GDP growth of 0.7 per cent in the final quarter of 2013 has finally confirmed that the recovery is taking hold. Growth for 2013 as a whole has come in at just under 2 per cent. Whilst welcome, this figure shows just how much our expectations have altered in recent years. It is becoming increasingly clear that the economy is unlikely to revert to the heady growth rates that existed before the financial crisis

However, what is particularly disappointing about these figures is that employment has grown at about the same rate, which means that GDP per person employed has hardly grown at all – if anything, these figures confirm that we are in the midst of a productivity crisis. The fourth quarter figures for employment have not come out as yet but simply extrapolating the 3rd quarter figures at the same rate of growth provides a decent estimate. GDP per person employed in 2013 is only a fraction higher than in 2012 (0.4 per cent). GDP per hours worked tells the same story (with 4th quarter hours extrapolated there would appear to be a small fall in GDP per hour worked of 0.4 per cent). Output per worker to the third quarter of 2013 was only 0.3 per cent higher than in the first 9 months of 2012.

So from where is the growth coming? Essentially, growth is coming from household spending which is increasing at roughly the same rate as hours worked and employment. People are working more, producing more and spending more. However, unlike in recent decades, people are not increasing the amount they produce per hour worked. As such, even if living standards rise, given current trends, they will only be rising because we are working harder.

This shows how fragile the recovery is. There is a limit to the extent to which employment can rise. Until we see business investment picking up and the building of capacity, growth in the medium term will be anaemic, probably at around 2 per cent for the foreseeable future. The ‘catch-up growth’ from the Great Recession will not happen. This contrasts markedly with the record after the Great Depression or, indeed, after post-war recessions. Business investment in Q3 2013 (five years after its peak) is 24 per cent down from that in Q1 2008. In contrast private sector investment in the Great Depression was 3.5 per cent up from its 1929 peak five years later.

What can boost growth and get the economy back on to a reasonable growth path? The answer lies in raising private investment to grow and improve productivity as well as improving the productivity of that investment. The first point to note is that this is a problem for the real economy which cannot be solved by monetary policy. The second thing to realise is that private investment is unlikely to grow with so much political uncertainty around. The state sector is still at historically high levels crowding out private enterprise and the budget deficit and government debt are still not showing clear signs of control – again quite contrary to the situation from 1933 after the Great Depression. The election in 2015 and the implications for future taxation are unclear – and they were made still less clear over the weekend.

As well as reducing the size of the state in terms of government spending, we also need to reduce it in terms of its regulatory role. For example, there are clear signs of an increased demand for housing in the UK, but little capacity for a sustained increase in supply (in contrast to the recovery in the 1930s). This not only prevents the highly productive activity of house construction, but it also prevents labour and businesses from moving from low to high productivity areas. In the field of energy, government regulation and subsidies are promoting energy production through very-low-productivity mechanisms and in financial services government policy is strangling bank lending through capital regulation.

The good news is that there is plenty of unrealised potential for higher growth if any government genuinely wishes to preside over a growing economy with rising living standards. The bad news is that we have had a decade or more of poor or indifferent policy choices and radical change does not look like coming soon. Although the government does seem to wish to make some incremental improvements in some areas, much more could be done to raise productivity, growth and living standards.

Kent Matthews 154x154

Shadow Monetary Policy Committee

Kent Matthews is the Sir Julian Hodge Professor of Banking and Finance at Cardiff University. He is a graduate of the London School of Economics, Birkbeck and Liverpool University. He has held research posts at the LSE, National Institute of Economic & Social Research and Bank of England. He has held permanent and visiting academic appointments at Liverpool University, University of Leuven, University of Western Ontario, Liverpool John Moores University, Humbolt University Berlin and Cardiff University. He was Principal Economic Forecaster for the Liverpool Macroeconomic Research Group 1979-89 and UK Economist at Lombard Street Research Ltd 1994-95. He has been the Secretary of the SMPC since its establishment.

8 thoughts on “Working harder – but not more productively”

  1. Posted 30/01/2014 at 08:44 | Permalink

    Some reasonable points are made here. However, I do wonder about productivity figures. During the credit-fuelled boom, productivity appeared to be rising reasonably strongly because output per person appeared to be increasing because GDP was increasing. However, as we now know (if we didn’t before) GDP was unsustainably inflated due to to the credit boom. Do we not see an opposite effect during and immediately after the crash? Just as the productivity figures looked better than they really were, can they not now look worse?

  2. Posted 31/01/2014 at 10:47 | Permalink

    I am willing to concede that the ONS often gets the measures wrong and it is possible that the GDP figures for 2013 are understated but whether the credit boom systematically inflated the GDP figures pre-crisis so as to distort productivity estimates is questionable. If you examine an 8-month moving average of the growth in GDP per hours worked so that you iron out noise and measurement errors, what you see is that underlying productivity growth remained in the 2-3% between 1995-2007. Only in 2003(1)-2004(1) did underlying productivity growth rise above 3%. So the credit boom did little to distort the productivity figures systematically. By 2006 underlying productivity growth had fallen to the bottom of the range, so productivity growth had begun to weaken before the excesses of the credit boom, consistent with the argument that the expanded state sector was destroying capacity in the private sector.

  3. Posted 31/01/2014 at 11:14 | Permalink

    Kent – An 8-month moving average will certainly iron out noise and measurement errors but that does not mean that the resulting figure tells you the underlying productivity growth. It merely tells you an averaged figure – it does not tell you that it represents ‘underlying’ productivity growth. We know that we experienced an extremely long credit boom. As measured GDP and productivity growth were reasonably steady across this period, I would conclude that the average figure merely concealed the fact that underlying productivity growth was slowing because it was increasingly replaced by credit-inflated ‘growth’. This is consistent with the figures for particular sectors that we do have. Manufacturing productivity grew strongly, yet output stagnated and then fell. Much more was spent on the public sector but, for example, we know that the government’s own figures showed NHS productivity and public sector productivity in general falling. This would suggest falling overall productivity growth but the figures show it to be fairly steady. Surely the difference can only have come from credit expansion?

  4. Posted 01/02/2014 at 11:34 | Permalink

    HJ – You are right that a credit boom will inflate GDP growth and boost measured productivity growth but this is normally temporary becuase it is what Friedman calls a monetary phenomenon which works into GDP growth through an expansion in demand and the money supply. Usually this would result in inflation as output expands above productive potential. But inflation did not occur because international tradeables were kept low by the Chinese policy of shadowing the dollar and expanding traded output. However, there were several years when actuasl output was above potential and in the short-run productivity might appear to be inflated but theory also tells us that output cannot rise above potential at the same rate as the growth in hours worked in a sustained way because to expand above capacity results in dimminishinng returns. However, your point that the decline in public sector productivity is well taken. This is consistent with the point that the expansion of the state sector has destroyed the capacity for the private sector to grow and has permanently reduced the rate of growth of potentyial GDP. In only 2 years since 1995 did actual annual productivity growth rise above 3%. Since 2004 it has been declining and only rose temporarily in 2007 to 2.6%. Credit growth does play a part but not in a sustained way.

  5. Posted 04/02/2014 at 19:13 | Permalink

    Kent – I’m still not convinced. You say that “inflation did not occur” by which you presumably must mean that the CPI measure of inflation did not rise. While this is true, I question whether CPI tells us all that much about inflation (as it relates to our discussion), because it excludes housing costs AND public sector output inflation (which is not included since most public sector output is not paid for directly by the user). These two between them (even allowing for the fact that some public sector input is simply redistributed via the social security system) must constitute getting on for half of GDP.

  6. Posted 04/02/2014 at 23:36 | Permalink

    HJ – If I am right and that we are near to full capacity and that the low productive public sector has crowded out the higher productive private sector, we will see growth in 2014 consistent with low productivity growth. If I cannot convince you now perhaps we can revisit this exchange this time next year to see if the prediction is verified and I can convince you then.

  7. Posted 05/02/2014 at 10:20 | Permalink

    Kent – I don’t disagree with what you are saying. All I am saying is that I think that productivity rises prior to the crash were exaggerated upwards and that since the crash productivity falls have been exaggerated downwards – not that neither effect hasn’t happened. We are in agreement that the low productivity public sector has crowded out the higher productivity growth private sector.

  8. Posted 05/02/2014 at 17:25 | Permalink

    Fair comment

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