A confusing week for economists

This week has seen a considerable amount of contradictory economic information. On the positive side, employment in Britain reached a record high in the three months to April, 2018, with an employment rate of 75.6%. Unemployment has remained at its current low of 4.2% and the inactivity rate, those people, such as students, of working age, but not in the labour force, is also at a record low. Retail sales grew by a record 4.1% in May

However the rate of increase in earnings, which we would expect to be high given the low unemployment figures (as suggested by the Phillips Curve), has dropped from 2.6% to 2.5%. In real terms, the rate of growth in real earnings was only 0.1%, implying that future consumption growth will be low.

Other disappointing news was an announcement from Land Rover that they are moving production of the Discovery from the UK to Slovakia and news that Poundland and House of Fraser have collapsed, putting thousands of jobs at risk. However even these news items are not clearcut. One of the reasons behind Land Rover’s actions is that, once production has moved out of the UK, the site will be used to produce new, more high-tech, more expensive hybrid and electric models and the decline in traditional retailing is happening as on-line purchases increase, creating delivery and warehouse jobs.

However possibly the most disappointing pieces of news were firstly the latest data on manufacturing output for April, showing the fastest fall for 6 years and secondly, the deterioration in the UK’s trade deficit which grew by £1.6bn to a deficit of £9.7bn, the worst monthly figure since October 2016.

Possibly the best way to evaluate the data is to look at what the markets thought and they were pessimistic, thinking that the weakness of the economy will make an interest rate rise less likely and therefore sterling fell in the foreign exchange markets.

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Productivity and the Economy

By definition, productivity is the measure of output per unit input. Inputs include labour and capital while output is typically measured in revenue. Between July and December data shows that output per hour rose by 1.7% – the fastest rise since 2005. However, part of the rise was due to the fact that the number of hours worked has fallen. Labour productivity grew by 0.7% in Quarter 4 2017 and it was the second quarterly increase in a row leaving productivity at 1.8% above its peak in Quarter 4 2007 (before the financial crisis). However, the output per worker and output per job only grew by 0.1% showing that there has been a fall in the average hours worked. The fall in average hours worked also suggests that workers incomes are stagnating and so due to inflation, their real incomes may be falling.

Productivity plays an important role in the economy as there are many benefits that come with higher productivity. If a firm is more productive, it will have lower costs of production as they are able to produce more goods and services in a set amount of time. This means that the firm can become more competitive, assuming ceteris paribus, the lower costs of production means that a firm can decrease their prices. This decrease in prices can lead to an increase in demand and mean that UK goods and services could become more competitive in global markets. This can also lead to an increase in revenue for the firms and so these can be reinvested back into the firm to make it even more productive. These benefits can also lead to economic growth as output increases due to higher productivity, which in turn brings benefits to the country. If workers are receiving higher wages – as they work the same hours to produce more output meaning that a firm’s costs of production lowers and so firms are able to afford wage increases – this can also cause a further shift outwards of AD due to the multiplier effect. If a worker receives a pay rise, he will then spend some of his extra income on goods and services and so this in turn increases AD.

So the big question that occurs is why is the productivity in the UK so low? It has been a question that is very hard to answer. New machines and technology can make workers more productive, however companies’ capital spending is only 5% above its pre-crisis peak, compared with a 60% increase over the decade after the 1980s recession. This could explain a reason as to why productivity in the UK has remained so low as workers haven’t got the capital they need to become more productive. Another reason that could have caused low productivity is that firms have been retaining relatively (unproductive) workers rather than investing in machines. Helen Miller from the Institute for Fiscal Studies commented that “changes to state pensions and benefits are likely to have contributed” showing that people have been more willing to work in this financial crisis compared to other recessions. Therefore, firms have avoided large costs by investing in machinery and have instead increased the number of workers in order to meet demand. This is supported by the fact that the UK now has the highest employment rate since 1971 at 75.3%. With real pay (after accounting for inflation) down 0.2% in 2017 compared to the same time in 2016 – it shows that it is easier for firms to increase workers due to a low wage demand as inflation is not at a high rate relative to wages. This means output becomes more labour intensive which often have a lower productivity.

The blog also mentions that the government imposed an apprenticeship levy, with the idea to increase skills and training workers receive and this can in turn increase their productivity – the workers can develop the skills needed to produce more goods/services in a set period of time. The scheme was introduced in 2015 and aims to create 3 million new apprenticeships by 2020. However, in January 2018 there were 25,400 apprentices in training compared to 36,700 a year earlier showing that the scheme may not be as effective. However, this is focusing on human capital rather than physical capital such as machines. In some industries, such as construction, it is easy to run an apprenticeship scheme and train labour but in the services industry it has proven much more difficult to provide apprenticeship training. This supports the idea that it is easier to increase and improve labour than capital as the government have focused on encouraging firms to increase apprenticeship programmes. In the long term it is more important to focus on increasing capital than it is labour. This is because as technology advances, capital becomes more advance and so it can aid workers to produce more goods/services in a set amount of time. It is also more important than an increase in skilled labour as if you increase capital – the worker can become more productive too and so produce more goods and services. However, an increase in skills doesn’t affect how productive the capital is and so there may be a limit to how productive a worker can be without an increase in the capital available to them. An increase or improvement of capital means that LRAS will shift outwards and the sustainable output of the economy will increase.

The UK productivity is only above one other G7 country. All of the other G7 countries have a higher GDP per hour worked than the UK. This is shown in the graph below. Here you can see that the UK is the second lowest country despite all being at the same rate in 2007. There has been a slow down in labour productivity in the G7 countries, however there seems to be a higher slowdown in the UK. The UK’s nominal productivity gap in output per worker terms narrowed from 16.9% in 2015 to 16.6% in 2016, compared with the average for the rest of the G7. Compared with the rest of the G7, the UK had below average real productivity growth in both output per hour and output per worker terms in 2016. The UK has the largest gap between pre-downturn productivity trend and post-downturn productivity performance was 15.6% in 2016 which is double the average of 8.7% across the rest of the G7. This shows that the UK has suffered a larger productivity problem compared to the other G7 countries.

 

Lower productivity levels are detrimental to the UK. If the economy remains unproductive, it will not be able to benefit from lower average costs (unless wages remain low) as firms won’t be able to produce as much as more productive firms in the same time period. This means that UK goods will be less competitive on a global market – due to that prices of UK goods will be higher as costs of production remain higher due to lower productivity. This could worsen the balance of payments as exports remain low, and result in lower Aggregate Demand as the balance of payments is one of the components. The higher priced goods are also bad for UK consumers as demand for goods and services will fall due to the high prices. This means that there will be little, if any, increase in output and employment as demand levels remain the same. Higher prices, and lower demand, will mean that businesses retain lower profit from sales. This means that they don’t have as much money to reinvest into the firm which could be spent on training or capital in order to become more productive. The government will also not receive an increase in tax receipts if productivity remains low, as firms will not be selling as many goods and services and so the amount of Value Added Tax and Corporation tax that they receive won’t change.

Low productivity also means that workers wages will not rise as much as the firms cannot increase wages due to a lower demand and profit. This also means that the government will receive less tax receipts from VAT and income tax. Economic growth is also impacted by low productivity. This is because without an increase in productivity the Long Run Aggregate Supply curve will not shift outwards and so the sustainable output for the economy will not increase.

What does the future hold?

“Accurate predictions” and “economists” are not words which always go together and the longer the time period, the less accurate are predictions likely to be. Last year, it was predicted that driverless cars would soon be with us and we would be summoning our driver-free Uber with as little worry as ordering a take-away via Deliveroo. However, following the death of a 49-year-old woman in Arizona, as a result of a collision with an Uber vehicle being driven in autonomous mode, (with a human behind the wheel), both Uber and Toyota have suspended trials and a number of American states are reviewing their attitude to trials of driverless vehicles.

A worry which has been with us for longer is the impact of technological progress and more recently AI, on employment prospects. Keynes, in 1930, during the Great Depression, wrote an article predicting a 15 hour working week by 2030. For him, this was not a worry since he suggested that the average person would be significantly richer in 2030 than in 1930, since businesses would still be producing goods and services and workers enjoying their increased leisure. However, he did raise the possibility of technological unemployment where the fall in demand for labour from technological progress was greater than the increased demand for labour needed to produce new goods and services. Trying to estimate the costs and benefits of new technology in terms of employment has been a problem since the Luddites in the 19th century – English textile workers and weavers who destroyed machinery which they thought would take their jobs away. On the other hand, technological optimists see the arrival of robots as an advantage since they will allow tedious, repetitive jobs to be undertaken by machines while the humans focus on rewarding, creative areas.

Examples support both views. The rise of online shopping is a cause of the decline in high street retailers. However internet shopping has created jobs in warehouses for workers to fulfil orders and among van drivers. But, in the future, will the goods ordered be collected from the shelves by robots and delivered by drones? What will happen to the number of workers in supermarkets if the technology used in Amazon’s cashless store becomes more widespread? There is a consensus that the types of jobs most at risk are those which are routine and repetitive while the safest are those which involve creativity, judgement and manual dexterity. An area which should be secure, and in which the UK is currently strong, is the creative sector, which covers such things as advertising, film and television programme making, architecture, and fashion, employing two million people and contributing over 5% to GDP. One might also think that teaching is a safe occupation since, so they tell me, it involves judgement, empathy and creativity. But if the school of the future is based round individualised learning with students working in large open-plan spaces, supported by “facilitators”, will so many people be needed? How long before we get the department blog generated with no human involvement? How do we take account of the jobs which have not yet been created?

What is clear is that there will need to be resources put into re-training existing workers to allow those who have lost their jobs to move into new areas and, more importantly, those entering school in September, will need to be taught to be adaptable and creative so they can learn new skills, rather than being trained in the skills in use today.

Olen niin iloinen

For those of you who do not speak Finnish, a clue to the meaning of the words above might be found in the following questions.

What happens on 20th March 2018?

Answer – UN has declared it to be World Happiness Day

What do Norway and Burundi have in common?

Answer – they both dropped in the UN World Happiness Report. Burundi dropped to bottom place while Norway dropped out of the top slot to be replaced by Finland – hence the Finnish comment “I am so happy”.

The Report ranks 156 countries by their happiness levels, and, this year, it also looked at 117 countries by the happiness of their immigrants, with Finland coming top in both rankings.

The top and bottom 10 are recorded below. A sample in each country are asked to score their happiness on a scale of 10 (most happy) to 1 (least happy) with Finland scoring 7.6 and Burundi 2.9. In order to identify the reasoning behind the score, the report also looks at economic strength (measured in GDP per capita), social support, life expectancy, freedom of choice, generosity, and perceived corruption. The biggest loser was Venezuela, dropping 2.2 on the scale, which is little surprise considering the state of their economy. This year the study also looked at the happiness of migrants,

It is worth a warning note about the numbers – the difference between the top 6 countries is only 0.191 on the 1 – 10 scale.

The world’s happiest – and least happy – countries 2018 World Happiness Report
Happiest Least happy
1. Finland 147. Malawi
2. Norway 148. Haiti
3. Denmark 149. Liberia
4. Iceland 150. Syria
5. Switzerland 151. Rwanda
6. Netherlands 152. Yemen
7. Canada 153. Tanzania
8. New Zealand 154. South Sudan
9. Sweden 155. Central African Republic
10. Australia 156. Burundi

TRADE WAR 2

It is rare to see two successive blog posts on the same topic but it is also rare for an economic issue to receive the attention which President Trump’s proposed tariffs on steel and aluminium have attracted. Since the last post, Gary Cohn, his chief economic adviser, has resigned in protest at the decision, swaying the political balance in the White House from supporters of free trade towards protectionists, the EU has added to its list of potential targets for retaliation to include peanut butter, Bourbon, Florida orange juice and Harley Davidson motorcycles, and President Trump has continued to threaten retaliation against the retaliation, talking of tariffs against EU car exports. There have also been comments in the newspapers looking back to the 1930s and the protectionist measures imposed by the USA as a way of helping them escape the Great Depression, which served only to make the world situation worse.

The language of the debate (if that is what it can be called) continues to be confused. On the one hand President Trump argues that the tariffs are justified by WTO rules on the grounds of national security, a legitimate reason for imposing tariffs; the argument being that steel is an important product for the defence industries. However the main exporters of steel to the USA are the EU (the largest), Canada, Mexico and South Korea – hardly countries which are likely to go to war with the USA. China does not feature among the list of the major steel exporters to the USA. Furthermore some of the steel exported is highly specialised and not even manufactured in the USA.

While talking of national security as a justification, President Trump simultaneously continues to refer to the need to reduce the US balance of payments deficit, arguing that the deficit is “BAD” and the fault of foreign countries. Not only has the deficit occurred in part because foreign producers can produce more cheaply than US ones, it has also allowed the US to consume more than it produces and, subsequently, living standards have risen. Foreign trade is not a zero-sum game – both deficit and surplus countries benefit from greater trade.

So how has a country like the USA (and the UK) been able to run such a large and persistent deficit? This is because foreign governments, banks and individuals have been willing to hold dollars and US assets rather than change them back into their own currency. In the same way that a generous parent’s continual lending allows their children to spend more than they earn, the UK current account deficit might be partially financed by a financial account surplus caused by rich foreigners and businesses placing money earned from selling to the UK in UK banks or buying property in London, UK shares or government bonds. The same applies to the US, but is reinforced by the additional benefit the USA has which is that the dollar is so widely used for international trade and as a reserve currency.

Structural Unemployment in Australia

http://www.straitstimes.com/business/companies-markets/gm-to-close-last-holden-factory-ending-over-a-century-of-car

Structural unemployment has many causes; advances in technology can make some jobs redundant, offshoring production to low-cost producers means a lack of domestic demand for certain workers, and a permanent decline in demand can make some industries obsolete.

This article, courtesy of Ryan Z, is an illustration of the 2nd cause mentioned above. Australian’s, obviously, will still buy cars, but all will now be imported as domestic production ends. Car plant workers will find it difficult to find work because their skills are no longer in demand. They either move overseas to find work or retrain. The latter is far more likely but does come at a cost to the individual, through lost earnings, and the government, who are likely to partly fund re-training programmes. Building a flexible workforce can help reduce the level of structural unemployment, but this is far from easy.

 

 

Falling Share Prices – Causes and Effects

This week has seen major falls in share prices across the world with $6 trillion being wiped off world share values.  America’s Dow Jones index dropped 5.2%, Japan’s Nikkei index fell 8.1% and the UK’s FTSE index fell 4.7%, the lowest it has been for 15 months, while in Japan and America the falls broke records for the size of their drop since October 2008.

The initial reason for the fall was, paradoxically, good US economic data as their service sector boomed and wage levels grew at the fastest rate since the start of the decade. This good news meant that it is now more likely that US interest rates will rise sooner and by more than had previously been anticipated. Mark Carney reinforced this view when he expressed similar sentiments about the future of UK interest rates.

Although a rise in interest rates has been expected for some time as the world economy’s growth accelerated, the reminder that it might occur soon has come as an unpleasant shock. The scaling back of QE by central banks is expected to reduce the ability to borrow cheaply, some of which has financed recent purchases in shares. Financial investors expect that the forthcoming rise in interest rates will reduce company profits, therefore reducing the demand for shares. Simultaneously existing shareholders might be encouraged to sell quickly before prices fall further, thereby increasing the excess demand. In addition, the economic uncertainty was increased by the fall in the value of bitcoin by approximately 50% since the state of the year.

Economists are trying to decide whether we are currently experiencing a “correction” or  are entering a bear market, where prices fall by more than 20%. The “correction” proponents believe that shares are over-priced in terms of their price compared to their earnings – the price:earnings ratio – and therefore the fall was due. However there is concern that the behaviour of investors, whether in shares, currencies or commodities, sometimes leads to markets over-shooting since falls (increases) in price encourage selling (buying) which further reduces (increases) the price.

According to economic theory, the fall in share prices might lead to a negative wealth effect (the idea that consumption is determined by one’s wealth as well as one’s income). However, given that many shareholders are in the upper income brackets, their marginal propensity to consume will be low and therefore the effect will small. More significant might be the general impact on consumer and business confidence from the media reports about the falling share prices. As Keynes wrote in his General Theory,  “animal spirits” outweigh the  “weighted average of quantitative benefits multiplied by quantitative probabilities.”.