Free Lunch: Productivity and politics

Δημοσιεύθηκε: 20 Απριλίου 2015 - 11:38

Economics and the UK election

In the weeks leading up to the UK general election on 7 May, Free Lunch will examine the main economic issues at stake in the campaign and, more importantly, in the policy choices that will confront whoever forms the next government. Today we take a look at the UK's productivity performance or, more precisely, the lack thereof.

There is a well-known "productivity puzzle" in that the UK's recovery has been driven entirely by more work and not by an improvement in output per hour worked. The UK still lags behind France, for example, as we discussed a few weeks back:

Compared to the G7 average, UK GDP per hour is about 17% behind - and the level of productivity on this measure is getting worse.

The FT's economics team this morning brings an updated report on the productivity crisis that highlights just how much productivity matters for the fiscal room for manoeuvre: "If productivity growth rebounded to the rate of the early 1980s, so great would be the boost to the economy that no further government spending cuts would be needed." In other words, anyone who cares about the public finances should pay more attention to productivity numbers than to what politicians say they will do with the deficit.

The puzzle is in fact broader than the question of why productivity growth stopped so abruptly in 2008 and has not restarted. Ken Mayhew of Oxford university has written a useful history of the UK's productivity experience under both the coalition and previous governments. He points out that there were problems also in the catch-up period from the 1980s up to the crisis. Catch-up was in fact never complete, which is why the UK still lagged so far behind most other large rich economies when it entered the crisis. And what catch-up there was had more to do with capital accumulation than a more efficient use of resources. Mayhew argues that an emphasis on human capital in the 2000s biased investment towards education and training with sometimes dubious results, to the detriment of physical capital investment.

If so, that has only got worse since the crisis. Public investment in infrastructure was slashed in 2009-2010 and has not recovered. Private capital spending is down as well. More and, crucially, better infrastructure spending is economist John van Reenen's proposal for the "economists' manifesto" put together by Tim Harford.

The FT piece breaks down the productivity puzzle by economic sector. It confirms that the disappointing record reflects productivity slowdowns within sectors, not that more productive sectors have shrunk and less productive ones expanded at their expense. Indeed, most of the shortfall compared to the pre-crisis trend can be found within professional services and telecoms, as the graph below illustrates:

The FT's Ferdinando Giugliano surveys the four main competing explanations for the puzzle. Being a puzzle, it is naturally hard to say which is right, and the answer is probably a combination of all. Two are, however, particularly interesting.

Rather than the other way round, productivity stagnation may be a result of Britain's pitifully slow real wage growth, itself linked to increased labour supply. The flip side of fast UK jobs growth is "capital shallowing" - less capital per worker. There is both an immediate, arithmetical, effect on labour productivity as more workers crowd around the same number of machines, and a longer-term dynamic effect as cheaper labour encourages business models based on hiring more workers rather than investing in capital to make them more productive.

Another (compatible) explanation notes that as productivity falls in a sector, capital ought to find it attractive to shift to higher-productivity (and therefore higher-profit) ones. But this has not been happening. The broken banking system is to blame: despite strong incentives for capital to move and loose monetary policy, promising businesses (especially small ones) have struggled to secure finance. As a result, capital reallocation has been unusually slow, and productivity growth through sector reallocation has failed to materialise.

Can politicians be expected to do anything about all this? The last problem suggests finally fixing the banking system should be high on the list. The LSE's Centre for Economic Performance has published an excellent briefing on productivity and business policies - both the overall challenges and the main parties' proposals. Of particular note is how the tax system - corporate tax cuts notwithstanding - remains heavily tilted against the use of equity in favour of debt financing, even though the former "is more conducive to long-term investment, especially in innovation". The authors welcome Labour's consideration of a tax allowance for corporate equity, something many economists have recommended.

More Greek myth-busting

Better late than never: five years after the question first arose, people are beginning to cotton on to the fact that a Greek default is not synonymous with Greece abandoning the euro for another currency, despite every noise you hear to the contrary. That point cannot be made often enough, given how much public (and private) debate is based on the incorrect premise that debt restructuring must be avoided to keep Greece in the euro. In his FT column this morning, Wolfgang Munchau explains why default within the euro is not just possible but desirable.

JW Mason, meanwhile, makes two very important points about the mechanics of default. One is just how outrageous it would be for the ECB to shut down liquidity provision to the Greek banking system: "Imagine if, during the Detroit bankruptcy negotiations, the Fed had announced that if the city did not pay off its creditors in full, the Fed would use all its regulatory tools to shut down any banks operating in the city. That's a close analogy to the situation in Europe." Second, he points out that even in such a situation, the Bank of Greece can continue to manage the payment and settlement system between Greek banks.

And over at Bruegel, Zsolt Darvas warns against assuming default is imminent. He points out that the Greek state holds a large number of financial assets - more as a proportion of GDP than most other European states - and could probably draw on these to service debt for longer than many expect.