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.
