creation over the past year - such as transport and communications and profiessional services - have also reported weak trends in output. For example, while the construction sector has seen a drop in GDP of more than 9pc over the past year, the decline in employment was less than 2pc.

Some say this is because employers are "hoarding labour" in order to keep hold of skilled workers. But as Oxford Economics explains, it is unlikely that such hoarding would still be in place so many years after the onset of the crisis.

Others suggest that this is a reflection of more people taking on part-time work, but "given that output per hour has fallen back by a similarly large amount, this factor does not seem to have had a significant impact," Oxford Economics questions whether GDP growth has in fact been under-reported.

Getting GDP right

GDP is measured in three ways. Output, which is the value of the goods and services produced by all sectors of the economy. Expenditure, or the value of the goods and services purchased by households and the government, and income, which measures earnings, mostly via wages and profits on investments.

Compiling the data is a complicated process. The output measure alone - considered the most accurate in the short term - involves surveying tens of thousands of UK firms and government departments.

Once completed, the ONS issues a preliminary estimate of UK growth, 25 days after the end of the quarter. This is based exclusively on the output measure of GDP, and represents roughly 44pc of the data.

A second estimate is released eight weeks after the end of the quarter, based on 83pc of the data. A third, issued after 13 weeks, includes 92pc.

But that's not the end. Revisions are ongoing, meaning it is common for data changes to be done for up to two years after the initial estimate.

Much more emphasis is now placed on the quality of the data, as well as quantity. Before 1989, statisticians simply took the three measures of growth, added them up, and then divided the result by three. The quality of the different data were ignored as all three components were given equal weighting.

This over-simplistic way of calculating growth was criticised by the Treasury in the 1988 Autumn Statement, which said it was "difficult to assess how strongly the UK economy has grown over the past two years" because the data showed wide disparities between the output measure, which had increased by 6pc in the year to the first half of 1988, while expenditure had only grown by 2.5pc. In an perfect world, all three should produce a similar number.

This led to an overhaul in 1989 of how GDP is calculated, known as the Pickford Review. Today, the Treasury still keeps tabs on the ONS to make sure it gets its sums right. Each quarter, officials from the Treasury, the independent Office for Budget Responsibility and the Bank of England meet to quiz the ONS on its methodology.

The ONS has also launched an "improvement plan" to ensure that its current method of calculating UK growth is still fit for purpose. The review's initial findings, published last Autumn, revealed a shake-up in how GDP will be calculated, the first stage of which will be reflected in the final estimate of Q1 2013 GDP in June.

The ONS has already warned that the change in methodology "could introduce larger than usual revisions in inventories and potentially GDP".

In other words, if you don't usually trust the ONS's GDP estimates, be prepared for even more changes now.

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