Some of the better
reporting and
interviews with
George Osborne yesterday did try and put the strongish 2014Q2 output growth in context. Yet the much stronger growth in UK employment continues to be greeted by many as unqualified good news - even by
some who should know better. So, rather than
trying to be satirical, let me attempt to be as clear as I can. Those who already understand the problem can skip the next three paragraphs.
By identity, strong employment growth relative to output growth means a reduction in labour productivity. In the short term when unemployment is above its ‘natural’ (non-inflationary) level, falling labour productivity is good news. It means that a given level of output is being produced by more people, so there are less people unemployed. This is good news because our
evidence is that the costs of being unemployed are very high. Of course if more workers are producing the same amount of stuff, their real wages will fall, but that just means that the cost of a recession is being evenly spread rather than being concentrated among the unemployed.
Now lets move on until unemployment has fallen to its natural rate. It is what happens next that is crucial. If labour productivity starts increasingly rapidly,
such that we make up all or nearly all of the ground lost over the last five years, that will be fantastic. Rapid productivity growth will bring rapid growth in real wages, meaning that much of the
unprecedented fall in real wages we have seen in recent years is reversed. After a decade or so, UK living standards will end up somewhere around where they would have been if there had been no recession. The UK ‘productivity puzzle’ will have been a short term affair that economists can
mull over at their leisure. Analysis will not look kindly on the policies that allowed output to be so low for so long, but - hysteresis effects aside - that will be history.
The alternative is that labour productivity does not make up lost ground. If this happens, the average UK citizen will be 15-20% poorer forever following the Great Recession. Living standards in the UK, which before the recession appeared to be
growing at least as fast as those in other major established economies, will have fallen back substantially relative to citizens in the US and Europe.
This is the alternative that most forecasters, including the OBR (see chart reproduced here), are assuming will happen.
So the absence of labour productivity growth is good in the short term, but is potentially disastrous in the long term. The problem is that the absence of growth in labour productivity since the recession is unprecedented (see chart below): nothing like this has happened in living memory. The reason to be concerned is that the rapid growth in productivity required to catch up the ground already lost is also unprecedented for the UK, which is why most economists assume it will not happen. Which brings me to another puzzle.
As long as I can remember, UK governments have been obsessed by long term productivity growth, and its level relative to the US, France and Germany. They have put considerable effort into understanding what influences this growth, and what policies can help increase it. This was true when UK labour productivity was steadily increasing at a slightly
slower rate than in other countries, or increasing at a slightly
faster rate. Given this, you would imagine that the UK government would be frantic to know what was currently going on. Why has UK productivity stalled, why are we falling behind our competitors at such a fast rate?
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| GDP per hour worked: source OECD |
Instead this government seems strangely indifferent. If they have an explanation for the absence of UK productivity growth, I have not seen it. You generally need to understand something before you know what to do about it. Instead the Prime Minister and Chancellor would seem to prefer not to talk about it, because it ‘feeds into’ the opposition’s complaints about low wages. This really is irresponsible. Is it simple arrogance? - they know what is good for the economy, even if they do not understand it. Or is it indifference? - we do not care too much about long term UK prosperity, as long as you keep voting for us. Or is it just too embarrassing to admit that the most calamitous period for UK living standards since the WWII has happened on their watch.
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