Sunday 12th November, 2006

 

Better safe than sorry

 
 
 
 
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In the literature of information technology thinkers, organisational change processes have been conceptualised in terms of a continuum from automation, rationalisation, and re-engineering, through to paradigm shifting.

As this column indicated last week, dramatic changes in the national economic indicators should therefore precipitate some re-engineering and paradigm shifting for us in the field of financial planning.

Last week we looked at inflation and what we can do to help ourselves. We are also told by the Central Bank that GDP has never been so good. But what exactly is GDP? And what does GDP have to do with our personal savings programmes?

First of all, what is the economy? One way to understand this is to simply recognise that there are four major groups that make up the economy: firms, households, government, and the rest of the world.

Now GDP! It is the acronym for gross domestic product. This is a measure of the total output of the economy, during a given period, in terms of current production or new goods. Output is reflected in the market value of all the goods and services produced by everyone. The word domestic emphasises that it is production located inside the country.

It is calculated by multiplying the real output or income times the overall price level for final goods and services. Final goods and services refer to things that are ready for use, so that a plant which produces iron rods for another plant to use to make something else for the consumer is not a final good in itself. Rather, that will be classified as an intermediate good, and will not be counted.

In effect GDP shows the final value of sales for all new things produced in the country, and ignores the value of goods that change ownership if they are not NEW items. For example, when a house is sold, the value of such a transaction is not counted in GDP, unless the house is brand new.

Also sales of stock certificates are just ownership transfers and are not counted in GDP.

However, the fee that may be paid to the stock broker for his service will be counted since a new service has been rendered. But a profit realised by the seller is not counted in GDP.

The more specific components that make up GDP are:

1) household spending on consumption items

2) spending by individuals on new residential properties

3) spending by firms on new machinery, inventory goods, buildings etc.

4) the money spent by government

5) gross investments by government, and

6) the sum of exports minus imports.

Of those, the largest portion of spending is typically attributed to the personal consumption items of the first group: households.

Personal consumption

Personal consumption is divided into three types of expenditures. We buy what is called durable goods such as appliances and motor cars. The next category is called non-durable goods such as clothes, rum, and medication. The third in the category is called services. Services refer to doctor’s bills, school fees, bank charges etc.

I have taken the long road to get us to this point. The crux of the matter is that we have to rationalise our spending habits against the backdrop of higher prices, and re-engineer how we distribute limited incomes between durables and non durables and services.

It is better to be safe than sorry.

Methodology is crucial. According to the old Chinese proverb told to me recently by a safety consultant: even the faintest of ink, is more powerful; than the strongest of memory.

More on economic indicators next week.

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