Presented by Nicholas Oulton (London School of Economics and ESCoE)
Venue: Office for National Statistics, 1 Drummond Gate, London, SW1V 2QQ
What effect, if any, do changes in the terms of trade have on the level of output (GDP) or welfare? I examine this issue through two versions of a textbook, Hecksher-Ohlin-Samuelson (HOS), two-good model of a small, open economy. In the first version both goods are for final consumption. In the second, one good is an imported intermediate input into the other. In both versions, economic theory suggests that an improvement in the terms of trade raises welfare (consumption) but leaves aggregate output (GDP) unchanged. This follows from a continuous-time analysis using Divisia index numbers. I argue that Divisia index numbers are the appropriate theoretical foundation for national income accounting, even though they cannot be calculated exactly. I then show that a national income accountant applying the principles of the 2008 System of National Accounts (SNA) would reach the same conclusions as the theorist. In other words, applying the principles of the SNA enables one to distinguish between changes in welfare and changes in output. However, the way that the “trading gain” is treated in the SNA leaves room for improvement.
Nicholas Oulton is a Fellow at the National Institute for Economic and Social Research, a member of the Centre for Macroeconomics at the London School of Economics, and a Fellow at the Office for National Statistics. He was previously a Senior Economist at the Bank of England. He has published some 60 articles in academic journals and books and he is the co-author of a book on UK productivity. His research has focused on productivity at the firm, industry and country level. He has also worked on improving price indices and purchasing power parities.