The trend in trend growth is downwards
Much was made in the media of the Office for Budget Responsibility’s suggested reduction in the assumed long-term trend growth rate of the economy. It would appear from the analysis that there was a 0.65% reduction in assumed trend growth from 2.75% to 2.1% (from 2014). This is a huge reduction, but it was glossed over by the media because of the fact that Treasury forecasts tended to use a “conservative” 2.5% figure instead of 2.75%. Because the new Treasury forecasts will use the (central) 2.1% figure the fall in the trend growth rate as far as the forecasts are concerned is “only” 0.4%.
We can only be thankful that Gordon Brown and Alistair Darling did not have the courage of their convictions and base their government spending on what they regarded as trend growth.
There are various reasons for the fall in the trend growth figure – and it is clear that the OBR believe that trend growth was less than 2.75% even before the crisis. The crisis will have, it is believed, a lasting effect. There are then factors such as population ageing, decreased migration, decreased capital accumulation and so on which will reduce trend growth. It is true that the OBR have not started with the old 2.75% figure and then knocked bits off to allow for changed circumstances but, with regard to many of the factors that will affect trend growth (especially total factor productivity and employment), they are assuming that the pre-crash status quo resumes.
This seems to ignore what has been happening to the economy in recent years. The years before 2007 also saw a dramatic increase in public spending, a growing problem of workless households, a reduction in saving and an increase in regulation. If these are factored in it is surely possible that trend growth will be even lower than the OBR suggest. Of course, it may be the case that the OBR is assuming that the government will sort these problems out – and that public spending will return to 2005 levels (for example) as a proportion of GDP. If this is the case (and I doubt that it is) then this should all have been discussed explicitly. Having said that, they may have got things wrong in the other direction too. For example, if population growth slows and tightens the labour market (as the OBR suggest) then there may be more migration – they do not seem to use dynamic models (or even dynamic thinking) with such second round effects factored in.
This report is naturally a rushed job – as this blog post is. The reduction in the trend growth rate assumption is welcome and, no doubt, realistic. However, with somebody of the calibre of Alan Budd at the helm, I hope that a rigorous analysis of the supply side of the economy is a feature of future reports.