The Return of the UK’s Productivity Problem

Last week the ONS reported a fall of 0.1% in UK productivity over the three months from April to June. This follows a fall of 0.5% for the three months from January to March and an overall fall and a fall of 0.3% compared to last year. While the numbers are small, they should be compared both to historical data for productivity growth and to other countries. Historically, some commentators have suggested that if productivity had grown since the financial crash at the rate it was growing before, we would be 20% more productive than we are today. When looking at other countries, German workers produce 36% more per hour while the French and the Americans are 30% more productive. Ed Conway, writing in The Times last week, noted that there are only three regions in the UK out of 168 which have higher productivity than the German average. A recent paper by Richard Davies, Anna Valero and Sandra Bernick for The Centre for Economic Performance (http://cep.lse.ac.uk/pubs/download/special/cepsp34.pdf)  note that productivity varies significantly by area with mid Wales at the bottom and, at the top,

“there are three high-productivity hubs: the oil industry around Aberdeen, the area around Greater Manchester and a band of productivity in the South. Contrary to popular belief the high productivity of London does not spread into the South East but rather spreads west along the M4 towards commuter towns like Reading and Slough which have their own high productivity companies.” (Page 3)

They also identify key sectors:

“The highest productivity sectors—real estate, mining and utilities—are small employers and so play little role in aggregate performance. Of the high employment sectors that drive national productivity the leading sectors are finance, information and communications, construction and manufacturing. Professional, scientific and technical services vary within and across regions–this sector houses some very high productivity firms together with much weaker ones. However, it is important to consider high employment sectors with weak productivity, such as retail and wholesale trade, administrative services and accommodation and food services. Raising average productivity in these sectors could have a large aggregate effect due to their high employment shares.” Pages 3 and 4

While not as exciting as Brexit or the Tory leadership, low productivity is a significant issue. If we have lower productivity then our workers are not producing as much as those in other countries and will consequently receive lower wages. Furthermore firms profits will be lower, hence meaning less funding available for investment, hence lower productivity growth and we find ourselves in a downward spiral relative to our competitors. Hopefully the Chancellor will address the problem in his budget next month but, if not, we face a slow decline in UK living standards and relative prosperity compared to our European neighbours.

 

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Pub smoking ban: 10 charts that show the impact – BBC News

It’s 10 years since smoking in enclosed public spaces was banned in England. What has the impact been?

Source: Pub smoking ban: 10 charts that show the impact – BBC News

This is an excellent article, written by an old uni friend of mine, exploring the impact of restrictions on where people can smoke. Cigarettes are considered by economists as a demerit good, one that generates negative externalities through consumption. These externalities, costs to a third party, can occur in many ways, for example, the adverse effects on the health of bar workers. The ban has helped to reduce the number of people smoking in the UK, although it still remains predominantly a habit of the poor. However, it is important to note that changes to packaging legislation and increased duties may have helped to reduce the number too. A reduction in the number of smokers helps to reduce the pressure on the NHS of treating tobacco-related illness, although, of course, if people live longer then other, perhaps more expensive treamtents, need to be paid for. An unintended consequence has been the impact on pubs, a number are closing creating unemployment in the process. Again, however, other factors, such as a general reduction in alcohol consumption and cheaper substitutes, i.e. buying beer from a supermarket, will have had an effect.

This is a nice example of how a number of government interventions can be used to correct the market failure associated with a demerit good.

What’s going on in the UK economy?

Trying to understand what is going on in an economy can be difficult. Running the economy has been described as similar to trying to drive a car while only being able to look in the rear-view mirror. You know where you have been but cannot see what is ahead. Economic forecasters today probably look back to the period before the financial crash when the UK was in the NICE decade (non-inflationary, continuous expansion) as a golden period. Today life is more complex and one cannot help but feel sorry for the Chancellor busy preparing his November budget and the Monetary Policy Committee of the Bank of England when they meet in November and have to decide whether to increase interest rates.

On the one hand, implying  a rate rise is not yet needed, the Office for National Statistics has just announced that GDP growth has fallen from 1.8% for the first quarter of 2017 to 1.5% for the period April to June which is below expectations and the weakest figure for four years. This is partly down to a fall in services of 0.2% which comprise 80% of GDP inflation. Furthermore discretionary income (what you have left to spend after tax and spending on essential items such as food, energy and transport, has fallen and 60% of households are worse off than they were a year ago as a result of wages rising at 2.1% while inflation is currently 2.9%. Another piece of evidence is that a survey published over the weekend by the Nationwide  reported that house prices dropped in London by 0.6% between July and September compared with the same period last year. This is the first such fall for eight years. 

However the high rate of inflation combined with the fall in unemployment  to 4.3% would suggest it is now time  to reduce the level of aggregate demand by raising interest rates.

Just to make the whole picture more confusing , there is the danger of depressing demand at a time when the economy is fragile because of uncertainty regarding Brexit and one does not want to do anything to discourage business investment which is supposed to be weak because of low confidence. Yet business investment actually rose by 0.5% in the second quarter of 2017! Furthermore, although the current account deficit rose to £23.2bn in the second quarter from £22.3bn in the first quarter, exports of goods and services actually rose by 1.7% while imports increased by 0.4%. Finally, just when you might think you have taken account of all the main variables – what about oil prices which have a significant impact on inflation and discretionary income. OPEC’s decision to curb production is intended to keep prices high and, although this looked to be failing earlier in the year, the combination of hurricanes damaging US oil refineries and the OPEC production curbs have started to have an effect on fuel prices.

 

Uber rival’s drivers are ‘workers’, employment tribunal rules

Addison Lee is a well-established brand in the London taxi market. It appears that they too have been making use of the ‘gig economy’ in order to reduce labour costs and maximise profits. Businesses, such as Addison Lee, Uber, and Deliveroo, do not employ their workers, but, rather offer a service that connects a customer, someone who wants a taxi or take out, with someone willing to provide the service. This helps to keep costs down as Addison Lee do not have to pay the additional benefits that an employee would cost, such as holiday pay, pension contributions, etc. The worker does have increased flexibility, and the potential to earn more, but has less security and does run the risk of earning less than the national living wage of £7.50 an hour (25+, April 2017). The growth in the ‘gig economy’ is seen as one of the reasons why wage growth has been so slow when UK unemployment is so low (4.3%, July 2017). Economists would expect wages to rise as the labour market ‘tightens’ and firms struggle to fill vacancies. It appears the growth of the ‘gig economy’ has resulted in more flexible labour markets, which, in turn, has reduced the natural rate of unemployment, the rate at which we would expect to see workers ‘bid up’ their wage demands. Clearly the ‘gig economy’ is good at creating jobs, but courts, unions, and those politically left of centre appear to be concerned by the potential exploitation of workers whose incomes can be rather volatile and lack much in the way of job security and employment rights.

FT article

Good news for the Chancellor?

Friday’s papers contained news which might make life easier for the Chancellor when he prepares for his budget on 22nd November. Government borrowing in August fell faster than expected, meaning that the Chancellor will have approximately £10bn more to spend on helping reduce student debt, boosting public sector salaries, spending on the NHS, improving our infrastructure, etc. At £5.7bn, the Government’s August deficit has fallen to its lowest level for a decade. The reason for the fall is twofold. VAT receipts have soared because of  high consumer spending while current government spending, particularly local authority spending, has fallen.

However all is not rosy. Firstly, when interest rates rise, which is likely to happen sooner rather than later, government debt interest payments will increase, as will interest paid on index-linked borrowing because of higher inflation rates (borrowing where the rate of interest is linked to the rate of inflation). Furthermore, there are certain commitments which have already been made, particularly with regard to public sector pay, which will necessitate higher government spending. If these factors are not to increase government borrowing then either taxes will  increase, other areas of government spending fall or the UK economy must grow sufficiently strongly to generate enough extra tax revenue.

Secondly Moody’s, one of the major ratings agencies, last week downgraded the UK’s credit rating from Aa1 (the top rating, sometimes referred to as triple A) to Aa2 on the grounds that leaving the European Union was creating economic uncertainty at a time when the UK’s debt reduction plans were in danger because of the decision to raise spending in certain areas. This follows a downgrading in 2016 by the other major agencies, Fitch and S&P. The downgrade might affect how much it will cost the government to borrow money, particularly on foreign financial markets. The Labour Party has called the downgrade a “hammer blow” to the economic credibility of the Conservatives.

Thirdly the stronger than expected level of consumer spending which boosted VAT receipts is unlikely to be sustainable as real incomes fall because of the low levels of wage increases combined with the higher levels of inflation. The forecast for the growth in retail sales compared to a year ago was 1.1% whereas the actual number was 2.4%, with last month showing particularly strong growth. There are many possible reasons for this. Possibly the weak pound caused more people stayed at home instead of going overseas for a holiday, possibly the falling unemployment had an effect and possibly the figures will reverse next month since they are extremely volatile.

Finally it is worth noting that the OECD (the Organisation for Economic Co-operation and Development, an organisation comprising the world’s major economies) forecasts that we will fall from being the second fastest growing  G7 economy to the second slowest as the other main economies improve and we do not.

If the UK economy is to flourish, an increase in the rate of growth, an improvement in productivity and a satisfactory agreement with the EU are all crucial.

Unemployment, inflation and the Phillips Curve

Recent data published last week on inflation and unemployment in the UK is causing excitement among economists – something rare among the practitioners of what Victorians called the “dismal science” after the gloomy predictions of Thomas Malthus.

Employment reached a record high of 75.3% and unemployment fell to 4.3%, a 42 year low, and almost half its 2011 peak of 8.5%. However, inflation rose, reaching 2.9% in August, up from 2.6% the previous month. Since wages rose only 2.1% in the quarter ending in July, real wages fell because the rate of inflation exceeded the rate of wage increases. This is unexpected since falling unemployment normally coincides with rising real wages as workers use the tightening labour market to obtain pay increases. Compared to the other 34 members of the OECD, only Greece, Mexico and Portugal have experienced weaker recoveries in wages than the UK.

There are two theoretical questions resulting from these figures. The first is whether we have yet reached the “natural rate” of unemployment (the rate at which inflation is stable) or whether there is scope in the economy for unemployment to fall even further without causing a significant rise in inflation. The Bank of England previously estimated the natural rate to be  5% and now estimates 4.5%. Yet wages are still not increasing as fast as before the financial crisis. Is 4% rate a better estimate?

The second, linked question is what has happened to the Phillips Curve. This was an important idea for economists and politicians since an article written by William Phillips, a Keynesian, in 1958. He suggested there was an inverse relationship between the rates of wage inflation and unemployment via the level of demand. Subsequent economists substituted price inflation for wage inflation and the idea of politicians facing a trade-off between inflation and unemployment was born. This lasted until the stagflation (stagnation and inflation) of the early 1970s when many developed economies simultaneously started to experience rising inflation and rising unemployment, something not possible with the original Phillips curve. As a result, economists such as Milton Friedman, argued that although the trade-off indicated by the Phillips Curve was valid in the short run, there was no long run trade off. He suggested that there are a number of short run Phillips Curves and a vertical long run Phillips Curve, which exists at the natural rate of unemployment – the rate of unemployment at which inflation is stable. Although one would experience lower unemployment and higher inflation in the short run if the government were to stimulate the economy, in the long run, as inflation eroded the effects of the stimulus and workers and businesses adapted to the higher rate of inflation, the economy would move back to the natural rate of unemployment but with a higher rate of inflation.

What we have today is a curve which seems flat. Unemployment has been falling but, although inflation has risen, it is still low (and largely explained away by the fall in the value of sterling following the referendum) and real wages are falling. Has the labour market changed significantly to finally kill off the Phillips Curve or is it that fear of the consequences of Brexit and economic uncertainty are allowing employers to recruit more staff without significantly raising wages?

The changing age structure of the population

Much of what goes on in economics has a short time span. Will economic growth accelerate or slow  this year? What will happen to inflation next month? What will be the impact of Brexit? However one of the most significant challenges we and other countries are facing is much longer term and has to do with increasing life expectancy.

Pre 1800, according to The Economist, no country had an average life expectancy of over 40 while today, every country does. In the UK today, life expectancy is 79.5 for men and 83.1 for women. Infectious diseases are now much less significant; people with cancer now survive for much longer than in the past and survival rates from heart attacks have improved.

Why the concern? Surely we can look forward to a long, healthy retirement, with a high standard of living provided by our state and private pensions, living in properties which we own (and with the mortgage paid off long ago), spending time playing golf, becoming a “silver surfer” and embarking on regular  SAGA holidays (the travel company catering for the older traveller).

Unfortunately the picture for the majority of the population will not be so rosy. A study by Public Health England, published earlier this year, suggested that the average woman has poor health from the age of 64 and the average man from 63½ and, although life expectancy has increased, much of it will be spent in ill health, with back pain, diabetes, obesity and dementia becoming common among older people. As people live longer in poor health, the demands on the NHS increase.  A BBC report (http://www.bbc.co.uk/news/health-38887694) suggested that spending per patient for a 65 year old was double that for a 30 year old while, for an 85 year old, the cost was five and a half times as much.  The Office for Budget Responsibility has suggested that spending on the NHS and care will rise from 6.1% of GDP in 2021 to 12.6% by 2066. In addition, there has much comment in the press recently about the rising cost of providing care homes for the elderly. And, finally, the spread of ill health is not uniform across the country. In the richest areas of the UK people enjoy nearly 20 years more good health than in the poorer areas. A survey by Canada Life, an insurer, found that three million more people think that they will need to work beyond 65 than did in 2016 and 10% of those surveyed expected to be working until they are 85 because of the increased costs of care home provision. Another issue to take into account is the way that low interest rates have reduced returns for pension funds and savers (many of whom save for retirement).

It is not just the elderly who will suffer. As people live longer, the amount of money needed to provide pensions increases and this money comes from the taxes paid by the relatively fewer working-age tax payers who find themselves supporting an ever-increasing number of retired workers as well as paying for the increased cost of NHS treatment for the elderly.  Three years ago, the Institute of Economic Affairs suggested that Britain faces significant tax rises and government spending cuts in order to meet the needs of an aging population in terms of pension payments and health care.

The situation is not restricted to the UK. In Japan, the country with the most rapidly aging society and where 33% of the population are already over 65, a report found that over half of live-in carers are themselves pensioners and the Prime Minister, Shinzo Abe, suggested that Japan’s declining birthrate and aging population was the major obstacle to economic growth. To reduce the problem, the pension age is gradually being increased to 65 and Mr Abe has set a goal of increasing the number of women, and hence taxpayers, in the labour force.

The Government has just announced that the state pension age for men and women will rise to 68 in 2037, seven years earlier than previously planned. However a retirement age of 68 compared with one of 65 in 1948, when the NHS was founded, does not fully take into account the much greater increase in life expectancy since 1948.

So what are the solutions? Do we all work even longer and is this viable in some occupations? Does part-time work become more common for older workers? Do we encourage migration so that there is a relatively larger working population? Do taxes increase to cover the rising costs of pensions and care for the elderly? Does the government encourage (or force) people to save more towards their old age or cut the real value of the state pension? This is something for the younger reader to decide. I am off to book a Saga holiday!