Winner of the New Statesman SPERI Prize in Political Economy 2016

Saturday 26 July 2014

Why strong UK employment growth could be really bad news

Some of the better reporting and interviews with George Osborne yesterday did try and put the strongish 2014Q2 output growth in context. Yet the much stronger growth in UK employment continues to be greeted by many as unqualified good news - even by some who should know better. So, rather than trying to be satirical, let me attempt to be as clear as I can. Those who already understand the problem can skip the next three paragraphs.

By identity, strong employment growth relative to output growth means a reduction in labour productivity. In the short term when unemployment is above its ‘natural’ (non-inflationary) level, falling labour productivity is good news. It means that a given level of output is being produced by more people, so there are less people unemployed. This is good news because our evidence is that the costs of being unemployed are very high. Of course if more workers are producing the same amount of stuff, their real wages will fall, but that just means that the cost of a recession is being evenly spread rather than being concentrated among the unemployed.

Now lets move on until unemployment has fallen to its natural rate. It is what happens next that is crucial. If labour productivity starts increasingly rapidly, such that we make up all or nearly all of the ground lost over the last five years, that will be fantastic. Rapid productivity growth will bring rapid growth in real wages, meaning that much of the unprecedented fall in real wages we have seen in recent years is reversed. After a decade or so, UK living standards will end up somewhere around where they would have been if there had been no recession. The UK ‘productivity puzzle’ will have been a short term affair that economists can mull over at their leisure. Analysis will not look kindly on the policies that allowed output to be so low for so long, but - hysteresis effects aside - that will be history.

The alternative is that labour productivity does not make up lost ground. If this happens, the average UK citizen will be 15-20% poorer forever following the Great Recession. Living standards in the UK, which before the recession appeared to be growing at least as fast as those in other major established economies, will have fallen back substantially relative to citizens in the US and Europe. This is the alternative that most forecasters, including the OBR (see chart reproduced here), are assuming will happen. 

So the absence of labour productivity growth is good in the short term, but is potentially disastrous in the long term. The problem is that the absence of growth in labour productivity since the recession is unprecedented (see chart below): nothing like this has happened in living memory. The reason to be concerned is that the rapid growth in productivity required to catch up the ground already lost is also unprecedented for the UK, which is why most economists assume it will not happen. Which brings me to another puzzle.

As long as I can remember, UK governments have been obsessed by long term productivity growth, and its level relative to the US, France and Germany. They have put considerable effort into understanding what influences this growth, and what policies can help increase it. This was true when UK labour productivity was steadily increasing at a slightly slower rate than in other countries, or increasing at a slightly faster rate. Given this, you would imagine that the UK government would be frantic to know what was currently going on. Why has UK productivity stalled, why are we falling behind our competitors at such a fast rate?

GDP per hour worked: source OECD

Instead this government seems strangely indifferent. If they have an explanation for the absence of UK productivity growth, I have not seen it. You generally need to understand something before you know what to do about it. Instead the Prime Minister and Chancellor would seem to prefer not to talk about it, because it ‘feeds into’ the opposition’s complaints about low wages. This really is irresponsible. Is it simple arrogance? - they know what is good for the economy, even if they do not understand it. Or is it indifference? - we do not care too much about long term UK prosperity, as long as you keep voting for us. Or is it just too embarrassing to admit that the most calamitous period for UK living standards since the WWII has happened on their watch.


  1. Could it be down to the increase in self-employed?
    Also one has to wonder whether the low tax intake from the self employed is down to tax avoidance/evasion. It might be that UK in this respect is resembling more a peripheral EU country rather than the usual northern comparators. It might also be that UK tax collectors are relatively inexperienced in tackling what would be a fragmented and widespread phenomenon. That might also explain the understated tolerance of a centre-right govt, in Italy for example, tolerance towards widespread small scale tax evasion has been the main reason for Berlusconi's 20 years of power....

    1. «whether the low tax intake from the self employed is down to tax avoidance/evasion. [ ... ] a fragmented and widespread phenomenon.»

      It used to be in the UK that only the "professions", that is the "middle class" portion of the establishment, like doctors, solicitors, barristers, brokers, authors, top journalists, were self-employed, and therefore they enjoyed phenomenally advantageous tax rules as a matter of right; most notably the self-employed in the UK until the 1980s did not have to pay tax advances in account, and paid taxes as a lump sum two years in arrears, and the tax people were very trusting as to expenses and receipts. Admittedly in part this was because those establishment professionals were actually trustworthy.

      Then a lot of immigration from countries with a tradition of tax evasion via micro-businesses and contract work, plus the desperate attempts of impoverished northerners etc. to make a living, plus the general "Blow you! I am allright Jack" Thatcherism attitude, plus really absurd marginal tax rates, changed things a bit and a lot of "hoi polloi" became self-employed too to enjoy the tax advantages originally meant for the establishment professions.

      Therefore HMRC tightened the rules and required periodic tax advances for the self-employed and started demanding more formal accounts, receipts and invoices.

      The current situation is that there is now a larger black economy where the "self-employed" in businesses like taxis, catering, delivery and especially the building trades do a fair bit of "cash-in-hand" work, but in the UK it is not as huge as in Italy, Greece or Spain.

      In the UK most tax avoidance is legal and (like in the USA) relates to capital gains, which are largely tax-exempt, and there is widespread enthusiasm for property capital gains to be tax-exempt or lightly taxed; and anyhow many property owners (especially divorced middle aged women) cash in their property capital gains entirely tax-free via second mortgages rather than property sales.

      If there is a significant amount of tax evasion in the UK it is among executives or more generally in financial services, where a lot of highly paid people, often technically "self employed" or working for their own company on contract to their "employer", receive their income via transfer from their "employer"'s foreign bank account in Mali or Hong-Kong to their personal bank account in Bahrain or Singapore, totally outside the reach of HMRC. These are the people who pay for their daily expenses using pre-loaded anonymous credit or debit cards issued by their foreign banks, or for larger sums use wire transfers from those foreign accounts.

      But while HMRC could make the efforts to track these down, after all they put a lot of effort in tracking the much smaller flows of money for political dissenters and potential enemies of the State, they have essentially given up on making financiers pay taxes, because "wealth creators", because "they will just move themselves not just their bank accounts to Bahrain or Singapore".

    2. Interesting to note that in the SE England home counties prosperity is very explicit - outside the primary schools the 4*4s Lexus line up for the kids, they are getting larger, they are for mums too, In our N. London self employed car park every car is over 20K ; the private schools are packed as are the nightly restaurants; extensions are rife and builders are enjoying a boom. Anecdotal maybe but the booming south east private sector suggests tax take is low and gentle and likely avoided.

  2. "Instead this government seems strangely indifferent. If they have an explanation for the absence of UK productivity growth, I have not seen it."

    Well, as ever, perfectly sensible economic analysis, coupled with bizarre lack of realism about how politics works in representative democracies. Four points,

    (i) I have not seen anyone provide a plausible account of why there has been a collapse in UK productivity. So, saying the government has no explanation is a bit unfair. Perhaps I just don't get out enough.

    (ii) We are nine months from a General Election. What would you expect any Chancellor to say? "The growth figure look good, but don't forget that the productivity numbers are complete crap." That isn't how you win votes in a democracy. This isn't a seminar.

    (iii) Labour have of course tried to make the 'cost of living crisis' central to their critique of the government. Why have they had so little traction with this line of attack? Because it isn't an alternative plan, but a whinge. 'Slower and shallower' was an alternative policy to Osborne's approach 2010-12, and in some respects has been vindicated (although I don't accept that the small cuts made in the overall scheme made as significant a difference as is claimed in this forum). "Cost of living crisis" only works as an attack line if you have some plausible strategies for dealing with the 'crisis'. Indeed, calling it a 'crisis' indicates some dramatic measures need to be taken. Labour don't have any suggestions, the oft cited freeze on energy prices being one of the daftest policies of any major party (and of course won't help with productivity.)

    (iv) What applies to Labour also applies I am sorry to say to S W-L. Anyone with a passing interest in the UK economy already knows about the horrible productivity falls we have seen.

    What should we do about it (that is not already being done)?

    That would be more productive.

    1. spinninghugo,
      The cause of collapsing productivity is effective demand. Here is a link...

    2. Thanks, will read (properly) with interest. My instincts tell me that there are some UK specific things going on as well with oil and gas production, finance and population profile.

      At first glance, whether you agree with what you say or not, at least it is an attempt to add to the sum total of human knowledge.

  3. Thanks for the detail, much appreciated.

    SW-L; " is it just too embarrassing to admit that the most calamitous period for UK living standards since the WWII has happened on their watch"

    Not embarrassing for them at all, that was the objective. They feel slightly put out that they can't crow about it in public in precisely those terms but do get all warm and giggly with their corporate sponsors over drinks about the success of their joint economic engineering project.

  4. So, are there any lower level breakdowns of productivity, at a lower level than country? Perhaps by sector? My gut feeling is that what we are seeing is not a lowering of productivity in particular sectors (though with continuing low investment we'd not expect rises), but more an increase in employment in sectors with low productivity. The level of detail I've seen in all commentary on this has all been at country level.

    1. Yes good comment. For example, could these figures be explained by the loss of very highly paid jobs in The City and 'replacement' by lower paying jobs elsewhere. That would just be a change in the balance of the economy rather than a drop in productivity as most people would think of the term.

  5. Basically, more people are working, but output is not increasing as fast as the extra work is.

    Why is that bad? Under what utilitarian logic can that be bad? Seriously, I would like to know.

    I mean, the productivity measure is the residual here. The other two we hope are reasonable estimate of real resources. It is always the case that the change in measured labour productivity is quite counter-cyclcal.

    I feel like you are confusing productivity, the aggregate measure, and productivity, the microeconomic idea about how we utilise resources.

    Also, you say that "Rapid productivity growth will bring rapid growth in real wages". Isn't one of the puzzles in macro right now why this hasn't been the case?

  6. I wonder if anyone has done a study of what has come out of the IEA, Adam Smith Institute, and the Taxpayers' Alliance since 2008?

  7. The interesting bit for me is in your first chart, GDP per capita. The Impact of the "slash and burn the public sector" rhetoric of the new Chancellor had on the economy in the second half of 2010. Mr Darling was running an 11% deficit in the first quarter of 2010 and the economy was responding to that fiscal stimulus as per the MMT text book. The Osborne zero deficit by 2015 strategy flat-lined the economy for three years, as he took train loads of spending power out of the demand side of the economy with QE taking out Gilt interest payments and fiscal tightening.

    We now see in the IFS charts that Osborne has not only abandoned the 2015 zero deficit target, he appears to be dumping the 2018/19 one as well .

    Looking back at the data the last two significant recessions are associated with similar "slash and burn the public sector" Conservative administrations, during their respective first three years of office. This last Conservative imposed recession, was superimposed on top of a bailout of Wall Street and Spiv City of London mortgage fraudsters. If ever there was a time NOT to elect a Conservative government, it was May 2010.

    Would some one please explain to the Conservative Party that we are not on the Gold Standard anymore and haven't been for decades. Also, tell them the UK has its own, sovereign, floating fiat currency. That means, the budget deficit, is your governments net spending in a fiscal year, you will eventually get it all back through taxes. Likewise the national debt - the sum of the deficits - is safe in the hands of the private sector who are saving every last pound of it - which is why you haven't got it back yet - in their pockets as cash notes and coins and 30 year Gilts in their pension and insurance funds and similar.

    Oh, remember that our children and our children's children, won't give a toss about us not paying all this so called "debt" back, because they won't be paying theirs back either.

    1. «This last Conservative imposed recession, was superimposed on top of a bailout of Wall Street and Spiv City of London mortgage fraudsters. If ever there was a time NOT to elect a Conservative government, it was May 2010.»

      For that election give thanks to swing voters in marginal Southern seats, that is middle aged property owning landladies or women working in secure public sector jobs, who got fed up with financing the luxurious lifestyles of the unemployed and disabled young (or even old) men in the North:

      From the The Times, 2011-09-17, by Janice Turner:

      «The C2 women who voted Conservative last time did so because they, in low to middling-paid roles such as nurses, secretaries and carers, believed welfare had grown too generous, that benefits rewarded the do-nothings while they toiled. They hoped the Tories would crack down.»

      And the government have cracked down, especially on the Northern disabled and unemployed who lived the high life on benefits in mansions with many unused bedrooms, or funded their luxuries by collecting welfare well in excess of average family earnings, while poor bankers in the City struggled to make ends meet with reduced bonuses due do the fall in mortgage fraud.

  8. What about the denominator? GNP might be increasing, but population growth (thanks to Labour's immigration policies which we now can't control - particularly the low skilled EU "economic migrant" and their high birth rates) is rising at historic rates. I am glad that personally am not at the bottom end of the wage ladder. Any increase in the demand for labour is likely, again, to be met from abroad, particularly at that end. Rent and prices will remain high, or go higher, where the jobs are, making relocation within the UK unattractive. Just as in Labour's long years of power, another chance to do something about the native long term unemployed and its social effects will be lost with this recovery.

    1. Please provide Daily Mail links and write with capital letters. Thanks.

    2. producivity in the us is growing though we have an influx of poor and uneducated workers so your position seems unlikely. perhaps there has been a slow down of growth in jobs that seen great productivity growth though i would expect that barristers and doctors have not seen much productivity growth in their professions; i am not sure that money managers are more productive than they were 10 years ago. So we are left with an interesting question; living in the wrong Cambridge, i am curious to here what you have to say about it.

    3. «producivity in the us is growing though we have an influx of poor and uneducated workers»

      The level of income and education do not necessarily correlate with productivity... Especially after a recession.

      But more importantly immigration in the USA is almost entirely, by design, illegal, and this means adding low paid "invisible" workers and their output to the figures. This means that the output per "official" worker looks higher.

      In a sense illegal/"invisible" low paid immigrants are a "productivity" booster like oil or slaves: they add to the output per "official" worker, at a low cost.

      There have been some studies that support the notion that in the USA (and presumably in other countries) a large part, if not the majority, of the "reported" increase in productivity per "official" worker has come from illegal immigration. Immigration, and in particular "invisible" illegal immigration is a powerful booster for the "official" part of the USA economy; apart from productivity, illegal immigrants who give a fake USA SSN pay social security taxes but will never collect their pensions or invalidity benefits, and this has hugely boosted the various OASDI funds to the benefits of "official" workers.

      «expect that barristers and doctors have not seen much productivity growth in their professions; i am not sure that money managers are more productive than they were 10 years ago.»

      Illegal immigration "invisibly" adds to to the denominator of "productivity", that is the size of the workforce.

      Burt there are even bigger issues with the the aggregate numerator, that is GDP, whether national, regional or sectoral, which is supposed to measure material *value added*, and productivity per . Since the *material* aspect is difficult to measure anyhow it is measured in nominal terms and then "deflated" by artfully and astutely constructed indexes that always make it look larger than otherwise.

      But an even bigger problem is that while it is difficult to measure properly the value added of the agriculture and manufacturing, there are huge theoretical and practical difficulties measure the value added of services and government.

      When the economy was 80% agriculture and manufacturing this mattered less; now that it is 80% services and government reported GDP numbers are essentially fantasy numbers.

      Because it is so difficult to come up with a definition of value added in government and services, and to measure anything like that, many national statistical agencies simply make up (and sometimes confess this in obscure footnotes to their methodology papers) government and services value added numbers.

      Some national statistical agencies try to finesse the "make up" story by "estimating" the value added of government and services by using various proxies, but this is just making up those numbers in a less brazen way.

      Barrister, doctors and money manager "value added" is exceptionally hard to define, never mind to measure, and there are strong indications that large parts of financial and related services are either purely redistributive (zero value added) or parasitic (negative value added), yet according to reported GDP numbers it is financial services and related services that have contributed most to reported GDP growth in the past 20-30 years...

      BTW there are problems with measuring value added in agriculture and manufacturing, but they are mostly related to the issue of capital depreciation value added is supposed to be net of that, and yet capital in the form of oil or land fertility gets liquidated that is counted as output but not as capital depreciation. An old trick...

    4. I think when we are looking at living standards we do have to look at the denominator as well as the numerator of GDP per capita. I think in both the US and the UK the losers from globalisation, especially the vast migrations we have seen here, are what the Wall Street to Woodstock set patronisingly call "white trash". High rates of immigration (free movement of labour) are not the only or primary cause of their plight, but at the very least they are a slap in the face, and they make fixing the problem (getting them back into stable employment) even more difficult. The main front here behind these policies is someone called Jonathan Portes who says he "understands the data". Well, his forecasts on immigration do not lead one to believe he understands the data and would be laughable if not for the seriousness of the results. It was a political blunder that could bring in a far right party and our exit from the EU.

    5. «in both the US and the UK the losers from globalisation, especially the vast migrations we have seen here, are what the Wall Street to Woodstock set patronisingly call "white trash".»

      The statistics show the losers are more precisely *male* "trash", mostly young and Northern (in both countries, as in both countries the North had the unionized industries the conservatives aimed to destroy), and trash here also means downwardly mobile middle income men.

      Jonathan Portes seems to me just one of the many water carriers, not a prime mover. In random order I would think that Michael Jensen, Lewis Powell, and Keith Joseph, but so many others.


    The ONS found that 3/4ths of the productivity decline is due to finance, north sea oil and utilities The first two at least are completely understandable given the crisis and declining oil output.

    The rest of the British economy is mostly fine, as productive as it has always been.

    1. I was about to post the same point. UK's declining North Sea oil and lower Financial sector profits explain most of the UK's underperformance. Notice bets performers are US and Australia who have been having resource led booms. UK is having the reverse.

  10. «Rapid productivity growth will bring rapid growth in real wages,»

    That has been the case when there were strong unions: workers made more money from productivity, and shareholders from higher volume. Things are becoming different in the UK, and have been different for a long time in the USA.

    «meaning that much of the unprecedented fall in real wages we have seen in recent years is reversed. [ ... ] The alternative is that labour productivity does not make up lost ground. If this happens, the average UK citizen will be 15-20% poorer forever following the Great Recession.»

    There was a gigantic once-only boost to the *real* standards of living of the UK starting in 1980 thanks to Scottish oil extraction, which flattered enormously "productivity" by raising the denominator with what was not in effect production but literally burning up capital. If you remove that capital drawdown the denominator has to go down.

    Plus another once-only boost to the *apparent* standards of living from enormous increases in City spivery financed by enormous regulatory forbearance resulting in a debt/collateral spiral, with front-loaded benefits and back-loaded costs, as spivery usually is.

    «3/4ths of the productivity decline is due to finance, north sea oil and utilities»

    That is the usual illusion: that extracting oil is counted in GDP as "production" instead of as capital liquidation; and that City spivery is counted as production instead of as pure redistribution from marks.

    Of course when the Scottish oil reservoirs become exhausted, the "productivity" per oil worker declines, and when the City runs out of marks, the "productivity" per spiv declines.

    While I think that overall RBC is a propaganda oriented theory of economics, real business cycle shocks happen, it is not just an eternal narrow fluttering of GDP around a smoothly linear upwards trend.

    As the working (middle) classes of the UK North or the USA Rust Belt can attest, sometimes there is an Ozymandias moment, and GDP and GDP per head can reverse, and for good.

    If the economic policy of the Coalition has a theme, it seems to be that they think that with the Scottish oil gone the economy of the South East, mostly based on a borrowing/collateral boom, is unsustainable and the South East will soon look like the North East or at least the Midlands, and the only hope for maintaining a high standard of living are in London and only as an entrepot, a money-laundering centre, to steal business from Switzerland and Singapore, by being outside the EU as they are, to receive tax-evasion money from wealthy continental europeans,

  11. Nobody in this discussion seems to have remembered the Easterlin Paradox: growth does not generally make people in rich countries happier, though o f course unemployment, which usually rises as growth slows or stops, does cause great unhappiness. Thus following Tim Jackson's Prosperity without Growth, such a future need not reduce subjective well-being, provided full employment is maintained. Indeed SWB could rise with shorter working time, lower material consumption, redistribution to relieve poverty, and less destruction of the environment.

  12. You assume a constant labor share which is a mistake.
    I have shown you before the answer is in falling labor share which weakens effective demand. It is crucial to understand "effective" demand. Productivity stalls against the effective demand limit.
    As Keynes said... "“The insufficiency of effective demand will inhibit the process of production in spite of the fact that the marginal product of labour still exceeds in value the marginal disutility of employment.”
    The quote shows that productivity is limited by effective demand, even when it appears that labor could be more productive. The shame is that people do not understand effective demand in the UK. The trick is to make the connection between low wages and the dynamics of an effective demand limit.
    Developing a model for effective demand has been my research for the past year and a half.

  13. Damn! Every time I write a post discussing the productivity data, I get attacked for being too much of a pessimist, so I wrote one post carefully avoiding that subject and I get a "should know better" jibe for not mentioning the productivity data. Can't win...

    There is no actual "news" about productivity this month, because we don't have complete labour market data for Q2 until next month. I have hardly avoided discussion of the data on a longer horizon.

    I am still confused about the way you frame this. Why is the "news" about productivity present in the employment data but not in the real GDP data? Specifically for 2012, I do not see much effort to "qualify" the weakness of real GDP with the fact that productivity was collapsing at an alarming rate. Why not?

  14. «I am still confused about the way you frame this. Why is the "news" about productivity present in the employment data but not in the real GDP data?»

    In an economy which is 80% services and government, how do you define "GDP" and "producitvity" for that 80% rs of the economy?

    Do you take whatever numbers the stats agency comes up with as something that has some relevance?

    Or do you prefer to pretend that such issues do not exist and engage in metaphysical arguments because they are engaging distractions and make-believe that "business as usual"?


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