I am keen on dogs. Recently, I saw an advert for a special canine toothbrush designed to get rid of the pet’s bad breath – surely a difficult challenge given what dogs get up to. Vans promoting home beauty visits for dogs have been widespread for some time now. A new service being promoted is day care for dogs, similar, one might think, to child care. The dog is deposited and entertained for the day while you go off to your meeting or out to lunch.
At one level, these stories are mere trivia. At another, they are a tribute to the continuing inventiveness of capitalism. The role of the entrepreneur is to imagine a product or service which no one, until then, realises they want, and to make a successful business out of selling it. But these stories are also relevant to the important policy concept of the output gap. This is defined very simply as the difference between the actual and potential levels of GDP.
Describing the output gap is one thing, measuring it in practice is quite another. The Office for Budget Responsibility (OBR) is required to provide an estimate. A key reason for this is that the output gap plays an important role in assessing the government’s financial deficit, once cyclical factors are taken into account. In recessions, tax receipts drop, so the deficit rises. A measure is needed which allows for this, and this is the so-called cyclically-adjusted deficit – what the deficit would be if the output gap were zero. The output gap is also crucial for central banks in judging whether inflation is likely to be a problem as the economy expands. During the past year, there has been a flurry of publications from the various US Federal Reserve banks on this subject.
But what is the potential level of output of the various dog services described above? Dog day care, of course, is just one illustration of a proliferation of inventive offers which are available in the modern service economy. Personal trainers and lifestyle coaches are other notable examples. There is obviously a limit to the number of dogs for which any one person can provide day care. But from the point of view of measuring the potential value of the output of a dog caring business, a great deal depends on what price the market will bear.
Part of the problem is that such services are not commodities like, say, gold bars, which are the same everywhere. They all have their own features, their own specialities. This introduces an inherent indeterminacy into the price, which is essentially a bargain between the seller and each individual buyer. If I can double my price, I can double the value of my output, with nothing else changing at all. And as the economy expands, the easier I will find it to put my price up.
Potential output in the personalised service sector of the economy is a very flexible and elusive concept. The idea of the output gap belongs to an economy which made steel bars and dug coal, not one which provides day care for dogs.