From the TUC

Productivity & Macro Policy Choices: A Flow Chart

06 Feb 2014, by Guest in Economics

I think, and the FT’s Chris Giles agrees, that this is the most important chart in British macroeconomics at the moment:

Prod chart with trend

It shows the fall and stagnation in labour productivity since the recession.

In yesterday’s Economic Review, the ONS provided another useful way of looking at this:

ons prod chart

As they put it:

Weak labour productivity is one of the defining features of the economic downturn which started in Q1 2008 and has important implications for the degree of slack in the economy. If recent reductions in labour productivity are permanent, then the extent of GDP growth which can be sustained without a corresponding increase in inflation may be limited. However, if recent reductions in labour productivity are reversed as the economy strengthens, then the potential for more rapid and sustained economic growth without rising inflation may be greater.

 It sometimes seems that the Government and opposition are talking at cross purposes when it comes to the economy. For the government the pressing issue is eliminating the structural deficit, whilst for Labour the key issue to to tackle ‘the cost of living crisis’.

On one deeper level though – this are both ways of talking about productivity.

As the ONS argued yesterday:

…the weakness of labour productivity is one explanation for the relatively slow growth of real wages in the UK in the post-downturn period. Productivity is one of several possible determinants of real wage growth which is discussed in a recent ONS analysis paper (An Examination of Falling Real Wages – 2010 to 2013), alongside changes in the composition of the workforce, movements in the relative prices of output and consumption and changes to nonwage labour costs.

Weak productivity post 2008 can’t explain the entirety of the fall in real wages over the last five years but it does explain quite a bit of it. The recent ONS real wage analysis found that the pace of real wage growth has been slowing for decades – suggesting a deeper underlying disconnect between wages and productivity – but it seems likely that the actual falls in real wages (as opposed to weaker growth) may be very influenced by productivity.

The structural deficit too (the part of the deficit that will remain once the economy has closed the ‘output gap’ and is back at potential) is heavily influenced (in fact driven) by productivity.

The IFS Green Budget made this very clear. For all the talk of “£25bn of cuts or tax rises” being needed to plug the structural hole – the size of that hole is uncertain. To estimate the structural deficit, one must first estimate the output gap and the size of the output gap is base don productivity growth.

There is considerable disagreement among independent forecasters over how much spare capacity there currently is in the economy. But the scale of the Chancellor’s fiscal consolidation plan means that even, if the most pessimistic forecasters are correct, the planned consolidation would still be sufficient to offset the estimated damage done to public borrowing by the financial crisis. If the most optimistic assessment of the amount of spare capacity in the economy is right, all spending cuts planned beyond 2014–15 could be reversed and the deficit would still be on course to return to pre-crisis trends.

If one wants a surplus and productivity growth is weak then billions of pounds of fiscal tightening are needed. But if productivity growth is much stronger the fiscal repair job needed is much smaller.

In other words faster productivity growth offers a route out of both the fiscal challenges and the living standards challenges.

Despite this, productivity growth is not something that really features very heavily in the political debate around the economy.

But whilst productivity assumptions are rarely made explicit in the policy debate, I think they are implicit in the policies people advocate.

So here’s my flow chart of productivity assumptions and policy recommendations.

Policy flow chart

Some people have (of course) nuanced views – i.e. productivity problems may have both demand and supply side causes. But I think this flow chart quite neatly summaries the major macro debate in the UK at the moment.

3 Responses to Productivity & Macro Policy Choices: A Flow Chart

  1. Phil Levy
    Feb 6th 2014, 12:23 pm

    What if weak productivity is a profitability/investment problem? Then there may be no solution within the present competitive economic system since one firm or some firms rise in profitability/productivity will at the very best only be offset by a compensating fall elsewhere.

  2. Dave Holden
    Feb 6th 2014, 1:10 pm

    So something changed in 2007 that caused output/hour to drop. It seems to me that the main thing that changed was a collapse in private credit creation and a great deal of deleveraging. Wouldn’t this explain why output and output/hour dropped?

    Also just because GDP was increasing prior to this doesn’t mean it was increasing in a productive stable way no?

  3. David Pendlebury
    Feb 6th 2014, 3:45 pm

    We know that in the long run, capital and investment become irrelevant unless labour productivity is increased. The only positive solution is to recapture the post-war ambition of Marshall, Beveridge et al, to invest in people and their potential. In any existing model, only the state has the capacity to invest in people on this scale. Especially given that the largest marginal inceases are achievable in those currently most excluded. i.e. Option RLR!