The TUC’s latest Economic Report is now online and covers the UK’s ‘productivity paradox’.
The report analyses the relationship between estimates of productivity growth and the size of the structural deficit and surveys the recent debate between supply optimists and supply pessimists. It then goes on to look at eight commonly given explanations for the UK’s recent weakness in productivity growth.
The report concludes:
An accurate assessment of the causes of the UK’s weak productivity performance since 2009 is vital if policy-makers are going to make the right decisions about macroeconomic policy in the years ahead.
Over-regulation can be relatively easily dismissed as the culprit for poor productivity growth and hence the government’s emphasis on deregulation will not succeeding in boosting growth. The much debated idea of ‘zombie firms’ appears to be over-stated and even if it were not, calling for an increase in interest rates and insolvencies would seem a perverse policy choice given the wider negative impacts there would be across the economy.
It is striking how many of the supposed ‘supply side problems’ currently afflicting the UK economy can actually be explained by a lack of demand. An increase in demand would almost certainly lead to higher business investment, adding to the UK’s potential output. An increase in demand would also add to firms’ output, potentially leading to a relatively rapid recovery in measured productivity.
Understanding the ‘productivity paradox’ means looking closely at what has happened to real wages in the UK since 2009. Both labour hoarding in 2009/10 and the growth in low-wage, low-productivity sectors since 2010 are very likely explanations for weak measured productivity. All things being equal an increase in demand should boost real wages and secure growth in higher productivity jobs.
This is not to say that the UK economy does not face supply side problems, they are just not supply side problems that can be dealt with through the traditional tool of deregulation. Improving the functioning of the UK’s banking sector (to start with through the establishment of large scale state investment bank) so that it better supports the real economy is necessary.
It is also likely that the returns in the financial sector pre-2008 were unsustainable and will not be repeated in the near future. There is also evidence that some sectors of the UK economy have faced productivity problems for a longer timeframe – possibly due to skills shortages and a lack of investment. These sectors may be expanding due to cheaper labour costs and, given weaker productivity growth in financial services, this may become more of a pressing issue for policy makers.
- There is a strong case for a stimulus to demand. Many of the suppose supply constraints the UK economy currently faces are actually related to problems on the demand side of the economy. Boosting demand now would boost productivity.
- The output gap is almost certainly larger than the government currently estimate. Fiscal policy is tighter than is far too tight. This raises questions about the choice of the structural deficit as the target for policy.
- The Government’s current supply-side polices will not address the real supply-side issues we face.
- The UK does however require supply-side reforms – but the reforms we need are reform of the banking system, corporate governance reform to encourage long-termism, a better skills policy and a modern industrial policy to support the sectors of the future.
- Most worrying of the Government continues with its current policies of extreme fiscal consolidation and the wrong supply-side reforms the UK risks going further down the path of a being a ‘demand-constrained, cheaper labour’ economy.
The real danger is that if the Government continues to get both demand and supply side policies so wrong, then it risks doing serious long-term damage to the UK’s future growth prospects.