Remember the supply-side?

Pretty much all the economic debate is about monetary and fiscal policy, which are ways of manipulating (possibly weakly) aggregate demand, rather than aggregate supply. However, with labour productivity growth is at a record low, surely we need to think about the supply-side too.
I am not unusual in worrying on this score. Andrew Sentance said last night that the output gap might be smaller than thought, which is consistent with the notion that the recession has permanently reduced our supply potential. And in its green budget, the IFS forecast that productivity growth will average only around 1% a year over the next five years.
So, what can be done about the supply-side?
One possible answer is: nothing. Maybe productivity has slowed because we’ve just run out of the technological changes that have caused it to grow rapidly in the past. There’s not much we can do about this. Or maybe the changes we’ve had are welfare-enhancing rather than productivity-enhancing. The interweb gives us free music and news, and so reduces the measured output of the news and music businesses without actually hurting aggregate well-being. Or maybe I’m just wrong and we will soon get a vigorous procyclical rise in productivity.
Another possible answer is to the free market one; shrinking the state, cutting taxes and removing regulation will raise productivity. I fear, though, that such proposals contain a high ratio of prejudice and self-interest to empirical evidence; looking at the time series of productivity growth, you’d struggle to identify a successful Thatcher revolution.
Indeed, I fear that memories of Thatcherism are downright pernicious here. Too many people have associated supply-side policies with mere attacks upon trades unions and welfare benefits, with the result that they have failed to think more seriously about the supply-side policies.
So, can I suggest three other possibilities?
1. Reducing barriers to entry. It cannot be stressed enough - which is why I bang on about it even though no-one else does - that productivity growth comes (pdf) from the entry and exit of firms, and not so much from incumbent ones upping their game. This implies that obstacles to new business formation must be removed. Whether these are mostly red tape, the lack of finance, or whatever, is moot. The point is that serious economic policy would give a huge weight to removing them.
2. Active labour market policies. One aspect of the productivity slowdown is a mismatch between unemployed workers and available vacancies. Policies that help match workers to vacancies are thus necessary. One important dimension here is the need for training, especially of the young unemployed.
3. Immigration. Migrant workers can help relieve labour shortages, and so should be encouraged.
4. Infrastructure investment or (more radically) ending presenteeism. Commuting is so burdensome that a day’s work is often a mere postscript to the effort of getting there. This, surely, must change. 
You might add to this welfare reform. But it’s not clear to me that shortages of unskilled workers are a significant supply-side problem.
I’ll grant that I’m being vague here. But that’s because I hope to encourage better, more detailed ideas. My points are simply that monetary and fiscal policy are not enough.

Comments

[Bruce]

Does the Big Society = a Smaller Economy? If I set up a group of volunteers to do something previously done by paid state employees, that's a drop measurable economic output. Or it is unless those former state employees can find something else productive to do...

[Jim]

So we need to pay more tax to re-train all the young unemployed (who have just had 10-15 years of State funded education) and at the same time allow lots of immigrants in to do the jobs the young people either can't do (because their super duper State education wasn't good enough) or won't do (because they're lazy)?

As for barriers to entry - have you ever run a small business? The amount of pointless makework paperwork for local authority goons is endless. No wonder that people can't be bother to start new businesses, and existing business owners are trying to get out, when you spend more time dealing with the demands of the State than those of your customers.

All small businesses should be exempted from all bureaucratic legislation. Let them get on with it and let the State get its nose out of what doesn't concern it.

[Cahal Moran]

A point to which you (kind of) allude by saying 'maybe the changes we’ve had are welfare-enhancing rather than productivity-enhancing' is that perhaps our measures of economic performance have become outdated.

It's an important point that has entered the blogosphere as a result of Tyler Cowen's 'The Great Stagnation' (some good posts about it on http://econlog.econlib.org/).

The problem is that, although traditional economic measures suggest that productivity and growth have been slower since the 1970s and are continuing to slow, peoples living standards have clearly improved a great deal. So perhaps we need to update our models instead of trying to use them to identify problems that they are not designed to identify.

Then again, perhaps I'm being too dramatic and the problem is simply supply side!

[Barbara]

I totally agree. Removing barriers to entry seems to be the best idea to pump up supply.

[Glenn]

Can I be a bit heretical here and suggest that the UK needs a long term strategy, nay, even an industrial policy?

Most of the experts and ex World Bank staffers all agree that the role of the state in shaping the industrial structure of their economies is important. Most of the naysayers rely on empty arguments with less empirical justification than the proponents of industrial policy.

PS - by industrial policy I'm not talking about picking winners here. Whether its stronger exporter support (whether insurance, credit guarantees and so on) or increased R&D spend etc, or where/if you build your high speed rail, or broadband - all can help, if well designed and managed, to help build new or enhanced value added activities.

Yet we're in the middle of an era where laissez faire seems to be the order of the day - despite actually most evidence pointing to quite low and unimpressive growth rates associated with such policies.

[Keith]

So to sum up

a} There is no evidence that right wing supply side policy ,i.e. attack the poor, trade unions, welfare spending etc has any positive effect on economic growth as Prof. Krugman keeps pointing out.

B) The statistics probably miss welfare enhancing economic change which does not figure in GDP at market prices.

C } So the big society is incompatable with capitalism and its market value system; so David Cameron is a secret Communist. More big society means less market output, how funny! You communist tory!

D) Red tape exists for a reason. I am sure Jim would love the state to stop enforcing fire regulations in hotels to boost business. And when he is burned to death by the no fire drill or fire escape free market he will only have himself to blame. Or maybe jim will happily eat at restaurants allowed to ignore food safety rules and die from food poisoning instead?

junking red tape sounds good if you nerver think about it as tories never do!

Let the stae get out of the way and lets all die from the cowboys playing fast and loose with public safety. Any more ideas for growth? I cannot wait.

[Tom Addison]

@Jim: Yes, I'm afraid we do have to retrain or help lots of young people somehow, the education system has let them down and there aren't enough companies offering apprenticeships to take people on and help them learn new skills, for whatever reason.

There's also the issue that the only way of getting a "well-paid" job nowadays is to go through Uni, which for many is unaffordable or they simply don't have the right type of brains for that route.

This "too lazy" to get a job idea, I dunno. When I finished Uni (in 2008) I struggled immensely to get a full-time job, all there was in the paper and on the internet was £40k IT management jobs or part-time cleaning/nursing home jobs at minimum wage. I ended up working part-time in a local pub for 8 months, secured myself a long-term job in December 2008 (but didn't start the job until October 2009) and from March 2009 was lucky enough to have my Dad employ me for 5 months. Without a car at the time it was very difficult, and taking out a 20% unsecured loan to buy one and then having to pay the ridiculous insurance costs would have been too great a risk to take. My flatmates cousin is currently in that predicament.

I still have numerous friends in this situation, to blame them entirely for the situation they're in would be ridiculous. If seems as though if you're not a quite intelligent, middle-class kid who's parents could afford to put you through Uni (which I was lucky enough to be) then the job market is a bit of a bastard.

And starting up small companies isn't as difficult as you make out, I have a few friends who have started companies in the last few years, they told me it literally only takse a few minutes, you can pretty much buy companies off-the-sheld. You can one of them out if you like, it's called Festi Barrow. None of this bureaucracy you speak of.

[Tom Addison]

Yeah there's a few typos in there, apologies for that, I'm watching the Liverpool game as I type. Kinda rots the brain.

[Barbara]

Thanks a lot for such an interesting post!

[Straus]

A glance at the table of five-year-growth trends in your previous post shows that the productivity rot set in with a vengeance around 2002, that is, five years after Labour came to power.

Is it any coincidence that the period of sharpest decline in productivity was coterminous with a period of rapid expansion of the state? And does this not vindicate a policy that seeks to cut back the state and force more of the working-age population to seek employment in the real, productive sectors of the economy?

[Straus]

Sorry, that should be "productivity growth trends"

[Phbradley]

Chris - what do you think is the relevance of competition law (+enforcement) to this post?

Secondly - do you think UK firms aren't making the most of European opportunities open to them - that the average business owner here has 'splendid isolation' blinkers on?