Winner of the New Statesman SPERI Prize in Political Economy 2016

Tuesday, 28 July 2015

An optimistic view: a UK investment led recovery

Someone wrote to me the other day to complain that my posts were always negative in tone. I understand where they were coming from, as there is a lot going on here in Europe to be negative about. However just to show that I can do positive, here is how the next few years could be relatively cheerful ones for the UK economy.

The important point about today’s GDP figures, showing 0.7% quarter on previous quarter growth (not annualised), is that this has happened despite what looks like being a relatively poor quarter for employment. The combination means that UK labour productivity growth may have finally resumed after its six year pause. This while nominal wage growth shows clear signs of increasing.

What we could be seeing is an investment led UK recovery. It all goes back to my favourite explanation for the UK’s productivity puzzle: that after the recession, high unemployment (both in the UK and Eurozone) pushed down UK wages, which led firms to put investment that would have led to labour productivity growth on ice, and just employ more people instead. (There may also have been direct labour for capital substitution of the kind beloved by macroeconomists.) With reasonable growth in demand this generated rapid employment growth, cutting the unemployment that helped cause stalling productivity.

It was my favourite productivity puzzle story, not because I was sure it was right, but because it was optimistic. It was optimistic because, as unemployment fell and labour shortages began to become common, the process would stop and investment would resume. Provided demand continued to increase, both actual growth and growth in productivity might continue above trend and we would find that at least some of that output which pessimists thought was lost forever after the recession would return. I also thought there were some grounds for this optimism: stories about the pre-2007 trend being artificially inflated by debt were, well, inflated, and productivity innovations do not take six year holidays.

The caveat about demand remaining strong was crucial, of course. Fiscal policy and you know who will not help beyond 2015, and neither has the recent strength in sterling. However lower oil prices go the other way. The big unknown is monetary policy. If nominal wages start rising before productivity growth resumes, that would be a trigger for the MPC to start putting on the monetary policy brakes too soon. They could still make that mistake, of course, but rising productivity growth coupled with core inflation below 1% should make them wait.

I should add in passing that if this does all happen, it in no way excuses what has gone before. Strong growth after a long recession does not make the recession OK! The cost in terms of lost output (at first compounded by the costs of high unemployment) has been huge, and you know why I think much of it could have been prevented.

I should also stress that this is an optimistic scenario, not a forecast. I know enough about unconditional macro forecasts not to do them. All manner of things could go wrong. But if this is how things do pan out, it will not just be good news, but it will also be fascinating from a macroeconomic point of view. It will show how you can have a prolonged demand deficient recession without persistent high unemployment, partly as a result of what economists call flexible labour markets. This was always something that could happen in theory, but I’m not sure we have many examples where it has happened. However, I should not allow my optimism to count chickens before they are hatched.


  1. The 16% QonQ increase in Brent helped (production actually down), given this mostly reversed (if use experienced to date plus futures) should see a bigger fall than the rise imparted last Q

  2. Not that the still use such arcane forms of data, should the MPC really be raising rates when the money supply (below) is still plateaued with no real sign of increase.

    Also, does anyone still think money supply is worth looking at, as it surely serves as a good estimate of demand for goods and services in the economy. If it is worth looking at the graph is pretty shocking?
    (Could someone let me know how to link into the post, I'm new to this)

  3. Excellent blog post. Often the subject matter can be depressing (like never-ending high unemployment in Greece or the corruption of MediaMacro), but these are questions of central importance. But I find your tone and writing style non-depressing which helps alleviate the depressing nature of some of the subjects.

    Often just understanding and being able to diagnose and explain the issues make them less depressing. We can do something about it or at least try.

  4. Surely it's the duty of a professor of the dismal science to be permanently dismal?

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  6. If the government withdraws spending from the economy, as is their current trajectory will firms defer their investment plans?
    I wouldn't be surprised if this growth is a result of renewed immigration, as it's firmly rooted in the service sector.

  7. If the government withdraws spending from the economy, as is their current trajectory will firms defer their investment plans?
    I wouldn't be surprised if this growth is a result of renewed immigration, as it's firmly rooted in the service sector.

  8. I'm not sure now in the time for rhetorical optimism; given the last two election results and the contours of the economic debate since 2008 - or 1981 - I don't think it is time for university economics to withdraw into even a hint of the panglossian.

    See Krugman's 'Second-best Macroeconomics' JULY 28, 2015:

    "Which makes me ask myself the question: Do people like me spend too much time being limited by what is presumed to be politically practical? Should we devote more time to trying to widen the range of options, to pointing out that we really would be much better off if we threw off the fetters of conventional deficit fears, the 2 percent inflation target, and the extremely ill-advised euro project?"

  9. Have to say the figures took me by surprise, was expecting a continuation around 0.3-0.4%. The things I took from the figures are industrial production fell and the service sector provided most of the growth. Can I then ask a naive question can you have productivity growth in a service based economy when industrial production, construction and farming output is falling.

  10. There is very good macroeconomic evidence for the idea that the productivity growth "puzzle" is explained by the lack of investment.

    See the graph on

  11. SWL means well but ....

    It's possible there could be a "cheerful" few years for the UK economy, but SWL needs to make clear this is surely very unlikely given current evidence.

    UK consumers too much debt already. High £ hurting exports. GO won't provide fiscal stimulus. If you close down your manufacturing industry and import instead condemed to low productivity.

    Not enough demand in the Eurozone. No sign of a turn to sense even from the French.

    US deficit too low. Low Oil net negative due to lost Oil CAPEX. US Q2 GDP could be less than 2.5% SAAR tomorrow 30th July. High chance of a global stock market correction in Q3. High $ means world short of it's dominant currency.

    Apart from the above everthings fine. Oh wait China .....

    The world is short of demand. SWL needs to wrap this message around a brick and throw it hard against the Overton window.

    Thats it fartig

  12. For employment to rise (notwithstanding suspect reclassifications of some benefit groups) when there were no real wider signs of increased investment and improvement in the economy, including wage growth, had to mean that the growth was in low-paid jobs. If this is permanent, or becomes a reality for many people, then the argument surely moves to how to address the inevitable widening of income inequality?

    I bet that doesn't come up in the leadership debates in any meaningful way.


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