Will May face down those who want no deal?

In which I find a silver lining around the current weak state of the Labour party

The negotiations between the UK and EU that will take place over the next two years involve two components. The first will be about non-trade issues, such as how much does the UK pay to the EU to cover pensions etc, and agreeing the rights of EU citizens currently in the UK and vice versa. The second will be the terms of the transitional arrangements for trade while a full trade agreement is negotiated.

The obvious transitional arrangement is for the UK to stay in the EEA, which means staying in the Single Market and customs union while a new trade agreement can be negotiated. It would also mean on the face of it accepting free movement and European Court judgements.

What will be difficult for May is continuing free movement, accepting European Court judgements and paying as much as the UK currently pays during the transitional period. It may be possible to fudge all of those, such that May can appear not to cross her red lines in accepting a transitional arrangement. But to agree to this, the EU will want something else that allows them to say the transitional arrangement is clearly worse than staying a member. That may be the detail that the negotiations over a transitional arrangement are all about.

These negotiations will not be about meeting somewhere between the UK's and the EU's position. That would be a major misunderstanding. The moment the UK triggers Article 50, all the cards are in the EU’s hands, because the UK has a lot more to lose by falling out of the EU with no agreement than the EU has. And Frances Coppola is right is saying that the EU is quite capable of playing hard ball. So the negotiations are more about the UK exploring the EU's trade-offs rather than a genuine give and take.

The key criteria for the EU is that any deal has to be obviously worse than EU membership. A lot will depend on whether the EU negotiators are prepared to take the UK not having a say on the rules of the game as sufficient to indicate a worse deal compared to full membership. That will help determine how much the UK pays the EU during the transitional phase.

That is obviously the sensible way for both parties to proceed. The only uncertainty is whether the UK feels able to accept it. The problem for the hardest of Brexiteers (which includes the Mail and Sun) is that a transitional arrangement of this kind makes it very easy for the UK to change its mind. That could easily happen if the prospective trade agreement makes firms start to leave the UK and public sentiment changes because the promised land was not as advertised. That has been their nightmare all along, which has led the Mail to call judges enemies of the people. Based on what has happened so far, we could expect these Brexiteers to start turning their guns not on the EU, but on May herself, if it looks like the deal will go the way I suggest.

If this happens, how will May react? You can look at what has happened so far as a guide. The trouble with doing that is all the ‘bad deal is worse than no deal’ stuff may just be Econ 101 game theory: make it appear as if you might walk away to get a better deal. The reaction of the press to the NIC changes in the Budget were an obvious warning shot from them towards May. Her climbdown makes it appear as if the press are calling the shots, but that may simply be a sweetener for the major let down that is yet to come.

So recent events provide no clear guide as to how May will react if the hard Brexiteers turn on her. It all comes down to a question of character. In this respect, a discussion by David Runciman in LRB of Rosa Prince’s biography of May is very interesting. He writes

“May didn’t do negotiation; in the words of Eric Pickles, one of her cabinet colleagues, she is not a ‘transactional’ politician. She takes a position and then she sticks to it, seeing it as a matter of principle that she delivers on what she has committed to. This doesn’t mean that she is a conviction politician. Often she arrives at a position reluctantly after much agonising – as home secretary she became notorious for being painfully slow to decide on matters over which she had personal authority. Many of the positions she adopts are ones she has inherited, seeing no option but to make good on other people’s promises. This has frequently brought her into conflict with the politicians from whom she inherited these commitments. By making fixed what her colleagues regarded as lines in the sand, she drove some of them mad.”

I have written before that it was unfortunate that our post-referendum Prime Minister should be the minister who had tried and failed for six years to reduce immigration. Runciman's description above also helps explain why she did not do the two things David Cameron would have done if he had remained leader: given the close vote seeking the softest Brexit possible, and before doing that going back to the EU to see if they were now prepared to be more flexible on free movement. But it does not really tell us how she will play the next two years.

I can see one hopeful element that could allow May to see off those pushing for no deal, and that is the hopeless position of the Labour party. If Labour was strong, the last thing she would want was a 2020 election dominated by internal Conservative fights over her ‘Brexit sell out’ and the press against her. That might have forced her to appease the ‘no deal’ Brexiteers. Luckily in this respect the official opposition is the last thing she has to worry about during these negotiations.

Brexit makes the economics of Scottish independence much more attractive

There is a slightly later and extended version of this post, which may also be a little clearer, at the New Statesman here.

It is difficult to think clearly when you watch the utter hypocrisy of our Prime Minister, lecturing the SNP about politics not being a game, moments before she needlessly rejects a Lords amendment to secure the rights of EU citizens in the UK. Everyone knows those rights will be guaranteed during the negotiations, so it would be so easy to seize the moral high ground by doing that now. But I’m not sure our Prime Minister, and her MPs, would recognise the moral high ground if it was staring them in the face.

Nicola Sturgeon had no choice but to announce a second Scottish referendum. Brexit is a huge economic and political change, and she would be neglecting her duty to the citizens of Scotland not to explore ways she could avoid a hard Brexit fate for her people. She was given no choice by the decision to leave the Single Market, made not by UK voters but by the Prime Minister.

Yet it is also difficult to forgive the SNP for inventing the term Project Fear, which became the vehicle by which the Leave campaign was able to pretend that Brexit would not be the economic disaster it almost certainly will be. It is difficult to forgive them for trying to pretend that the short term costs for the Scottish people of leaving the UK would not be severe. I thought then that it was a huge risk to bear those short term costs when the long term benefits outlined by the SNP appeared to be little more than wishful thinking.

But Brexit changes everything. The economic cost to the UK of leaving the EU could be as high as a reduction of 10% in average incomes by 2030. If Scotland, by becoming independent, can avoid that fate then you have a clear long term economic gain right there. But it is more than that. If, Scotland can remain in the Single Market it could be the destination of the foreign investment that once came to the UK as a gateway into the EU. By accepting free movement, it could benefit from the immigration that has so benefited the UK public finances over the last decade. No, that is not what you read in the papers or see on the TV, but I’m talking about the real world, not the political fantasy that seems so dominant today.

There is an additional issue regarding the short term costs of independence. With little oil at a low price there is no doubt that the rUK is currently subsidising Scotland by a significant amount. Under Cameron it was reasonable to suppose that this subsidy would continue for some time, if only to prevent another referendum. I do not think we can make the same assumption about Theresa Brexit May. The prospects for the UK public finances under Brexit are dire, yet after the Budget there seems no way that the Conservatives will put up taxes to pay for the extra resources the NHS and other public services so desperately need. As the situation gets steadily worse, nothing - absolutely nothing - will be safe from continuing austerity. To be brutally honest, if the SNP loses another referendum, even the formidable Ruth Davidson will not be able to prevent Scotland being plundered by this government.

There are a huge number of issues that still need to be clarified regarding this second referendum. Will the SNP still go for, or at least appear to go for, staying in a monetary union with the rUK and keeping sterling just because it is the more popular option, even though having their own currency is much more sensible in economic and political terms? Will they be honest about the short term costs? Will the EU give them the chance of staying in the Single Market or EU, or will they insist they join the queue? But the bottom line is that the case for Scottish independence is now much stronger than it was in 2014. Then a brighter future outside the UK was patriotic wishful thinking. Now, if they can stay in the Single Market, it is almost a certainty. 

Does free movement really enable a low wage economy?

Tom Kibasi writes

“Immigration is such an important issue precisely because free movement of labour is the crucial enabler of the low skill, low productivity, low wage economic model that has been imposed on much of the country.”

This line may be very attractive to the liberal left: it gets to love immigration controls and can begin again to represent the part of working class that dislikes immigration. 

The reasoning is attractive. Starve firms of cheap labour, and they are forced to innovate and invest in labour saving machinery and/or in training their workers, which drives up productivity and real wages. In a world where capital is not mobile, that mechanism could work over a very long time period. But when capital is mobile, the firm has an obvious alternative: produce somewhere else where labour is cheaper. Keynes taught us not to make the mistake of assuming output was fixed, and the same is true here. Labour shortages could equally lead to less production, more imports, and a depreciation that makes everyone poorer.

Chris Dillow talked about these issues some time ago. He wrote

“The answer to this set of problems is to increase workers’ bargaining power – which requires, among other things, policies such as stronger aggregate demand and greater redistribution.”

Chris is right. If wages are low because of immigration, that will also mean that wages are unlikely to rise if demand expands. That in turn reduces the level of unemployment at which inflation is stable, allowing stronger aggregate demand and higher output. It is this additional demand that will allow firms to invest in more productive techniques, driving up productivity and real wages.

The endogeneity of aggregate demand and therefore output is key here. We could argue about whether labour shortages would be more likely to encourage firms to invest in labour saving machinery or move production abroad. But there is a third option which can achieve higher investment without running the risk of firms going overseas, and that is to expand demand. At the end of the day the only constraint on demand expansion is inflation, and if immigration is holding back wages it will also hold back inflation. We should not base policy on the assumption that governments undertake unnecessary austerity or central banks make deflationary mistakes. [1]

The link with austerity is even clearer when Kibasi writes

“What’s more, there is nothing progressive about declining to invest in skills in this country, while plundering poor countries of nurses or doctors or carers and then approaching immigration as if people were commodities to be bought up on the open market.”

This makes exactly the mistake that right wing newspapers have encouraged voters to make, which is to confuse the symptom for the cause. It is not private sector firms that have failed to invest in training nurses or doctors, but the public sector, most recently because of continuing austerity. Once again, what would be the consequence of cutting the immigration option? More money spent on the NHS, or a smaller NHS? It seems bizarre to argue that immigration enabled austerity, and that therefore EU immigration should be controlled. [2]

There is no evidence that immigration has in practice had any significant (in term of magnitude) impact on real wages. The trend in UK GDP per head had remained remarkably constant until the global financial crisis, despite periods of low or high immigration. The initial years of A8 EU immigration showed no fall in average earnings growth, with real wages continuing to rise. What we do know is that immigration helps the public finances, which means reducing it will mean either lower spending per head on public services like the NHS or require higher taxes. 

This point about public services illustrates the real problem with how the government dealt with A8 immigrants. As Nicholas Watt and Patrick Wintour relate, it was not a problem of poor forecasts: the forecasts were not bad once you factored in that Germany would impose transitional controls. It was a problem that the migration was concentrated in particular areas or towns, and nothing was done by government in response. So these towns saw greater pressure on public services, while the taxes immigrants paid went to the Treasury in London.

The data suggests that people in the UK have always favoured lower immigration. I suspect this is similar to questions like ‘do you favour lower taxes’: faced with something that naturally raises questions and concerns, it appears most people would rather have less of it. What began to happen at the beginning of the century is voters started saying that immigration was a key issue, alongside the economy or the NHS. This rise predates A8 immigration, and is strongly correlated with concern over defence/terrorism until 2008.

In truth, immigration is too tempting for some politicians and the media. As Tim Bale reminds us, the Tory opposition quickly started talking about Britain becoming a ‘foreign land’ after Labour was elected. Stories about benefit tourism play upon existing fears, and when politicians join in they appear to validate the problem. If that happens voters can easily turn their concerns about real wages or public services into concern about immigration, erroneously believing that immigrants are the underlying cause. So when austerity began, the government exploited these associations and the media either led or played along. If spending on the NHS was being ‘protected’, what else could rising waiting times be due to other than immigration? As concern about the NHS rose, so did concern about immigration. The truth was that the NHS was not being protected, but that truth was hard to find. 

The coup de grace of this strategy was to then associate immigration with the EU, which until the beginning of 2016 had been way down the list of popular concerns. Leavers managed to convince voters that reducing immigration required leaving the EU, even though non-EU immigration remained as high as EU immigration. The Prime Minister and Chancellor, having both pretended that immigration was a major problem, could not turn around and start singing its virtues. In that sense austerity beget Brexit.

As the referendum shows, no good comes from a strategy of using immigration as a scapegoat. The obvious way of handling such a close referendum vote would have been to leave the EU but stay in the single market. But by electing a Prime Minister who had spent 6 years trying and failing to reduce immigration, that option was ruled out because it would preserve free movement. EU immigration may fall anyway as a result of the Brexit and the depreciation it has caused, but beyond that it will be difficult for the government to reduce it further without hitting businesses at a very difficult time.

You do not kill immigration as an issue by talking about British jobs for British workers, still less by pretending that low wage jobs and a decade where GDP per head has hardly increased is the fault of immigration. As I argued here, to allow policy to be dictated by popular concerns risks making exactly the same mistake of those on the left who wanted to embrace austerity, although as I also noted popular concern is more deep rooted in the case of immigration. For that reason, turning the tide on attitudes to immigration will need much more than just facts and figures.

Although that task may seem daunting now, in five years or so it is likely to seem much easier. The chances are we will have left the EU, and the benefits that so many expect in terms of their access to public services or their real wage will not materialize. Either the government will avoid bringing immigration down, or if immigration does fall no obvious benefits will follow and there will be plenty of stories of firms suffering from labour shortages and leaving to produce elsewhere. Arguing then that lower immigration will usher in a period of high wage jobs will seem even more far fetched than it does now.

[1] A point that opponents of immigration often make is that immigration puts upward pressure on house prices. If there is no constraint on building houses, that in itself is no problem, just as it is no problem that immigrants will need refrigerators or cars. Those who argue that the country is full up have obviously never been to Scotland. Of course it may be a problem that most immigrants will go to English cities rather than Scotland, but that is again an existing problem of regional or industrial strategy which can and should be solved.

[2] The language of ‘people as commodities to be bought up on the open market’ is really too much. Are people in Poland forced to go and work in the UK? Of course not. They choose to do so, and most are better off as a result. If you want to be emotive then be accurate, and talk about how immigration controls cut off the chance of potential immigrants making a better life for themselves. 

International GDP per capita comparisons

As I have noted before, it is one of the great ironies of UK politics that recent growth only looks respectable because of immigration. Because mediamacro does not connect dots, politicians can get away with talking about a solid UK recovery, even though it is only half respectable because of the immigration they say must be reduced. But large migration flows are not just a UK experience.

The focus on GDP rather than GDP/capita distorts international comparisons as well. I conducted a small twitter poll (something over 500 votes) asking which of these 4 countries had grown most rapidly from 2006 to 2015: Germany, Japan, UK and US. Now those who voted are by self-selection well informed about economics, but over half chose the wrong answer in a comparison where the winner is ahead by a mile. Here is a chart (using IMF data).

I suspect the main reason why less than 50% chose Germany is that we are so used to GDP comparisons, and both the UK and the US experienced large scale immigration over this period. Using GDP the US wins (with 12% growth), closely followed by Germany (10.5%) and the UK (9.5%) with Japan way behind at 3.5%. But both the US and UK numbers are hugely flattered by immigration.

Why did Germany do so well in terms of the average living standards of its people? We need to talk about demand and supply. As readers should know, Germany suffered from austerity just as the US and UK did. But as you should also know, this was compensated for by a large competitive advantage it had gained over its fellow Eurozone members because of slow wage growth from 2000 to 2006. Strong growth in net trade made up for austerity, leading to a comparatively strong output per head performance (and, going with that, a huge current account surplus).

How was this demand boost met in terms of increased supply? Not through more rapid productivity growth (measured in terms of output per employed person), which hardly increased over this period. Instead it was through an amazing decrease in unemployment. In 2006 the unemployment rate in Germany was 10%, whereas by 2015 it was less than 5%. This in turn reflects the Hartz reforms, discussed by Tom Krebs and Martin Scheffel here. As they point out, this reform created losers (in terms of risk, particularly) as well as winners in terms of average income per head.

All this emphasises the point that GDP figures can be a poor guide to growth in average incomes. It also puts into perspective claims by Conservative politicians, widely repeated by the media, that the UK has been doing better than everyone else. Over this reasonably long period (you can always cherry pick short horizons), Germany has clearly been doing better than anyone else among the major countries, with growth from 2006 to 2015 of over 11%. Next come a group of countries at around 4% growth, including the USA and Japan as well as Sweden and Switzerland. Below them is another group of around 2% growth, including the UK, Ireland and the Netherlands. Just behind at 1% is France and Belgium.

The UK is certainly not at the bottom of the league, with a number of countries with GDP per capita in 2015 still below 2006 levels. These include Spain, Portugal, Finland and Denmark, with really poor performances from Italy and Troika run Greece. But growth of even 4% over 9 years is nothing to be proud of. Among all these countries, only Germany can claim to have actually recovered from the recession. [1]

[1] Outside this established group, we have seen strong growth from Australia, Israel, and the Czech and Slovak republics, as well as some smaller countries.

The Output Gap and the Innovations Gap

A major objection to my suggestion that the UK is in an self-fulfilling expectations led recession is that measures of the output gap suggest that gap is near zero. What I want to argue here is that measures of the output gap ignore what I will call the innovations gap, and the innovations gap could indicate that demand expansion would not be inflationary.

The output gap is the difference between actual output and trend output, where trend output is the level of output at which inflation is stable. The OBR are the output gap kings. They have a composite measure, which Ben Chu shows here, but this is derived from many different measures, shown in the OBR’s latest forecast on page 36. The OBR also show (p38) that estimates produced by other organisations vary widely. Most measures of the output gap can be categorised into four kinds.

1. Time series filters. These, at their most simple, just smooth the data on actual output to produce the measure of trend output that is one half of the output gap. These have no economic content and therefore tell us almost nothing.
   
   
2. Production function estimates. These combine measures of the labour force with the capital stock to give potential output: the level of output that could be produced if all factors of production were fully utilised. The major problem with these measures is that they have no measure of technology: how much can be produced by capital and labour. What is generally done is to use time series methods to estimate this, which takes us back to the smoothing idea. As a result, measures produced by the IMF and OECD suggest the years before the recession were a huge boom, which is implausible given other evidence we have.
   
   
3. Labour market measures, like unemployment or participation. There are of course many problems in knowing what the non-inflationary level of these variables are.
   
   
4. Firm surveys. These ask questions like are you producing at normal levels of capacity utilisation. The answer you get right now is that firms are indeed working close to normal capacity.
   
   

With these definitions in mind, what we have to ask is do any of these measures tell us what we really want to know, which is would firms react to increases in demand by raising prices and wages. I want to argue that they may not after an economy has grown at rates well below previous trends for a while. The reason is that, in these circumstances, firms may know that their current production methods are outdated, too labour intensive and inefficient, but at current levels of demand it is not worth them investing in new techniques. However if demand did increase, rather than raise prices to choke off that new demand, it would be more profitable to investment in new equipment to meet that additional demand. An expansion in demand would not be inflationary because firms would not raise their prices. In addition, because these new techniques were labour saving, there would be no inflationary pressure in the labour market (although real wages would rise because productivity increased).

We can tell the following story about the UK economy. At the peak of the recession, unemployment was high and firms had spare capacity. All the output gap measures said the output gap was large. What would normally happen next is that output would start recovering rapidly at above trend rates of growth, leading to a pickup in investment and new techniques being embodied in new production. But that didn’t happen in the UK, mainly because austerity held back demand and interest rates couldn’t go negative. 

When demand did finally begin to expand at a modest rate in 2013, cautious firms decided to meet that additional demand not through new investment but by using existing spare capacity. During 2013 and 2014 employment increased and the output gap fell, but productivity was stagnant because most firms were not investing in new techniques. (The market leaders were, because being market leaders they were expanding more rapidly and investing. So as Martin Sandbu has discussed, the UK productivity puzzle is associated with the average firm, not leading firms.)

This meant that by 2015, unemployment had fallen to more normal levels, and firms no longer had spare capacity. All this had been achieved with stagnant productivity growth, because most firms had stopped investing in new innovations. It was not because those innovations had stopped being made. So the output gap had been replaced by an innovations gap, with most firms using out of date production techniques that are too labour intensive.

If this story is right, we have become locked in a self-fulfilling low growth trap. Firms will not invest because they see recent slow growth continuing. They are right, because policymakers, looking at the output gap rather than the innovation gap, are doing nothing to expand demand for fear of inflation, or worse still because of mistaken worries about government debt. I do not know if this story is right, but it seems to me that the cost in lost output if it is right is so great that it is foolish to ignore this possibility.   

Budget Day Nonsense

For the last several budgets/autumn statements I have agreed to write an immediate response for some media outlet, and have therefore felt obliged to watch either the speech itself, or the media reports on the day. The good news is that no one has asked this year, and so I can ignore all budget coverage until tomorrow. This will leave me better off, because in macroeconomic terms most budget day coverage has over the last seven years been largely nonsense.

I can confidently forecast that today you will hear a great deal, at great length, about how the path of government borrowing has changed since the Autumn Statement. Journalists will ask endlessly whether he has done enough to reduce borrowing, or whether he had enough money to spend more. At the moment this is all utterly meaningless. In fact it is worse than that. It encourages people to think that government budgeting is just like household budgeting. It is, to be blunt, what gave us the disaster that was austerity.

What any macroeconomist should ask of this budget is has the Chancellor done enough to get UK interest rates off the zero lower bound: to get us out of what economists call a liquidity trap. When interest rates have gone as low as the Bank of England feels able to take them, then it has lost control of the economy. That is the situation right now. The only duty of the Chancellor in that situation is to give the Bank back control through a fiscal stimulus. [1] If he does do that the short term deficit and borrowing numbers that go with that stimulus are completely irrelevant. If he does not do that his budget has failed.

That is basic macroeconomics. But you will not hear any macroeconomics from the Chancellor, or most of the mainstream media. The idea that the Bank does macroeconomic stabilisation and the Chancellor does bookkeeping has become embedded in mediamacro, and even seven years in a liquidity trap has not been able to change this. Alas even the IFS, which is so brilliant at everything else, does not do macro and so reinforces the household budgeting metaphor.

Mediamacro will also spend hours talking about the OBR forecasts for this year and next. This too is pointless. I am sure the OBR will do what it normally does, which is put together a short term forecast that is not far from the average of other forecasters. To their great credit, they also forecast GDP per capita. It will be interesting to see who in the media picks that up. No doubt Brexiteers will go on about how great the economy has been in 2016 despite all the gloomy forecasts. There is a simple antidote to this, which any journalist can apply. Note that a great deal of the growth in GDP in 2016 was due to immigration, the same immigration that the Prime Minister has said was the cause of the Leave vote. [2]

What the better journalists focus on from the OBR is its forecast of where trend output is and how fast this trend will grow in the future. That is the only thing that will influence how much the Chancellor thinks he can borrow in future years. It is the only forecast that matters for future budgets, and as I have already noted it should have no influence on the current budget. Note particularly how the OBR has had to adjust its forecasts for future growth and tax receipts as a result of Brexit. (On this, see some good analysis by IPPR’s Catherine Colebrook.)

Of course the individual measures the Chancellor announces (either in his speech or elsewhere) are important. But even here a day’s reflection is useful, to deconstruct the spin and put the measures in context. (Once again, the OBR’s document can be very useful in that respect.) For pretty well anything the Chancellor does on the spending side, one important context is the extent to which he is just reversing the cuts his predecessor ordered. This is why the IFS wisely waits a day before presenting its post-budget analysis.

What I hate most about budget days nowadays is the constant repetition by government politicians, echoed by mediamacro, about not being able to afford improvements to public services. The reality, the detail of which Polly Toynbee sets out clearly, is that this government has managed to cut plenty of taxes which seem to have been affordable. But there is a deeper concern.

As I showed in this post, the performance of the economy since 2010 has been terrible. There has been no recovery, using the proper meaning of the word, from the Great Recession. All this time the Bank has been forced to keep interest rates at or near their floor, and use incredibly inefficient instruments like QE, because the government has kept on cutting spending. It is not normal to cut spending in what should be a recovery phase of the business cycle: at least not normal since the mistakes of the 1920s and 1930s.

In the years immediately following 2010 the government could claim its austerity policies were the international consensus, but no longer. In the Eurozone outside Greece austerity has come to an end and their recovery is gathering pace. In the US the central bank, for better or worse, is raising rates. Only in the UK does austerity continue and the economy continues to stagnate. Which is why I’m glad I do not have to watch lots of people completely ignoring all these points today.

[1] I’m not talking measures that might allow the Bank to raise interest rates by a quarter of 1%. I’m suggesting a stimulus such that members of the MPC say unequivocally rates will need to rise, and the only debate is by how much. Anything less than this just allows the economy to get blown back into a liquidity trap when something mildly bad happens.

[2] As background, GDP per capita increased by just over 1% in 2016, which does not sound so good. Average growth from 2010 to 2016 has been 1.2%, compared to 1997-2010 when the average was 1.4%, a period which included a global financial crisis and the worse recession since WWII. Having to get the deficit down is no excuse for this terrible performance, because fiscal consolidation need not reduce GDP if it is done outside a liquidity trap. This is the basic bit of macroeconomics that both this government and mediamacro fail to recognise.   

Why it’s your bloody GDP, not ours

Why does the recovery mediamacro constantly talk about seem not to apply to most people? Aditya Chakrabortty tells the story behind my title better than I did here, and picks up the important regional angle. But there is more to it than that.

First, there is the abuse of language I talked about here. I make a strong case that recovery should only be used when GDP is catching up with a past trend. Instead mediamacro use it for any non-negligible increase in GDP. They are egged on, of course, by the politicians who are partly responsible for our failure to actually recover from the Great Recession.

Second is an old favourite. Mediamacro constantly uses GDP rather than GDP per capita. This makes a big difference when an economy experiences a large increase in immigration. This chart from an article in the FT recently attracted attention, showing that the UK was the only major economy over the period 2007 to 2015 to combine growth in GDP with a fall in real wages. (I assume below the chart means growth between 2007 and 2015, rather than between 2006 and 2015.)

If we use the latest ONS data, UK GDP did indeed grow by 7% between those years (0.85% average annual growth), but GDP per head increased by only 0.8% (0.1% annual growth). It is one of the great ironies of this period, and a largely untold mediamacro secret (because mediamacro hardly ever connects dots), that the government has relied on claims about GDP growth that were in large part a consequence of the immigration which they were at the same time complaining about.

GDP per capita is of course the relevant comparison for real wages. But the claim in the FT article remains true: the UK does combine growth in GDP/capita (albeit small) with falls in real wages. The chart below uses ONS data on average earnings deflated by the consumer expenditure deflator. [1] That is the relevant deflator to use, if you want to look at the purchasing power of wages. However if instead you use as a deflator the price of GDP as a whole, the GDP deflator, then you get a very different story. As the chart below shows, that measure of real wages has increased by a similar amount to GDP per capita between 2007 and 2015.

So what has caused the price of consumer goods to increase more rapidly than the price of total output? There are a number of factors, but I emphasised two in a similar analysis I did two years ago: the depreciation in sterling in 2008, and the increase in VAT in 2011. The impact of the later is clearly evident in the chart, but so is the depreciation if you recall that there was a temporary cut in VAT in 2010, which led to a short term fall in consumer prices. The depreciation raises after a lag the price of imported goods and therefore consumer prices, relative to the price of domestic output. [2]

The disparity between GDP growth and real wages is therefore due to a combination of three factors: immigration, which boosted GDP, a rise in indirect taxes and a depreciation which both raised consumer prices. If we focus on GDP per head, as we should, then very weak GDP growth caused by the global financial crisis and austerity was translated into negative real wage growth, because of the global financial crisis (the depreciation) and austerity (the rise in indirect taxes). We are not seeing a shift from wages to profits. [3]

If there is one overall message here, it is that since the global financial crisis overall GDP growth in the UK has been terrible, and austerity plus an exchange rate depreciation has made it even worse for real earnings. That the media have not presented it that way is an important reason why it seems like your GDP, not ours. 

This disconnect in mediamacro between GDP and real wages has been very evident more recently as well. On the one hand Brexiteers have made great play about the fact that GDP in 2016 has been much stronger than some had expected. The media has also noted how inflation is increasing, and earnings growth is flat, implying a squeeze on real wages. Yet the two facts are hardly ever brought together. If they were, they might note that the 1.8% growth that the Brexiteers are so proud of in 2016 falls to 1.1% if you take out population growth (immigration). And they might also note that any growth in GDP in 2017 is likely to seem like ‘your bloody GDP’ if real earnings fall because of the Brexit depreciation. (No wonder they are in such a hurry to start negotiations.) Another message of this discussion is that the media could try a little harder to relate GDP growth to average earnings, rather than treat them as disconnected events just because the statistics are published on different dates.

[1] The fall in real wages shown in this chart is a lot less than in the FT chart, but without knowing their exact source it is difficult to know why.

[2] If you are wondering how real wages managed to ride out the recession, there are two main factors involved. The recession reduced the share of profits in national income (as recessions generally do), and in addition there was a large increase in unemployment.

[3] The labour share (of GDP at market prices) did fall by over 1% over this period, but the profit share also fell. The share that increased was taxes, reflecting the VAT increase already noted.