Why economic growth is like a bicycle

GDP – volatility is normal

There is nothing too surprising about GDP volatility. It’s one of the reasons why we don’t get very excited about a single quarter’s results. On their own, they don’t mean that much.

The components that go into the GDP calculation are themselves very prone to volatility. Private fixed capital formation provides the bulk of variance in GDP as the principal moving part in every business cycle. Consumer spending may account for the bulk of GDP, but in contrast, it is far less volatile. Swings in inventories often account for sizeable movements in GDP, and this can be reinforced, or subsumed by net exports, where swings also have a tendency to be large.

In short, GDP volatility is normal. Stability appears unlikely.  

Developed nations more or less stable than their developing counterparts?

Some of Asia’s economies are not only growing quickly, but their growth seems extremely stable. In contrast, many developed economies exhibit not only slower growth, but more volatile figures. For example, the United States, a country that you would imagine operates state-of-the-art statistical operation for measuring national accounts, has seen growth since 2016 drop as low as 1.3%YoY (2Q16) and as high as 4% (1Q14), a range of 2.7 percentage points – many times larger than a lot of Asian economies.    

This raises a number of questions. Firstly, would you expect fast-growing economies to exhibit more volatility in growth than slower-growing developed economies, or less? Equally, would you expect less developed economies to be more, or less volatile than their developing counterparts?

This note takes a look at these questions and uncovers a few surprising answers.

What does the data show?

Our expectation before examining the data was that fast-growing economies would show more volatility in GDP than slower-growing ones. The rough-logic for this was simply a thought that if you managed GDP growth of only 2% on average, than a percentage point swing would be a far bigger deal than for a country where the growth rate typically averaged five or 6%.

To test this hypothesis, we took Asian Pacific economies, together with some developed economies which we will call the “G7 plus”.  We plotted their average GDP growth against the standard deviation of that growth. The results are shown in the charts below.

First, a bit of detail. We defined growth in year-on-year terms. This removes much of the seasonality that is embedded in Asian data, especially with respect to the Chinese New Year, which plagues much of the data here. It is also the only practical way of including data on China for which no other comparable quarterly real GDP data is available.

We also restricted the sample for this experiment to the period from 1Q13 onwards, since we didn’t want the data dominated by the global financial crisis.  This still left us with 26 observations for each country, close to what is usually regarded as a sufficient sample for approximating a normal distribution.

The charts are surprising. Although the fit isn’t great, for the full population of countries, there is a clear negative relationship between average growth and the standard deviation of that growth. That observation remains even when we split the countries up into a G7-plus and an Asia-Pacific group. So it looks fairly robust. Interestingly, this relationship is stronger for the G7-plus group than it is for the Asia Pacific group. 

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