The UK economy is registering very good numbers on the output and on the labour market front right now. The first quarter of 2014 saw the official GDP (Gross Domestic Product) numbers register quarterly growth of 0.8% which according to the NIESR has picked up to 0.9% in the 3 months to May. The labour market has seen saw 780,000 more people employed in the year to April and 347,000 fewer unemployed as the unemployment rate has fallen to 6.6%. These positive quantity numbers have pushed our economy forwards although there is a price issue in the labour market as we note that regular pay in the year to the single month of April rose by 0.4% andso it fell by 1.4% compared to official inflation and 2.1% compared to the Retail Price Index. One factor which is interlinked and entwined with the disappointing wage numbers has been the behaviour of UK productivity and it is this which I intend to put uner the microscope today.
The productivity gap
Ordinarily the numbers above for output and employment would be associated with rising productivity but the credit crunch era has been full of apparent contradictions and changes in consensus thoughts. Here is the view of the Bank of England in today’s Quarterly Bulletion.
Since the onset of the 2007–08 financial crisis, labour productivity in the United Kingdom has been exceptionally weak. Despite some modest improvements in 2013, whole-economy output per hour remains around 16% below the level implied by its pre-crisis trend.
Rather chilling numbers aren’t they? They are almost of a level which would require a warning that they are not for those with a nervous disposition. However I note the use of the word labour in front of productivity so let us be clear what is being discussed.
The level of labour productivity…. measures the quantity of output that an economy is capable of producing with its existing resources.
This particularly matters for the Bank of England because of this relationship.
Measures of productivity are also important for the conduct of monetary policy, since they can be used to infer the economy’s ability to grow without generating excessive inflationary pressure.
So we have another explanation for the way that the UK economy suffered from an inflationary surge in a recession/depression. This is awkward for the Bank of England which at the time told us it was “temporary” but now gives us (another) reason why it persisted although they do not put it quite in those words!
Some care is needed here because of this point.
In the long run, technological progress, which leads to advances in measured productivity, is one of the main determinants of economic growth and improvements in standards of living.
The Bank of England has gone back to 2008 and projected the previous growth forwards. Have you spotted the flaw? Some of the productivity “growth” for example in the banking and financial services sector never existed and was aa the pop group Imagination put it “Just an illusion”. This not only has the numbers here starting at too high a base but has too high an expected growth rate as well.
However there is an issue even allowing for the factors above as explained below.
Even six years after the initial downturn, the level of productivity lies around 4% below its pre-crisis peak, in contrast to the level of output, which has broadly recovered to its pre-crisis level.
The story starts well
During the recent recession, employment has been more resilient than in the 1980s and 1990s downturns, despite the larger fall in output.
Before the credit crunch economic journals were full of articles asking businesses to behave like this. However it turned out to have at least some elements of “be careful what you wish for in it” as after it happened they now worry about the productivity consequences. The same number of people with lower output means lower productivity. As firms who had shed jobs in the past had struggled in the recovery phase to employ the same quality workers we may have been exchanging a short-term weakness for longer-term improvements. If so it would not be unreasonable to be hoping to see the improvement phase appear soon.
How does the Bank of England explain developments?
This is a regular theme of this blog and the authors of this report are concerned about our GDP statistics. However sadly they think that what I regard as double-counting Research and Development (R&D) will help which is awkward to say the least if we look backwards for comparison as it was not (double) counted then was it? Re-writing of history seldom ends well. Maybe this recession will be revised in a positive manner over time like the majority of its predecessors but we may also discover one more time that it was a very different type of slow down.
They feel that if they add in other issue that around a quarter of the issue may be covered here. Extreme care is needed in my opinion as they do not know this.
Another UK “puzzle”
This is simply self-employment. In truth the official statistics tell us only one thing which is that it has grown. We know little about earnings as they are not counted in the official number so we only get very lagged glimmers of light from the income tax numbers. We also are very unsure about their output and hence cannot have a real clue as to their productivity.
As they have told me they do read my blog my suggestion to the UK Office for National Statistics is that they put a lot of effort into improving their measurement of the UK’s self-employed sector. Up to now we are viewing it through something of a smokescreen.
We have been investing less or as the Bank of England puts it.
Investment in the physical capital stock has been subdued in the aftermath of the crisis.
They also point out that relative costs may have reinforced the way that the labour situation has improved whilst investment has struggled.
In addition, because real wages fell considerably whereas the cost of capital initially increased at the start of the crisis, the relative cost of labour to capital is likely to have fallen.
The Bank of England estimates that around 2.5% of the productivity puzzle can be explained here. As they investigate the rest of this area and issues with what they cosider to be a falling amount of R&D they offer a daming critique of counting it in the GDP numbers.
But R&D expenditure is only a measure of innovation input.
Measures of innovation output are, for example, the proportion of companies that have introduced new goods or services.
Ahem exactly! Is there an economics equivalent for the concept behind a Freudian slip?
Here we have a conceptual issue as the Bank of England do not put it quite like this. Let me explain why. If you think that the monetary easing measures and bailouts have allowed firms with what might be called debt based business models to survive then a driving force of capitalism described so well by Josef Schumpeter as “creative destruction” has been blocked. I can understand why economist who presumably wish to have a career path at the Bank of England may wish to divert around and gloss over such an issue!
Another issue to be faced here is thet fact that some of what was considered to be productive investment pre credit crunch no longer is. In terms of calculations you could argue that it simply vanished although it is in many ways more accurate to say that we were over measuring it back then. Of course part of this road leads us back to creative destruction or rather the lack of it.
I welcome the efforts of the Bank of England economists here as our knowledge is so disappointingly finite. All though they end up reminding us that we can be sure of so little. Perhaps their analysis expalins half of the problem that they identify. Although care is needed in my opinion as extrapolating the past through a period of extreme change is unwise and frankly is misleading. I am reminded of the words of a column in the Financial Times written by Willem Buiter who was a tutor of mine at the LSE.
I know I know nothing: but at least I know that
If we move to more general central banker matters I note that the Wall Street Journal has covered a development which readers of this blog will be familiar with. This is the movement of equities onto the balance sheet of more and more central banks. Let me leave you today with this question. In the future will all central banks be hedge funds?