Productivity and the election

Many of my recent posts have focused on productivity and the UK’s poor record when compared to other countries. As mentioned before, in general terms, UK workers produce in five days what workers in the USA, France, Germany and Italy produce in four. Although GDP growth has been good until recently (only 03% in the last quarter) and employment data in the UK is extremely positive with the employment rate standing at 74.6%, the highest since data was first collected in 1971, it has been accompanied by poor productivity growth with the increase in UK productivity since 2008 (the period immediately before the recession) being only 1.1%. This means that pay, and therefore living standards, will be lower in the UK than in more productive countries. The Bank of England’s latest Inflation Report suggests that incomes will rise 2% this year and inflation will rise to 2.8%, therefore implying a fall in real incomes.
There are many explanations for this. One explanation, which neatly sidesteps the problem, is that the main issue is not that the UK has low productivity, but is that we are simply poor at measuring it in the service sector, a key area in the UK economy. In manufacturing, it is relatively simple. One can count the number of goods produced; however, in services it is trickier particularly as the digital economy grows. 10 years ago, if I wanted directions, I would buy a map and eight years ago I bought a satnav and put it in the car (both are easy to measure). Today I  use my smartphone and these additional services are not easy to measure.
Nevertheless, most economists accept that there is a  productivity issue in the UK. Andy Haldane, chief economist at the Bank of England, suggests that poor management is a key factor, particularly in sectors where competition is low, allowing x-inefficiency to flourish. Lord Browne, former Chief Executive of BP, suggests three key factors. Firstly our service economy is not sufficiently professional compared with the USA; secondly there is a shortage of finance available in the UK for entrepreneurs wishing to start new businesses and, finally, he cites the anti-science culture in the UK where it is acceptable to profess an ignorance of mathematics and science. However almost all economists would agree that the UK’s low level of investment is a contributory factor and the uncertainty around Brexit and the election itself could cause businesses to delay their investment plans until the future is more certain. There is already anecdotal evidence of many financial institutions looking to open offices overseas.
There has been little focus specifically on the issue in the election. Labour plans to increase Corporation Tax to 26%. (It is currently 19% but due to fall to 17% over the next two years) which might impact on investment in the future but some of their spending plans might, in the long term, improve productivity. They also intend to renationalise the railways, water, the national grid and Royal Mail and borrow £250 billion to create a fund for infrastructure projects. The Conservative’s statement that “no (Brexit) deal is better than a bad deal” and a reluctance to remain in the Single Market has also caused anxiety among businesses, while a focus on grammar schools is not the best way to tackle Lord Brown’s concern over the UK educational system. However they do present themselves as a more pro-business, low tax government and hope that such sentiments will encourage investment. They are also committed to spend 2.4% of GDP on R & D by 2027 and to create a national productivity investment fund of £23 billion.
The IFS, an independent think tank focus on Labour’s additional infrastructure spending which would boost GDP in the near-term and would increase the productive capacity of the UK economy in the long term, although their increased labour market regulations such as a higher minimum wage would have the opposite effect as would four additional bank holidays and their higher rate of corporation tax. The Conservatives’ commitment to reduce net immigration would also weaken growth, although no specific timescale has been announced. Most disappointingly, the IFS suggest that there will be NO overall impact on productivity from either party. It is difficult to take into account the impact of Labour’s plans to take significant parts of the economy back into public ownership, not least because of the time which such measures would need to come into effect.

Roll on Thursday!

The UK Economy – how are we doing?

Since the Brexit vote ten months ago, there have been many reports about the state of the UK economy and its prospects for the future. In an ideal world, we could look at the recently-published data and decide how we are doing. Unfortunately, the picture is unclear with different data sets indicating different things.

On the positive side, unemployment has fallen to 4.7% and employment has risen to almost 75%, both numbers reaching impressive lows and highs respectively. What we would also expect to see simultaneously is an acceleration in wage increases as workers take advantage of a tighter labour market indicated by  low unemployment, high activity rates and employers reporting recruitment difficulties, with the effect magnified by an increasing number of migrant workers returning home because of the fall in their incomes when exchanged into their own currency due to the fall in sterling since June. However, money wages are rising at only 2.3%pa and, as inflation increases, real wages will fall. Possible explanations for the low average increase in wages are the 1% cap on public sector pay increases thereby reducing the average, a possible increase in retired workers returning to the labour force depressing wages and the increase in self-employment since the self-employed are not counted in the data.

Other positives for the economy are our growth rate, the reduction in government borrowing and improvement in the  balance of payments. Our annual GDP growth of 1.8% has been the second highest in the G7 behind only Germany at 1.9%. However there is concern that consumer spending, which has been an important contributor to the UK’s growth, is now slowing.  Further factors which might impact on consumer spending are the expected fall in real income, mentioned above,  and the slowdown in the housing market which, according to the Halifax, grew at its slowest rate for four years.  The housing market is important for an economy in terms of the wealth effect, its impact on consumer confidence and the effect it has on related markets, such as carpets, furniture and household appliances, which people buy when they move.

The slowdown in consumption growth, and therefore probably GDP growth, is such that the Bank of England is now thinking that the increase in interest rates which has been talked about for some time, is likely to be postponed from late 2018 until the middle of 2019. It will then be almost twelve years since the last increase in UK interest rates which took place in July 2007 when they were increased from 5.5% to 5.75%.

The Public Sector Borrowing Requirement (PSBR) has come in below expectations and is now back to levels experienced before the financial crisis. This is largely due to  income and corporation tax revenues being greater than predicted. However, if the economy slows down in the run-up to Brexit, tax revenues will fall and benefit payments increase, increasing the PSBR.

The current account deficit dropped from 5.3% to 2.3% of GDP in the last three months of 2016. Unfortunately this proved to be a temporary improvement and the deficit has widened again this year. This makes it clear that devaluation alone will not be sufficient to improve our balance of payments and significant structural changes will also be necessary to improve the attractiveness of UK products. (Consider Germany which has a current account surplus equivalent to 8.7% of GDP not because of cheap goods but because of high quality, well-designed products). FDI increased in the last quarter of 2016 but a worrying development are recent surveys which have found that the UK has fallen in attractiveness as an overseas country in which to set up compared to other countries.

On the positive side, we could be in Greece where unemployment is 23%, and average wages have fallen approximately 10%, income tax has been increased from 40% to 47%,  the retirement age has been increased from 60 to 67 and  pensions have been cut 14 times compared to 2009.

 

The mystery of the missing young US workers and the supply curve for labour

In the USA over the last 15 years, there has been a steady fall in the number of young people in the labour force in America. Before 2000 and 2015, the employment rate for male workers without a degree dropped from 82% to 72% and a fifth of this group had not worked for a year. This took place at a time when the unemployment rate nationally dropped to 5% and almost 3 million jobs were created in the economy.

As the time spent in work decreased, time spent on leisure activities increased, with the main leisure activity being on-line gaming. Economists have struggled to explain this fall in employment among this group. One view relates to the trade-off between work and leisure whereby the more one works, the less time one has to enjoy the benefits of one’s increased income. Therefore, by implication, this cohort is satisfied with a low income and more leisure because the additional leisure time allows them to engage in their favoured pastime. Linked to this is the idea of “leisure luxuries” which are the leisure activities one spends more time on as one has more leisure time. They correspond to the idea of luxury goods which are income elastic.  For example, as one’s income rises, one might spend proportionately more on restaurant meals since they are a luxury item. Similarly, according to this view, put forward by Hurst, Aguair, Bils and Charles last year, as one has more leisure time one does not spend more time washing dishes or eating breakfast, one spends significantly more on one’s preferred hobbies. For these people, the marginal utility of an extra hour of leisure which they can spend on their preferred activity exceeds that from the income provided by an extra hour working. The authors are clear that not everyone behaves like this since some will prefer to work longer in order to be able to afford better goods and services, e.g. the two-week holiday remains at two weeks but is spent in more exotic destinations, paid for by the higher income from work.

Given that the longer one is unemployed, the more difficult it is to get a job, the implication of this trend is that this group of missing workers, mainly but not entirely male, will find it difficult in the future to get a job and pay for the non-leisure activities people need such as housing, furniture, food and a car.

Phillips Curve

The Phillips Curve can be used to illustrate a macroeconomic policy trade off, namely attempts to reduce unemployment will lead to an increase in inflation and a failure to achieve price stability.

Phillip’s work has been heavily criticized because the stable relationship between unemployment and inflation has broken down. The 1970’s was a period noted for stagflation – high unemployment and inflation. In 2016, the UK’s unemployment rate currently sits at about 5%, while the inflation rate hovers close to 0%. Both periods contradict Phillips’ original findings.

The following materials are intended to support your understanding of this topic. Review and add to your notes.

Economics Help

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Five charts that show why it’s miserable to be a young person

Britain’s youngsters are facing the worst prospects for several generations, as many are underpaid with little chance of getting on the housing ladder

Source: Five charts that show why it’s miserable to be a young person

Old people vote, young people don’t (as much), therefore it cannot be  a surprise to see government’s pander to pensioners. It does, however, mean some pretty gloomy prospects for young people in Britain, whilst old folk have their pensioners ‘triple-locked’. Another case of governments putting political motives before sound economic policy.