Policy Research in Macroeconomics

It’s simple: [Great Crash]+[Tory austerity] = productivity decline

What Crisis?

For the last several years the media have carried reports of a crisis of low productivity plaguing the British economy, both in terms of level and rate of change.  Almost two years ago, PRIME’s Jeremy Smith provided what I considered the definitive refutation of the existence of such a crisis.  But, far from ending, the “crisis” discussion has gathered pace to become a recurrent media theme.

A presentation of trends in UK productivity appeared in the Civil Service Quarterly in July of this year.  With a typically sensible civil service approach the authors did not use the word crisis, preferring “stagnation”: 

UK productivity has stagnated since the 2007 financial crisis, having remained broadly unchanged since the end of 2007. The gap between current productivity and where productivity would be, based on the pre-crisis trend, currently stands at around 17%. 

Thus, the putative productivity problem is an interpretation derived from comparing the actual outcome to the simple numerical projection of a pre-2008 trend.  The vagueness of the word “stagnation” suggests need for a more rigorous inspection of the numbers.

Productivity Measures & Trends

An informative discussion of productivity requires analytical treatment of concepts and measures.  First and most obviously, productivity comparisons across countries should come with numerous warnings.  With the exception of countries within a currency union such as those in the European Union, comparisons involve application of exchanges rates.  Since exchange rates change over time, some adjustment is necessary, for example, an average or baseline rate.  Which rate to apply is to a great extent arbitrary. 

Second, in addition to exchange rate choice substantially affecting cross-country comparisons of specific industries, more aggregate comparisons are extremely dubious.  The composition of output and employment by sector differ substantially across countries.  Two countries could have identical productivity levels in every sector of their economies (however measured), yet show different aggregate levels due to differences in the distribution of production across sectors. 

These caveats help interpret the chart below taken from an Office of National Statistics report.  It shows changes in aggregate productivity across countries measured as total GDP divided by total number of people employed.  The most obvious inference is that the results are much the same for all countries but Italy.  The British change for the longer time period is very close to that for Germany.  

For the shorter period the British increase is the lowest of the seven countries except Italy.  As I show below the post-2010 result can be explained by austerity policies, not a long term malady.  The article in the Civil Service Quarterly suggested that “recent performance contrasts strongly with productivity growth over the past few hundred years”.  While numerically valid, it is absurd to suggest that a seven or eight year divergence from a 200 year trend is prima facie a fundamental problem.  Not absurd but rather foolish is the statement in the article that “productivity in Germany is 35% greater than the UK”.  The different distribution of production by sector could account for a substantial portion of that 35%; e.g. the German share for manufacturing is considerably higher than in Britain.  

Changes in productivity by country, 1995-2016 (red) & 2010-2016 (blue)

Source:  ONS . Measured in constant prices.

Source: ONS. Measured in constant prices.

The next chart focuses on Britain, showing two commonly used measures of aggregate productivity, output (GDP) per worker and per hour.  The 12 years before 2008 show a robust annual rate of growth for both, 1.8% for output per worker and 2.2% for output per hour.   During 2009-2016 the annual rates drop sharply to 0.4% and 0.3%, respectively.

This sharp slowdown after the Great Recession of 2008-2010 has an obvious and simple explanation, the fiscal austerity imposed on the economy first by George Osborne during May 2010 through July 2016, then subsequently by Phillip Hammond.  The slow growth – including recession – during these years resulted in under-utilization of capacity, a well-know cause of sluggish productivity or “stagnation”.  Slow output growth weakened the incentive  to renew and increase private capital stocks, whose expansion is the main source of productivity growth.

As the dashed line shows, these attempts at aggregate productivity measures are little more than variations on output per head – GDP per capita.  The much noted productivity puzzle is simple to “unpuzzle”.  Productivity by any common measure grew at its long term trend during 1995-2007 as did income per head.  

The Great Recession caused a GDP collapse from growth to decline, a collapse manifesting itself in aggregate productivity indices because they are essentially the same as income per head measures.  Fiscal austerity stunted and continues to stunt the recovery of the economy.  The numbers used to allege a productivity problem carry a simpler message, the failure of austerity economics.

Indices of output (GDP) per worker & per hour, constant prices, 1995-2016

Source:  ONS

Source: ONS

The austerity effect shows itself clearly when we inspect the largest sector for which productivity measures are reliable, manufacturing.  The chart below has two time series, output per worker in manufacturing and non-manufacturing.  By definition the weighted average of the two is GDP per worker (shown in the previous diagram).

The difference in the growth of productivity for the two sectors is striking, though that may in part be the result of problems with measuring output in services.  Over the 32 quarters of 2000-2007, output per worker in manufacturing grew at an annual equivalent rate of almost 5%.  The 29 quarters beginning 2010Q3 (first full quarter of Conservative government) show no trend.

Indices of output per worker, manufacturing & non-manufacturing GDP,  2000.1-2017.3 (Quarterly)

Sources:  ONS .

Sources: ONS.

Those who anguish over Britain slow productivity growth should ask themselves the following question.  How is it possible that in the sector for which measurement is least ambiguous that the rate of change of productivity could quite quickly collapse from almost 5% to zero?

The answer is, insufficient demand as a result of fiscal austerity policies.  A government that reverses that fiscal policy, as the Labour shadow chancellor promises, will in doing so restore productivity growth. It really is that simple.

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