Friday’s national accounts release was not entirely disappointing: GDP grew by 2.7 per cent at annual rates in the third quarter of 2013. The better news was that GDI – Gross Domestic Income – grew by 3.4 per cent. GDI is not as well-known as GDP, and up until fairly recently there really wasn’t much point in paying close attention to it: it tracked GDP fairly closely up until 2002. But the surge in commodity prices in the last decade had led to a significant divergence of the two measures.
Here is how I explained the difference between GDP and GDI in this WCI post:
Suppose that Canada produces 100 beers, but we have to have a pizza with each beer. We don’t produce pizza, but other countries do, and we can trade beer for pizza with them at the rate of one beer for one pizza. So we can export 50 beers, import 50 pizzas, and we happily consume our 50 beer-and-pizza combos.
There are two ways that we can see our lot improved. One way would be if we simply produced more beer. If we were somehow able to improve our productivity by 50%, then we could produce 50 extra beers, trade 25 of them for pizzas, and we’d now have 75 beer-and-pizza combos.
Since Canada produces only beer, the increase in GDP is the same thing as the increase in beer production. But what we really care about isn’t beer production, it’s the consumption of beer-and-pizza combos – and this is what GDI measures. So long as the rate at which beer and pizza are traded on the international markets stays at 1:1, it doesn’t matter which measure you use. GDP has gone from 100 to 150 (50% increase), and GDI has gone from 50 to 75 (also a 50% increase).
But there’s another way that our situation can be improved. Suppose that beer production is 100, but for some reason – less beer on international markets, more pizza or some combination of the two – the relative demand for beer increases, and beer producers are now able to obtain three pizzas for one beer. This 200% increase in Canada’s terms of trade – the ratio of the price of the good it exports to the price of the good it imports – means that Canada can trade 25 beers for 75 pizzas. Even though beer production hasn’t changed, we can now consume 75 beer-and-pizza combos.
It is here that the distinction between GDP and GDI becomes important. Since beer production hasn’t changed, Statistics Canada would record no increase in GDP. But since we’re now able to consume 75 beer-and-pizza combos, measured GDI would increase by 50%.
This story is useful in interpreting what’s been going on in Canada since 2002. Although commodities are not the only thing – or even the main thing – that Canada exports, its prices are so volatile that they have been the main driver of movements in the terms of trade:
Statistics Canada’s Cansim Table 380-0065 breaks down GDI growth into its GDP and terms of trade components. During the 2002-2008 expansion, roughly 40 per cent of the increase in GDI came from the improvement in Canada’s terms of trade. And the collapse of commodity prices during the financial crisis aggravated the recession beyond its effects on employment and GDP: most of the reduction in GDI came from the fall in our terms of trade, not the decline in GDP.
The rebound in commodity prices played a key role in the first two years of the recovery, but as you can see from the first chart, they’ve gone sideways since early 2011. Since then, GDI growth has been driven entirely by GDP growth. Unfortunately, GDP growth has only just kept pace with population growth:
The slight uptick in commodity prices and in the terms of trade provided a boost to GDI beyond the increase in GDP in 2013Q3, but it’s hard to see how this increase is much more than random short-term noise.
The Canadian economy has spent the last two years in limbo: we’re more or less back where we were before the recession hit (see also here), but the next expansion hasn’t started yet.