Saudi GDP II : Productivity & Capital Stock

In my last post I discussed Saudi’s simple GDP dynamics. Yet we did not discuss anything other than oil fluctuations and its relationship with growth rate of GDP and the importance of looking at growth rather than levels of GDP. Nor did we consider the important distinction between nominal and real GDP. Where real GDP is adjusted for inflation. In this post we do. We also make some adjustments to our GDP variable, looking closely at GDP per person to give us a clearer picture about the well-being of individuals. Below is the inflation adjusted gross domestic product for Saudi Arabia from 1970-2014.Rplot05.png

Factors of production

Playing around with more R and some data I provide some interesting visuals that asks important questions.  Before we do that, we need to refresh our memory about a certain element that constitutes the production process in a country. When talking about an economy’s output of goods and services, it is agreed that it depends on its quantity of inputs. These inputs are called the factors of production. An economy’s ability to turn these factors/inputs into output is represented by a production function.

The two most important inputs in production are capital and labor. Capital refers to the set of tools/machines/equipment that workers use, and Labor is the time people spend working. Another important element exists in the production process is the Total Factor Productivity (TFP). TFP is the portion of output that is not explained by the amount of input used in production. It determines how efficient inputs are utilized in production. The graphic below illustrates the process of converting inputs into outputs.

prod

Consider three economies, that have the same level of inputs 100 Labor and 100 Capital, but they differ in productivity. The table below shows how TFP plays a role on output. Country A has a TFP of 1 and correspondingly its output is 10,000. Country B has a TFP of 1.2, suggesting it can convert its inputs more effectively and can produce 2,000 more output than country A. Country C has a TFP of 1.6 and therefore is the most efficient country that yields the highest output.

prod2

Total Factor Productivity (TFP)

Now that we have a solid introduction to these factors let us consider again the Saudi case. Using the Federal Reserve data of St. Louis that acquired the TFP data on Saudi Arabia from the “Next generation of the Penn World tables” .(TFP is indexed to USA =1). We plot the Productivity level on the left, and Productivity change on the right, of Saudi Arabia against time (1970-2014).TFP

Now, let’s plot the productivity change on top of Real GDP change. Consider the graph below, we can see below that Real GDP moves close with productivity. The rough estimated correlation is 0.6.Rplot03

Plotting the GDP per person against TFP (Below). We see that as productivity goes up we expect to see higher GDP per person. In other words, the more productive Saudis are, the more incomes they will earn.RGDP Per capita with TFP

Capital Stock 

Let us shift our focus to another aspect of the production function, Capital stock for Saudi Arabia. The capital stock is simply the amount of capital stock in Saudi Arabia across time. Consider the left graph that depicts capital stock levels and right graph capital stock change.

Capital stockCapital stock has been increasing since the 70s with the similar story of the dip in the 80’s, that followed a continuous rise. Now let us examine how changes in capital stock goes with output or Real GDP. Below we plot real GDP per person against change in capital stock. We see a somewhat linear relationship; the estimated correlation coefficient is 0.62.new

These visuals tells us that our production function story is relatively true, that is increases in capital and productivity are associated with higher incomes for people. We will refrain from discussing the labor input for another post.

To conclude

Let us see how it all adds up together. Below we plot real GDP per person on top of TFP (left graph).We see that there has been a close association from 1971-2000: the correlation between TFP and Real GDP per person is 0.95 (1971-2000).

lastone

This association departs in 2000, we see that after 2000 productivity did not catch up with the rise in GDP. This tells us something about the structure of Saudi’s economy, which is a natural resource dependent country. We also plot to the right the change in capital stock on top of TFP, we see that up to 90’s there was a close association between changes in capital stock and TFP: from (1971-1990) the correlation coefficient  is 0.95. The departure of the associations entails an interesting story. Despite the rapid increase in capital stock, Saudi’s productivity has remained within [1.0-1.5] range. Whether that is normal standards or not we can clearly see that dynamics of production have changed.

 

 

SAUDI GDP: Using R visualization

There is an important distinction to be made when anyone examines Gross Domestic Product (GDP). Before we go deeper let’s clarify what it means. Gross domestic product is the monetary value of all the finished goods and services produced in a country in each year. It entails all private and public consumption, investments, adding exports and subtracting imports. Simple equation illustrates,

GDP = C + I + G + (EX-IM)

GDP is an important indicator of economic health of a country, used by many as proxy for standard of living. Is it the full picture? what about the pulse of the economy?

Note: arguments that relate how GDP does not capture standard of living is for another post.

I will consider the case for my country Saudi Arabia. The graph below shows the GDP level for Saudi Arabia across time (in millions), specifically 1970-2016.SAUDIGDP1970-2016

We see a rise from 1970 level compared with 2016 level, a large dip in the 80s, and a somewhat steady continuous rise. Consider now the growth rate of GDP. The growth rate of the economy is the percentage change of the GDP from one year to the next. Which explains how fast an economy is growing.

Gdp Growth 1960-2017.png

The graph above shows the growth rate of 46 years of Saudi Arabia. This graph does does not look as consistent as we thought it is by checking the first graph, when looking only at GDP level. Growth rate tells us a different story about the pulse of the economy, one that is far more interesting than the GDP level, where the only story is during the 80’s, which we can relate to in the growth picture. In that time frame Saudi’s GDP year on year declined by 20%.

Moreover, considering the case for Saudi we can see that it is far from being consistent or stable. However, if one would look at the level of GDP Saudi starting in 1970 compared to 2016 we can safely say that on average the growth rate for 46 years was 3.7%. Yet that is far from the truth now isn’t it.

Saudi GDP.png

As we know Saudi’s GDP stems from its oil production, then there must be a considerable effect from the oil price fluctuations. Oil prices are very volatile, check the two comparisons below. The left graph depicts the price of oil since 1986, where the right graph entails the change of oil prices year on year. We see that oil is very volatile across time.

Rplot03

Now let’s see how oil price fluctuations looks with Saudi GDP growth. Below we can see that there exists some sort of lag effect from oil prices on GDP. By lag I mean it might be that last year oil price change effects the following year in GDP growth.Oil GDP growth 86 vs Oil price change.png

There exists an intimate relationship between the change in oil price and GDP growth for Saudi Arabia. When one looks at GDP level we do not see the whole picture of the pulse of the economy. For a natural resource driven country we see plenty of volatility from its reliance on oil as main source of income. Yet we can conclude that in the long run (46 years) Saudi has grown on average 3.7% per annum.

Update* June 20th 2017

I acquired data that explains this relationship better. As the graph below shows, the Real GDP Growth of the Saudi Economy and Oil Sector growth. They exhibit a 0.77 correlation which indicates the intimacy mentioned previously.

Saudi RGDP growth and oil sectory growth.png