Over the past few months the UK economic outlook has darkened. After a surprisingly upbeat performance in the second half of 2016, growth has slowed, real incomes have been squeezed and forward momentum has slipped away.
It is of course tempting, to someone who warned against the economic risks of a vote to leave the European Union, to lay the blame for our recent problems entirely at the door of Brexit. But whilst that might be intellectually satisfying, it would be to miss the bigger picture.
It’s hard to talk about the state of the British economy without discussing Brexit. But for all the sound and fury devoted to the rights and wrongs of leaving the EU, right now it’s not the ultimate determinant of our economic performance.
Productivity growth doesn’t excite the same sort of passions as Remain vs Leave, or at least not in most people. But ultimately, it’s our ability get more economic output from any given level of inputs that will determine our future prosperity. It’s often said that in the long run, productivity growth is almost everything. In the case of the UK, it seems the long run has finally arrived and it turns out Keynes was wrong about at least one thing—we aren’t all dead. Instead we have to deal with the consequences.
Over the past decade, tens of thousands of words have been written about the UK’s productivity slowdown and many hours have been spent debating the causes. But the problem—despite the insistence of economists that it is crucial—has often felt quite abstract. Indeed in some ways, poor productivity growth—at least in the short term—was a “nice” problem to have.
“In the decades before the crash, productivity grew by around 2.2 per cent a year. In the last decade it has flatlined.”Two of the most defining characteristics of the UK’s recovery form the recession of 2008 and 2009 have been its weakness and the surprising extent to which it has been “jobs rich.” Even if they are serious question marks over the quality of many of those jobs.
Despite the deepest recession in decades, unemployment peaked at far lower levels than in the early 1980s or during the early 1990s recession. And then despite the slowest recovery from recession in modern British economic history, the employment rate (the percentage of the workforce in jobs) rose swiftly.
The seemingly mysterious combination of sluggish growth but strong gains in employment are explained by an abysmal productivity performance. In the three or so decades before the crash, productivity—as measured by output per hour worked—grew by around 2.2 per cent per annum. In the last decade it has basically flatlined.
The ideal recovery scenario would of course have been rapid growth in economic output and rapid growth in jobs. But, at least in the initial recovery phase, weak GDP growth but decent jobs growth was certainly preferable to weak GDP growth and a poorer labour market performance. Back in 2013, 2014 or 2015 it sometimes felt as though those carping on about weak productivity numbers were missing the woods for the trees—yes, slow productivity growth was a problem but surely it was better to have weaker output per hour statistics but more people in work?
Perhaps it was. The silver lining to weak productivity has been more people in work, but look just at the silver lining and you risk missing the cloud itself. That cloud was on full display in the Bank of England’s quarterly Inflation Report this summer.
“Reducing the debt burdens built up fighting the recession will take much longer than hoped for”In short the Bank had two key messages to convey: it expects growth to be weak and household incomes to be squeezed and, if it is right on this grim picture, then it expects to have to raise interest rates sooner than financial markets had been expecting.
That’s an unusual message from the Bank. Usually a weak outlook and downgrades to its growth forecasts would not be accompanied by hawkish talk on rate hikes. But this is what happens when weak productivity growth is sustained.
UK growth over the past few years has been fuelled by using up idle resources rather than by getting more use out of existing ones, the unemployment rate has fallen from a peak of 8.5 per cent all the way down to a four-decade low of 4.4 per cent. We are now though hitting the point at which that spare capacity has been exhausted.
The trend growth rate of the UK economy—the rate at which it will grow in the longer term assuming a full utilisation of resources—has been slipping for years as productivity growth slows and demographics mean the workforce is growing more slowly. Pre-crisis, policy makers assumed trend growth was around 2.75 per cent but many now put that number well below 2 per cent. That might now seem like a huge difference but, over a decade, an economy that grows 2.75 per cent a year will expand by 31 per cent whilst one that only manages 1.5 per cent a year will grow by just 16 per cent. Weaker potential growth implies lower than expected rises in tax revenues over a time when spending pressures are mounting, it means slower wage growth than we got used to before the crash and it means that reducing the debt burdens built up fighting the recession will take much longer.
The short run “nice problem to have” of weak productivity growth was always bound to become a “very unpleasant problem to have” in the longer run. That longer run now looks to be arriving.
