When did relative UK decline begin? Productivity and the Global Financial Crisis

When did things start going wrong in the UK? Many would give the Global Financial Crisis (GFC) as the answer. Now that may be a good answer for some reasons (see below), but I want to suggest one reason that is perhaps not so good as it first appears. That reason is labour productivity, growth and living standards.

Why does it appear to be the answer for UK productivity and growth? Here I can just refer to the chart that is at the top of my post two weeks ago, showing UK GDP per head before and after the GFC. As I have noted many times, underlying growth in UK GDP per head (and therefore to a first approximation real earnings) before the GFC is remarkably consistent, with a trend growth rate since the 1950s of just over 2%. There are of course booms and recessions around that trend, but until 2007 every economic downturn seemed to be followed by a recovery that put the level of GDP per head back on its trend line. Of course that constancy from the 1950s until the 2000s could well be a coincidence, with different factors influencing productivity more than others over particular parts of those fifty odd years.

Below is UK output per hour worked, which shows the same pattern (source)

After the recession of 2008/9 there was almost no recovery in the sense of output or productivity growing faster than trend. So the level of productivity and GDP per head did not return to its previous trend line. In addition, the growth rate also slowed substantially, to something like half the previous trend. It therefore looks like something disastrous happened around 2007, and the Global Financial Crisis is the obvious culprit.

Now we all know that the GFC started in the United States, and that the US financial system was also very badly hit by that crisis. Below is a picture of US productivity growth (output per hour in the non-farm economy).

It is a more complex picture than for the UK, but growth after 2007 does not look that different from growth since the 1970s, with the exception of a period of more rapid expansion from the mid-1990s to the mid 2000s. That period of more rapid growth is generally put down to the impact of the IT revolution. Here are some average annual growth rates:

Year on year productivity growth in the US (defn and source as previous chart)

Period	%
1948-73	2.8
1974-94	1.4
1995-2004	3.1
2005-19	1.5
2020-24	2.0

If we put the rapid growth around the millennium down to the IT revolution, then there is no downward shift in either the level or the growth rate of productivity as a result of the GFC.

Now it is of course possible that the GFC had a much more profound impact on UK growth than in the US. But there is an additional empirical reason to doubt that the GFC was the obvious reason why UK productivity growth declined so drastically. Below is a chart of productivity in the UK financial sector [1].

Financial services productivity started growing rapidly around 2004/5. We now know this was unsustainable, because it was based on levels of leverage that meant the sector could not survive significant negative shocks. If we take financial services out of the UK aggregate, then it becomes apparent that productivity growth in the rest of the economy began to slow from the post-war trend a few years before 2007. In addition the growth rate in the early 2010s is a bit better than the aggregate figures suggest.

It was for this reason that in this previous post I was careful to talk about a productivity slowdown, in the UK and elsewhere, that happened around 2005, rather than after the GFC. Why does a difference of a few years matter? As the reason for the decline in UK productivity relative to other advanced economies remains something of a puzzle, associating it with the GFC naturally focuses attention on financial factors to explain that puzzle. Placing the decline starting around 2005 allows for a wider range of possibilities.

In particular, it ties UK productivity trends more closely to those in the US. Perhaps UK productivity growth also benefited from the IT revolution around the millennium, and so at least part of the absolute decline in UK’s productivity growth since around 2005 is a result of that revolution petering out, just as we saw in the US. Doing this allows us to be far more eclectic about when underlying UK productivity started growing less than other major economies like the US. Excluding finance, UK productivity growth was quite strong after the recession, and it is only around 2013 that growth rates seem to clearly shift to below US levels. Of course none of this rules the GFC out as a key factor in explaining the UK productivity puzzle, but it does remove the GFC as the empirically compelling cause.

Are there other reasons besides growth for suggesting the GFC was the beginning of the UK’s recent relative decline? The obvious answer is that the deep recession it caused was key in ending the Labour government, and therefore starting a period of Conservative government that has been economically disastrous. However even this could be contested. Gordon Brown became pretty unpopular as Prime Minister well before the recession hit, and some would argue his standing as PM rose as a result of his handling of the GFC.

It is also crucial not to get the impact of the GFC crisis confused with the policy response to it, which was general fiscal consolidation, aka austerity. The long period of ultra low interest rates that began during the GFC but lasted for the next decade, and which helped create a boom in asset prices including house prices, was not a result of the GFC but was instead due to fiscal austerity. If the 2010 Coalition government, and governments around the world, had responded to the GFC recession by continuing rather than reversing fiscal expansion, as financial markets were crying out for them to do (because all interest rates were so low), then the period of ultra low rates would have ended in the early 2010s, and we would not have seen such a marked increase in asset prices.

[1] Levels extrapolated from growth rates, source.