From the TUC

Rising productivity: What does it mean for policy?

03 Sep 2013, by Guest in Economics

For much for 2011 and 2012 one of the core debates in UK macroeconomics revolved around what came to be termed the ‘productivity puzzle’. During the crisis output fell by much more than employment and, as consequence, productivity fell. This led to a discussion about the causes of that productivity drop and the forming of two broad camps – those who believed that the UK’s weak productivity performance was due to supply side factors and those who thought the causes were more on the demand side.

This debate may appear to be of primarily academic interest but in reality it was crucial to policy makers, it cuts to the heart of the question – ‘why has UK growth been so poor since 2009?’

If the problems are on the supply side then any boost to demand (such as through a fiscal stimulus) will simply push up prices as output struggled to keep pace with increased spending. Whereas if the problems are primarily on the demand side, then there is a much stronger case for stimulus

Whatever the cause, the UK’s productivity performance since the crisis has been extremely poor:

Output per worker

After a big fall in 2009, productivity has failed to recover.

For what’s worth – I’ve always thought that the UK has both demand and supply side issues that needed resolving.  The correct policy response is on the demand side in the short run and the supply side in the medium run. (This TUC Economic Report from earlier in the year covers the debate in more detail).

I’ve re-hashed this all today because recent economic data is offering a tentative answer to the ‘puzzle’ and it looks like the supply side pessimists were wrong.

It is certainly starting to look like productivity may be about to rebound. I’d offer three bits of evidence.

Starting with GDP, we now know output grew by 0.7% in the second quarter (on a quarter by quarter basis).   

By contrast over the same period (Q2 on Q1), the number of people in work grew by only 0.2% (and the number of hours worked grew a little faster at 0.3%).  Simply put, output in the second quarter grew by considerably more than the number of people in work suggesting a pickup in productivity growth.

Of course a single quarter’s data doesn’t constitute a trend, but there are other signs to.

Yesterday’s strong manufacturing PMI showed a pick pickup in orders and output but only a modest improvement in employment. This again is suggestive of improving productivity.

Today’s OECD forecast for the UK good upward revisions to growth in 2013 and 104 but again only modest changes to employment forecasts.

It is starting to look like a productivity pickup began earlier in the year and that it might be maintained.

Given there have been no major changes to the supply side of the economy over the past 6 months, the explanation for this productivity growth should be looked for on the demand side of the economy.

I would argue that the falling household savings ratio has provided a boost to demand and this is leading to higher measured productivity.

So, if productivity is picking up, what does this mean for the economy? I’d argue it could have potentially large effects on both monetary and fiscal policy but the impact on living standards might be more muted.

First off, a productivity pickup implies (given the Bank of England’s new thresholds and guidance) that rates will remain low for an extended period. Higher productivity will mean that unemployment falls less as demand increases than would otherwise be the case. This all implies that ILO unemployment may remain above 7.0% for longer than it would with lower productivity.

It also means that increased demand will be less inflationary, again taking away some of the pressure for rate increases.

Second, in terms of fiscal policy the impact of higher productivity could be substantial.  Faster productivity growth could easily led to the OBR revising up its forecast of the output gap and hence revising down its estimate of the structural deficit. As I’ve argued before, this could have huge economic and political consequences.

Finally, what does higher productivity mean for living standards? In the medium to long run it has the potential to be very good news indeed (higher productivity means more output per person and hence a higher standard of living) but in the short run it may not mean much.

Despite a productivity improvement in 2013 so far, there appears to be little upward pressure on wages. Beginning in the 1980s productivity and wages began to decouple and currently that does not look set to be reversed.  Re-coupling productivity and wages is a major challenge for policy makers and one that cuts to the heart of ‘economic reform’.

Rising productivity is no doubt a good thing for the UK economy but if we want to make sure that people in the middle and below benefit from it, then that means economic reform and that is the job of politics.

2 Responses to Rising productivity: What does it mean for policy?

  1. John
    Sep 4th 2013, 3:19 am

    Thanks for this interesting update.

  2. Aless
    Sep 4th 2013, 8:19 am

    You have a very good opinion, based on real facts. I share your thoughts, and hope that something will be done in order to help the middle and below class.