The productivity slump

Productivity growth is still falling. Today's statistics show that hours worked rose by 1.5% in the three months ending in April, but the NIESR estimates that GDP grew by only 1.1% in the period.

This is weird in two senses.

First, it means that productivity is now significantly lower than it was in 2007. Such a prolonged fall is almost unprecendented. My chart shows that, except for the transitions to peacetime after the two world wars, we haven't seen a six-year long fall in productivity since the late 1880s*.

Secondly, it gravely weakens the most optimistic explanation for the post-2008 drop in productivity. We had hoped that this was due in part to labour-hoarding; firms hung onto skilled workers in the downturn in anticipation of needing them in the recovery. This theory, though, implies that productivity should now be rising as output recovers and hoarded labour is utilized more intensively. That it is not doing so suggests that there's some other reason for the productivity slump.

But what? There are several possibilities, including a slowdown in technical progress (pdf) and the possibility that the fall in bank lending is retarding the "external restructuring" that usually contributes so much (pdf) to productivity growth.

Although the productivity slump - like so many other issues! - doesn't get much attention from the political class, it matters enormously for the cost of living crisis. If productivity is falling then real wages can rise only if there's a fall in the share of profits in GDP or if there's a favourable change in the terms of trade such that import prices fall. The former is unlikely given the power of capital. And the latter should not be banked upon, especially if Iraq's oil supply is disrupted.       

This poses the question: what can be done to raise productivity?

One possibility is that we should simply wait. Maybe, as MacAfee and Brynjolfsson argue, we'll see productivity surge once managers reorganize production to take proper advantage of digital technology. Or maybe the recent pick-up in business optimism will encourage firms to invest in productivity improvements; as Christopher Gunn points out, animal spirits can cause productivity changes.

But what if waiting isn't enough? What policy changes might raise productivity?

There's one answer here that isn't sufficient - deregulation. The data shows that during the free market era (1855-1914) output per worker grew by 1.1% per year, compared to growth of 2.1% during the social democratic period 1946-79. This tells us that the idea that free markets generate big productivity rises owes more to bigotry theory than to historical experience.   

* The data comes from the Bank of England, updated from ONS sources.

Comments

[Felipe]

The data shows that during the free market era (1855-1914) output per worker grew by 1.1% per year, compared to growth of 2.1% during the social democratic period 1946-79.

But the data also show that countries that liberalized the most in the 80s did grow more than the countries that did not. The UK GDP/capita started catching up to France around 1980.

I'm not sure you can use the time series data this way, because the whole developed world slowed down around 1980, yet not all embraced neoliberalism the same. There must be something else accounting for the slowdown.

[Socialism In One Bedroom]

The GDP/per hour worked data shows, generally, that the more 'social democratic' nations, Denmark, Norway, Sweden came higher than the 'liberalised' ones.

So we can certainly make the claim that 'free market' dogma is full of crap.

I never bought into the labour hoarding argument.

I also not a fan of looking at productivity in isolation, i.e. in one country. This is a globalised economy don't you know.

[Mick]

I was going as about international comparisons too... In particular the comparison with Ireland...

[Blissex]

«Productivity growth is still falling. Today's statistics show that hours worked rose by 1.5% in the three months ending in April, but the NIESR estimates that GDP grew by only 1.1% in the period.»

That's nearly meaningless as in the above "productivity" measured in currency rather than in physical terms.

The second is that what is measured by "real" GDP etc. is very misleading, in part because of difficulties with inflation indexing, but also because of a little noticed difficulty of the utmost importance.

GDP is supposed to report "value added" but most first-world economies have the vast majority of people employed in services, and defining or measuring value added in service industries is rather difficult.

Usually neither is attempted by most statistical agencies: they simply "assume" that service industry value added is a given function of service industry revenue (e.g. X% or wages+profits, or is simply made up). Consider for example an economy in which 40% of public company *reported* profits are in the financial sector, and what is the value added by the financial sector in that economy...

Also, in many economies, in particular in the service sector, a significant percentage of "hours worked" is unreported because it happens in the black markets, for example using illegal or otherwise unrecorded immigrants.

Plus there is always the oil story: the UK have become a net importer of oil in 2007, and oil prices have quadrupled since 2004. Oil has a pretty huge effects on output...

[Blissex]

«The UK GDP/capita started catching up to France around 1980.»

Good that you refer to GDP/capita instead of GDP, but as to both and 1980 I offer the usual graph and the usual quotes from Jim Rogers and from Tony Blair:

http://mazamascience.com/OilExport/output_en/Exports_BP_2013_oil_mtoe_GB_MZM_NONE_auto__.png

[Jim Rogers, "Street Smarts" page 17]
«Margaret Thatcher, elected in 1979, takes credit for the eventual British turnaround. And she is responsible for many positive changes.

But the fact is that 1979 was also the year that North Sea oil started flowing. You find me an elephant oil field and I will show you a very good time, too.»

http://www.lrb.co.uk/v09/n19/tony-blair/diary
«Mrs Thatcher has enjoyed two advantages over any other post-war premier. First, her arrival in Downing Street coincided with North Sea oil. The importance of this windfall to the Government’s political survival is incalculable.

It has brought almost 70 billion pounds into the Treasury coffers since 1979, which is roughly equivalent to sevenpence on the standard rate of income tax for every year of Tory government. Without oil and asset sales, which themselves have totalled over £30 billion, Britain under the Tories could not have enjoyed tax cuts, nor could the Government have funded its commitments on public spending.

More critical has been the balance-of-payments effect of oil. The economy has been growing under the impetus of a consumer boom that would have made Lord Barber blush. Bank lending has been growing at an annual rate of around 20 per cent (excluding borrowing to fund house purchases); credit-card debt has been increasing at a phenomenal rate; and these have combined to bring a retail-sales boom – which shows up dramatically in an increase in imported consumer goods. Previously such a boom and growth in imports would have produced a balance-of-payments deficit, a plunging currency and an immediate reining-back on spending, with lower rates of growth.

Instead, oil has earned foreign exchange and also produces remittance payments from overseas investments bought with oil money. The situation is neither stable nor healthy in the long term: but in the short term it allows the living standards of the majority to rise rapidly, even though the industrial base, the ultimate foundation of a successful economy, is still only achieving the levels of output of 1979.»

[Christiaan Hofman]

And again the explanation that robots are responsible for our economic and labor woes gets a hit. Because wouldn't robots replacing labor imply rising productivity?

[Luis Enrique]

if we measured output per unit of capital, we would see a slump in productivity immediately after a phase of factory building, before those factories were up and running.

I am an optimist. I think we are seeing investment in human form, workers being hired that aren't yet producing, and this is going to bounce back.

[Procyonm]

The sectors where the hours are growing are hospitality & Leisure and Healthcare, so if productivity has to be improved, it has to be in these sectors; in the rest neither the hours are growing nor is the economic impact out of them, so this is a better way of understanding the nuances around productivity growth.

[Edward Lambert]

Productivity stalls every time the economy is against the effective demand limit. There is no mystery in this. We only need to understand Keynes' concept of effective demand. Do you? Here is a link...

http://effectivedemand.typepad.com/ed/2013/07/productivity-really-is-demand-constrained.html

[Dave Timoney]

@Christian Hofman, it's entirely possible for productivity to be weak as robots march on. Though we assume that automation starts at the bottom, and raises per capita productivity, this only occurs where wages are high (hence why car production was such an inviting target in the 70s/80s).

Technological advance gradually pushes automation up the wage scale, where the benefits of substitution (i.e. the cost of labour) are greater. This leads to polarisation, with previously well-paid labour pushed down the wage scale (the growth of the self-employed is one aspect of this).

This can produce stagnant productivity as cheap labour makes automation uneconomic at current prices, and can even push productivity down if labour starts to substitute for capital (e.g. automatic car-washes give way to manual ones).

[Edward Lambert]

I just wrote about the basic model of effective demand and where it limits productivity...

http://effectivedemand.typepad.com/ed/2014/06/defining-effective-demand-as-keynes-saw-it.html

[Blissex]

«during the free market era (1855-1914) output per worker grew by 1.1% per year, compared to growth of 2.1% during the social democratic period 1946-79.»

When I read this I felt vaguely nauseous.

Given how many other things changed during those two periods calling them after political systems seems quite arbitrary.

Perhaps 1855-1914 was the age of coal, and 1946-1979 was the age of really cheap oil (except in the last few years) and other commodities.

[Metatone]

Coming to this late, so maybe Mr Lambert has covered it, but on the ground the observation is that British firms are largely not spending their cash piles yet. There's a pickup in the economy, but it hasn't translated into investment yet...