Idle Hands: Will Britain Get Back to Productivity Growth?

In trying to measure what a large and complex economy did over a quarter that ended just a few weeks ago there is not much difference between flat, slightly down and 0.2% up, which is what we actually got for the second quarter. There is, of course, quite a difference in terms of perception.

So what the Office for National Statistics said about the effect of special factors – the royal wedding and the extra bank holiday, Japan’s tsunami and its impact on manufacturing, Olympic ticket sales and unseasonably warm April weather – was rather important.

These factors, the ONS said, knocked 0.4 points off the service sector’s contribution to growth and 0.1 points off that of the production sector. Without them, growth might have been 0.7% rather than 0.2%.

Many people, reading what were unfairly described as George Osborne’s excuses, might wonder at some of this. But, though this is uncertain territory, it is uncontroversial that an extra bank holiday hits output, partly offset by extra spending associated with the wedding itself. Similarly, the effect of Japan’s supply chain disruption on manufacturing was clear.

Why did exceptionally warm April weather hit GDP? Because normally most of us would still have our central heating on. We switched off and energy production fell. The one I did not see coming was the Olympics effect While we pay for tickets now (if unlike me you were lucky enough to get some) it does not count towards GDP for a year, when the event occurs.

Anyway, there were distortions. I have always said that the period of biggest danger for Britain’s economy was in the first half of this year, with the January Vat and April National Insurance hikes and the onset of the big spending cuts.

The raw figures suggest the economy grew by 0.7% during the first six months of the year, a near-1.5% annualised rate. Adjusting for second quarter special factors, growth was 1.2%, a very acceptable annualised rate of almost 2.5%, which is very good in the circumstances.

If you really wanted to go to town you would do as we used to do, which is to look at non-oil GDP, which rose by an underlying 0.8% in the second quarter alone.

I would not go as far as the Institute of Economic Affairs’ shadow monetary policy committee, which this month votes 5-4 for an immediate hike in Bank rate (though several of its members agree with Vince Cable that the Bank should stand ready to do more quantitative easing). I would not pretend either there are no risks to growth.

The limited information we have for the third quarter suggests a subdued start.
A bigger problem than weak GDP growth, however, is weak productivity. It was Paul Krugman, the Nobel prize-winning economist, who coined the phrase: “Productivity isn’t everything, but in the long run it is almost everything.”

Productivity, output per worker, or output per hour, is the key to long-term prosperity. An economy in which productivity stagnates will wither and decline.
Output per worker fell sharply in the recession, by about 4.5%, picked up a little to early 2010 but has been essentially flat since, up by just 0.3% in the year to the first quarter and, though we have yet to see the data, probably no better since.

The problem is not in manufacturing. where output per job has risen by 10% since the recession’s low point. It is in services, where it has not increased at all.

On the face of it, we know why this is. Employment fell by less than feared in the recession and has grown more strongly than expected in the recovery. At 29.28m, employment is only 293,000, or 1%, below its pre-recession peak, while GDP is still 4% down. What we have gained in more jobs, we have lost in productivity.

Bill Martin, formerly of UBS, now with Cambridge University, has taken a deeper look at the producticity question in a newly-published paper: ‘Is the British economy supply-constrained?’

Martin’s sub-title, ‘A critique of productivity pessimism’, provides a broad hint. If you believed that the crisis and recession had deprived Britain of the ability to generate decent productivity growth, this would be a very depressing conclusion for the country’s long-term prosperity.

It would also explain why inflation has been so high in the aftermath of a big recession. The argument there would be that if we have lost the ability to generate productivity growth, we have also hugely damaged the economy’s supply capacity. In the absence of spare capacity – a big output gap – it is not surprising inflation is so high.

Martin goes through the arguments of the productivity pessimists one by one and finds them wanting. His conclusion is thus reassuring on productivity: it was not killed off by the crisis. Spare capacity remains; inflation is due to other factors.

If that is reassuring, is the outlook for jobs much less so? Have firms, particularly in services, been hoarding workers in the expectation of a pre-crisis return to normality that will never happen?

When the penny drops, will we see a mass shakeout, a jobless recovery or, worse, what the Chartered Institute of Personnel and Development once called a “job-loss” recovery. This is a prospect that keeps some in the Bank awake at night.

It could happen. One reason it might not is also identified by Martin. Firms have been prepared to endure weak productivity because wages have been so subdued. The kind of shift we have seen over the past year, 520,000 additional private sector jobs, against the loss of 143,000 generally lower-productivity jobs in the public sector would suggest it may be possible over time to grow employment and productivity together. That has to be the hope.

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This post originally appeared at David Smith’s EconomicsUK and is reproduced here with permission.