Winner of the New Statesman SPERI Prize in Political Economy 2016

Thursday, 2 April 2015

Silly questions or silly economics

On cue to confirm what I wrote yesterday, Ryan Bourne at the Institute of Economic Affairs complains about the BBC coupling the Telegraph business leaders story with the CFM economists survey. [1] Mr. Bourne’s main gripe is that the CFM question on austerity was silly. The question was “Do you agree that the austerity policies of the coalition government have had a positive effect on aggregate economic activity (employment and GDP) in the UK?”

Why was it silly? To quote: “the overwhelming majority of even supporters of austerity would disagree with the question, because in the short-term they would also believe that cutting spending and raising taxes would dampen growth. Indeed, the OBR and others factored this into their models. It is well known.” And later on: “these proponents of austerity were willing to make a trade-off: slightly slower growth today, in order to achieve other objectives.” [2] So they would be forced to disagree with the statement, even if they agreed with austerity. 

This tells us two things. First, it emphasises something I and others have occasionally said, which is how far austerity supporters have lost the intellectual debate. I remember not that long ago the arguments being about expansionary austerity, or how monetary policy could (would) offset any impact that fiscal policy might have on activity. Or it was about how we had to have austerity, because without it there would have been market panic. Apparently not - it was really all about current sacrifice for future gain.

Second, it illustrates the gulf between what most economists understand and mediamacro. In mediamacro, austerity was necessary because without it terrible things would happen (or at least there was a good chance of them happening). Not sometime in the future, but pretty soon. To quote the Prime Minister: “Britain was on the brink“. This of course is why some of the non-partisan media found the CFM survey interesting.

There is a huge amount in Mr. Bourne’s post that I could take issue with [3], but let me just focus on one point. He says: “Certain commentators are keen to claim that employment growth has only been strong because the productivity performance of the economy has been weak. This is an utterly bizarre claim.” He mentions this, of course, because the government is making great play over the number of jobs ‘they have created’.

To say that this is a bizarre claim is, frankly, bizarre? Let me explain why. No one disputes that our labour productivity performance over the last five years has been terrible. Here is a chart from the latest ONS release.

  
Note that a fall in productivity during a recession is not unusual. What is unusual is what has happened during the period of the coalition government. (See more on UK productivity from Ken Mayhew at the coalition economics site.)

Labour productivity is just output divided by employment (or hours worked). Why is stagnant productivity a problem? Because over the long term (across booms and recessions) the level of employment is essentially tied down by how many people want to work and how many hours they want to work, so productivity growth means output growth. Improving living standards depend on improving productivity. So if over the last four years we have lost productivity growth that we are not going to get back for some time, this will mean lower average UK prosperity.

Does this not also imply that had productivity growth been stronger over the last four years, output would have been higher and employment growth much the same? No, because coming out of a recession caused by a collapse in demand, most economists see output as being determined by aggregate demand: how much people want to spend, how much firms want to invest, and how internationally competitive UK firms are. That is exactly why austerity hurts output, a point which Mr. Bourne seems happy to concede. It therefore follows that if productivity growth had been stronger, output would have been much the same because aggregate demand would have been much the same, but employment growth would have been weaker. Over the last five years strong employment growth and weak productivity growth is much the same thing. Which is why celebrating strong employment growth is effectively celebrating poor productivity, which does seem silly.

[1] Mr. Bourne will have been pleased to note that, at least from what I saw, none of the evening news bulletins covered the CFM survey, while the business leaders’ letter retained its top spot. I’d love to know the reason for this change.

[2] Mr. Bourne gave three reasons why sacrifice now would lead to later gains: (a) lower borrowing costs, (b) preparing for the next recession, and (c) a smaller state increases productivity. As I have argued before, there is no evidence that at the beginning of 2010 interest rates on UK debt involved any noticeable default premium. I have discussed at length how we might be better prepared for the next recession, but strangely sacrificing large chunks of GDP today was not on my list. As for (c), look at the record on productivity.

[3] For example, the question Mr. Bourne would have rather seen is whether fiscal policy was the main cause of weak growth from 2010 to 2012, or whether external factors were more important? He does not say why this is a much better question. Of course the question Mr. Bourne would really like is why the economy did worse than the OBR expected, because the OBR were always expecting austerity to reduce growth. Personally I find questions like what impact did government policy have on the economy rather relevant, particularly coming up to an election.  


28 comments:

  1. Magnus Carlsen2 April 2015 at 05:19

    The IEA are one of the reasons the public mistrusts economists. Noone seems to care that they're just a mouthpiece for corporate interests. The media lap up their quotes, and they're always portrayed as impartial.

    An organisation called the Institute for Economic Affairs spouts uncriticial (and ideological) free-market drivel from the 1980s, and macroeconomics pre-dating Keynes. The public sees this, sees the journalist taking their views seriously, and then takes away the idea that this stuff is 'economics'.

    Interested observers should check the Wikipedia entry on the IEA. Note that they fail to disclose their funding.

    I would propose that journalists be required by law to state the full sources of funding before indulging these ''Think Tanks'' with air time.

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    1. What's needed is some tit-for-tat. Enough of the Institute of this and Adam Smith institute of that. I'm off to register TheThatcherInstitute.org as a web address and fill it with left wing propaganda.

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    2. Magnus Carlsen2 April 2015 at 11:07

      Well yes, though on the one hand the Koch brothers are unlikely to support you for very long.

      On the other, we don't need left wing propaganda. Prof. W-L will tell you that mainstream academic economics provides all you need to think critically about austerity. However, the interesting question now is why the media don't find this worth reporting.

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  2. Surely Bourne's claim for bizarreness is plausible. Higher employment can't cause sluggish productivity it's simply a mix effect of the employment growth. Have people become less productive? Has the economy become less productive? Merely pointing at changing average total production/total employment tells us little of real trends. Or are we debating about the meaning of "productivity".

    Your chart shows that the most productive workers got thrown out of work quite quickly in 2008, but then got back in to work quite quickly. The less productive workers have then struggled to make it back into the workforce but have been re-engaging for a few years now, a good result and not to be sneered at by Labour. The UK economy has also been dealing with/attracting large inward migration. I have seen no studies on the impact on those national productivity figures, but suspect it was not helpful.

    The next stage is the exciting one as full employment is reached and AD growth then pulls up wages for the lowest paid and productivity gains can occur for the mass of labour. Those market forces are now pushing wages higher for the lowest paid in the US, and coming to the UK soon.

    http://www.bloomberg.com/news/articles/2015-04-01/the-simple-explanation-for-why-mcdonald-s-is-raising-wages-for-some-of-its-workers

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    1. Higher employment DOES cause lower productivity if output does not rise - that's maths. You may say "but it's impossible - no one would increase employment if they were not also going to increase output." Unfortunately or not, this is not the case. Employment subsidies of many kinds (I've identified some of them before - EITC, apprenticeship subsidies) can change the optimal mix of labour to other inputs even in the absence of any increase in output. Again, the increase in employment created by these subsidies may have valuable social, and even macro-economic (Keynsian) effects but they will reduce productivity.

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  3. Apologies- I don't quite get what your saying - unemployment has fallen in the last 5 years... Is this because people are working less hours and therefore productivity down?

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    1. I believe he is saying that the low unemployment in combination with an economy that is standing still means that productivity is also standing still. In Britain during normal times and for most countries even during the crisis, people produce more and more output per hour of work. This stopped being the case for the British since the current crisis began, as Professor SWL shows in his chart. Basically, the low unemployment has only been achieved through a general impoverishment of the nation.

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    2. What I didn't get from SWL's post is why low productivity leads to low unemployment. What's the story behind these relationships in this case?

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    3. It's not that low productivity necessarily leads to low unemployment, but that if you have stagnant productivity, then any growth in output (GDP growth) must come from increased employment. We're not talking about any mechanisms here, just describing the situation. I think Professor WL's points are that employment growth with no productivity growth is not an unambiguously good thing, especially in the longer run; and that it's pretty bizarre to think that worrying about low productivity growth is bizarre.

      Fearghal

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  4. It all started going wrong at the BBC when Hugh Pym just before the general election of 2010 on the one o' clock and six o' clock news was allowed to state that the 364 economists writing to the Times were wrong in 1981 and Geoffrey Howe was right.

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    1. That would be the Hugh Pym who a few years back was gushing about the coalition's deficit reduction plans and saying that the next step was to pay off the whole national debt. I see he's now reporting health where, hopefully, he can be a bit less stupid.

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  5. If you supported Austerity and thought it a short term hit in return for improved performance later, or if you thought Austerity was the least worst option even, and those things came to pass, then you could in perfect good faith say that you thought Austerity had a positive effect - no?

    This isn't hard surely?

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    1. How would you know those things came to pass? You can't see the counterfactual no-Austerity economy, so you can't measure its performance to find out if Austerity was the least worst option.

      Fearghal

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    2. “then you could in perfect good faith say that you thought Austerity had a positive effect - no?”

      No. Fearghal is right: you would be compounding your error, not acting in good faith. I was disappointed to see Robert Skidelsky defending this sort of thing recently.

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    4. You'd only compound your error if you were in error (which, granted, you might be - but remember this was a survey, not a test - there are no wrong answers).

      For sure, knowledge is never perfect. But if you predicted good (or other) things from Austerity back in 2010, you might have some idea of how things seem to have gone 5 years later. Heck, you can even test against multiple instances of Austerity from around the world. That's how we'd know (or not know - not knowing was an option on the survey), even if imperfectly.

      I don't see why anyone would be trapped (as Bourne asserts) by the question 'has austerity delivered positive results?' - it's hardly a trick question.

      If you think (in error or otherwise) austerity was the right thing to do, you ought to be able to say so in a survey without getting in muddle and accidentally saying that it's had a negative effect.

      Even if you thought austerity was some sort of least worse option, it still shouldn't throw anyone: -2 is +2 more than -4. And last I looked +2 was positive.

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    5. There are no wrong answers in that sense (it was a survey: all honest answers are 'correct'), no, but those economists who agreed with the statement of Q1 certainly were compounding their error.

      Admittedly some of them might've been acting in good faith in the sense that they really do still believe austerity was the right policy but in that case I'd judge them crackpots.

      I don't see why anyone'd be trapped by the question either. If Bourne is right it'd just mean economics has an even worse problem with incompetence, intellectual dishonesty, crackpottery or whatever than the survey results suggest.

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    6. ( ... and looking at the actual responses just now I see it's not only those economists who've “Agree”d with the statement of Q1 who seem determined to make defending economics as a science more difficult than it ought to be. :< )

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  7. At my end of the economy, I'm disabled and so relatively poor, it seems to me a lot of young people are not claiming unemployment benefit (Job Seekers Allowance), as the benefit is too low for the difficultly of claiming it. Of these most do some work with their parents or for friends or neighbours for two days, or so, which gives them enough to get by with parental support. Others do blocks of 2, 3 - 6 months work, loose their job (a contract ends) and they then live off their savings until they find a another job, For people around my age most go self-employed to escape the clutches of the DWP, and do what ever work is available. It's a rare week where they get a full week's work. Rates of pay vary quite a lot, construction can pay very well, indeed, for someone living in their parents extremely well, but in general rates are at or below the minimum wage. From this anecdotal 'evidence' it appears some of the new jobs created provide only a few hours/days work per week and at a low rate of pay. I've been trying - as a thought experiment - to work out how this stacks up with respect to productivity (it's influence on demand is obvious). I do not know how many hours is allocated in these circumstances. I suspect its more than they actually work and I believe this would lower productivity. Another point of interest comes from this issue and the inadequacy of measuring unemployment and employment using the present system. I guess we need something that measures hours worked rather than per person working?

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  8. Suppose the IQ of every worker went up by 30 points overnight and everyone was suddenly able to operate on 2 hours sleep a night. Does SWL really believe the result would be mass unemployment? Surely this increase in productivity would increase output as well (so there is no presumption employment would fall)?

    This is my understanding of Mr Bourne's discussion of productivity and it seems reasonable to me.

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    1. Let me ask you the same question I asked him - which component of aggregate demand would rise in your example? There is no point firms producing more if they cannot sell the extra goods.

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    2. It seems a lot of folk really have a hard time grasping that firms don't just make stuff cuz thats what you do after you get up in the morning. Contract manufacturing (in the US) runs on shorter time scales, so that a drop off in demand for part A leads to a near-immediate decrease in employment, in that less temps are hired that month (just as an example). Part A picks up, things are busy, more temps are hired on or returned. So in a general slow down, nobody is making more parts just because they can... People make parts and stuff cuz they have orders for them, not cuz they think they might sell it, that sort of gambling is gauche. And of course everyone wants to keep their inventory at a target level compared to outputs, and for various accounting reasons. Anyway, rambling as I am, would strong employment growth and stagnant productivity just be a chimerical effect of high turnover jobs, effectively, people just switching places with each other at the unemployment line? Or everyone just working eight less hours a week?

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    3. "which component of aggregate demand would rise in your example"

      Anon's question was about movement along the AD curve in response to an SRAS shock, not a movement in the AD curve itself. Working out how an SRAS shock breaks down across GDP is not particularly relevant.

      Yes, if you assume that output is fixed by AD, there are no SRAS shocks and you will get strange results like labour supply is determined by the inverse of productivity... or vice versa? You are a long way from a textbook model here, and I imagine a lot of British central bankers would fall out of their chairs laughing if you told them there cannot be SRAS shocks, or at least such shocks don't affect output.

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  9. I think we both agree that in the long run (once we're away from the ZLB) production will be higher. Won't this have an impact on demand today (e.g people will borrow against their higher future income)?

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  10. Simon! My goodness! You have gotten old. I hope it isn't one of those rapid aging conditions:

    http://en.memory-alpha.org/wiki/The_Deadly_Years_%28episode%29

    Thankfully your mind remains intact.

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  11. Have you factored-in migration?
    Thousands of workers have migrated from the higher-unemployment and low-growth areas of Europe (i.e. most of it) to work in the UK where there are jobs available and economic growth.

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