More on productivity

ONS has published analysis of its microdata on the productivity of UK firms since the downturn.  On the ONS website, see Microdata perspectives on the UK productivity conundrum, An Update, released on 4th October.

Overall, they show working hours back above and output below pre-downturn levels.  Hence, productivity is still falling on average.  But, the variation by firm and by sector is wide.  ONS confirms that exporters, foreign-owned and larger companies perform better, in relative terms, as do high broadband users – although, the downturn has had more negative effects on some of these ‘better’ categories in absolute terms.

The ONS’ central finding is that the lack of recovery in productivity is worse for services (excluding the financial and communications sectors) than manufacturing, and that labour productivity performance in 2010 was weaker among smaller firms than larger firms across all sectors.

This research confirms that historical relationships about productivity in UK firms persist but shows that the downturn has narrowed some of the relative gaps and has been worse, generally, for smaller, low-tech services than for most.

As we have said before, we believe that these trends have to improve before the recovery can be considered secure and sustainable.

Productivity … further from the Holy Grail

The latest international comparisons on productivity show the UK’s relative position weakening in 2012.  Output per hour and output per worker were 16 and 19 percentage points respectively below the G7 average.  The ONS says the former was the largest gap since 1994.  Unlike most of its peers, UK productivity was lower in 2012 than in 2011.

In current prices, last year, UK output per hour was 29 points behind the USA and 24 points behind Germany and France.  In terms of GDP per worker, the equivalent gaps were 40 points and 10-11 points.  The large relative US differential between these measures (40-29) is explained by its longer working hours whereas the opposite is true in Europe (10-24).

In constant prices, UK productivity remained below its 2007 peak in 2012 and slipped back relative to its rivals and, significantly, compared with its own previous long term trend.  Here is the real cost of the UK downturn.  We are less competitive, buying a less negative employment impact at the price of poor productivity.  I am not saying this is right or wrong.  It just is.  In contrast, the USA and Canada in particular, have seen a more normal pattern of productivity and employment fall and rebound over the downturn.

Why does this matter?  It matters because productivity growth is the ‘holy grail’ of economic performance.  It is what underpins future living standards.  If our relative productivity performance is slipping and our absolute productivity is not increasing, relative living standards will fall over time and absolute, post-inflation, living standards will, at best, stagnate, and probably drop.  In turn, this means lower employment and real incomes, and higher unemployment down the line.

Many don’t get this.  “Surely,” they say, “productivity destroys jobs.  The easiest way to increase productivity is to sack people.  I think it’s better to have high employment than high productivity.”  This confuses the micro and the macro and the short and medium term.  For an individual firm, it may be that shedding labour will boost productivity – for a while.  In an upturn, this may be because new technology is adopted which raises output per hour/worker and less workers are needed to produce the same level of output.  In a downturn, this may be because demand has slumped and the current output level needs fewer staff.

But, in the first case, the new investment should make the company more profitable and more competitive.  It will be able to enter new markets, develop new products and increase its market share.  In the medium term, this growth will lead to a need for more staff as the company grows.  The chain is from productivity to growth to jobs.

In the second case too, shedding staff can turn things around by releasing resources that can be redeployed to better effect elsewhere in the economy and by turning round financial positions to the point where more positive trends can emerge.

In the medium term, productivity growth is a generator of jobs, especially at a macro level.  If everybody sacks workers to boost productivity, demand will fall and the economy will shrink and productivity will then drop again.  But, if everybody raises productivity, it will raise spending power, start to increase demand and hiring across the whole economy.

The bottom line here is that the UK recovery will not be sustained and secure until productivity starts to climb again, in absolute and relative terms.  In the short-term, this may restrict employment growth but, later, once we have got on to a productivity-led growth path, the increases in employment will come.

Politicians and commentators have been talking about rebalancing the UK economy to make it more internationally competitive for the long run.  My argument is that the crucial element is for it to be investment-led in a way that boosts productivity.  The latest productivity figures are awful and current policies are not really helping.  Let us pray that the UK political parties go into the 2015 election with productivity boosting policies at the ready.  Fundamentally, this probably means getting out of the way of entrepreneurial drive, innovation and skills acquisition.  The search for the ‘holy grail’ of productivity is paramount to a sustained upturn.  Unfortunately, right now, unlike our competitors, we are going in the wrong direction.  Until, we turn around, the recovery can only be weak and vulnerable to shocks.

 

Monetary Physics

The universe is made of matter and energy, but the boundaries between the two can seem to blur.  For example, physicists say light is made up of particles (matter) that behave like a wave (energy).  The quantum boundary between the two remains somewhat of a mystery – at least to me.

Money is similar but not exactly the same.  It appears to have economic mass and generate gravity: like matter, money attracts money and appears capable of destruction (through inflation) or expansion (through real growth).  It also appears to have economic energy, fuelling a range of supply and demand chains that suggest “what goes around comes around”.  Money can be sucked into a black hole (the event horizon of a debt-deflation induced liquidity trap) or it can be ejected out to grow new business stars with planets where new species (living standards) can evolve.  Creative destruction is a force of physics and economics.

Does monetary economics have the equivalent of the physics laws of thermodynamics concerning the conservation of energy and the process of entropy?  Yes, in the sense that the monetary system is always in balance – for every credit there is a debit, for every export there is an import,  – and yet it does seem to degrade over time (discounting the future).  Work and order are finite in the economy as well as the physical universe.  In both, some chemistry of creation and destruction seems all too natural

Bankers, whether central, investment or high street, have found ways to innovate with money over the years to influence the development of these laws of “flationarydynamics”.   Sometimes they goes too far – causing imbalances in stocks and flows that upset normal market functions and cause eruptions – supernovae that eliminate existing structures and trends.  Yet, in the death of one monetary star, the seeds of creation are soon.  New, more complex elements emerge to enrich the next cycle of growth.  Sometimes financial innovation, including in response to crises, can add real value, reallocating resources in a way that makes markets more efficient through new businesses, products, processes and markets.  New stars with complex elements that fuel recovery and development.

Right now the question is has the destructive phase of the 2008 financial supernova run its course or has it further to go before some new money-stars are born.  An optimist looks to new technologies, inventions and organisations, as well as the skills and creativity of the young, for our salvation.  The pessimist sees only the debt hangover, fiscal austerity, the low velocity of money and structural logjams.

The cycle turns but, in this period of “monetary physics”, we know not when.  As yet, it’s still long run opportunity and short term threat.  Just perhaps, however, we are getting nearer to the turn in confidence we need.

Productivity Conundrum

Productivity, and changes in it, is a key element of the present conundrum about growth.  In the second quarter of 2012, UK productivity dropped, with output per hour 2.6% below the year ago level and 3% below the pre-downturn peak.  This measure may recover somewhat in the second half of the year.  Nevertheless, heading into the fifth year of this downturn, it is unusual for productivity to be so low and still not growing.

The textbook economic cycle is:   1) the onset of recession causes output to drop more than labour input and productivity falls.   2) firms respond by laying off workers (often more than output) to defend profitability and, thereby, productivity starts to recover.   3) the recovery of productivity and profitability encourages firms to re-invest and re-start output growth.   4) with a lag, employment picks up, bolstering demand, and the downturn is over.  The chart below shows that this was the case in the three previous UK recessions.  (In this chart, the lines start at the pre-recession peak and are set at 100.  The lines then track productivity by quarter thereafter.  In the ‘normal, case, productivity is back to 100 quickly and continues to grow.)

Not this time … whilst productivity almost got back to 100 in early 2010 and briefly in 2011, it has failed to take off in the usual way for sustained recovery.  As the chart shows, it has basically been flat throughout this downturn and, consequently, the incentive to invest, employ and grow has remained subdued.  Official economists are keen to explain this pattern, particularly at the Bank of England where they are concerned to know why loose monetary policy has not stimulated the economy to date.  In my mind, it is a combination of the unusual employment and demand effects as well as the highly uncertain global environment.  What is clear, however, is that a boost to productivity is needed for recovery.

Export or Die!

The decline in UK Real GDP during the second quarter of 2012 has been revised down from -0.7% to -0.4%.  Although this revision is a bit bigger than normal in the first few months of ONS estimation, it doesn’t change the underlying story of a weak economy.  Construction, manufacturing and household spending were all a little bit better than first thought, probably reflecting the fact that the awful weather dampened both April and May but June data, coming in later, turned out to be a bit better.

The key UK number of the week, however, was the balance of payments release for the same three month period.  The Current Account deficit was a whopping £20bn: a huge 5.4% of GDP.  We used to expect a major crisis when these kind of ratios were evident in emerging economies.  Moreover, the goods and services trade deficit was £10bn and there was a big net outflow of income funds too – this element of the UK accounts is usually positive.

This UK current account position is unsustainable.  If it continues, it will mean problems for the currency and gilts and wider economic confidence.  With all eyes on the Mediterranean countries with their large deficits and high debts, it seems the UK’s disastrous external position is being overlooked – for now.

The other thing, of course, is that this negative trade position is another drag on growth.  How can an economy recover when a) household real incomes are falling, b) government is trying to rein in expenditure, c) uncertainty is dampening business investment and d) net exports are so negative?

Recently, the financial markets have looked at the UK economy in a relatively positive light because of its currency independence.  Nevertheless, if that currency flexibility is not supporting a fall in the net external balance – i.e. encouraging UK firms to increase exports and market shares at homer and abroad – that spin cannot continue indefinitely.  Time for the mantra “Export or die!”

 

 

Relationship v Deal Banking

In a previous part of my career, I worked as an industrial economist for one of the clearing banks.  At one time, I was an expert on the food and drink industries and later, I was responsible for the motors and transport industries – across the world.  In those days, I supported the corporate bankers who were, themselves, experts on the banking needs of particular industries.  They had close relationships with the ‘primes’ and other companies across each sector.  In turn, this was supported by the regional branch network where the managers knew local companies well.  This was a successful and profitable model based on ‘relationship banking’.

After ‘Big Bang’ in 1987 and the gradual merger of investment and corporate banking, the world of UK banking changed.  Initially, the ‘deal-based’ banking of the investment bank was often unprofitable.  Tying it in with the very profitable corporate bank made investment banking viable.  The irony was that the deal culture of (American) investment bankers steadily took over from the relationship culture of (UK) banking and, thereby, destroyed an important conduit of credit and growth for UK businesses.

The ‘credit crunch’ has shown us the result of this folly.  Contrast it with the federal, integrated ‘mittelstand’ approach to banking still prevalent in Germany.  With the state effectively owning RBS and Lloyds, the opportunity to restore a corporate banking structure based on local relationships is clear.  Come on Osborne, Cable and Balls, get together to create regional corporate banks that establish a relationship between local wealth/investors and local exporting/growing businesses and locally expert bankers motivated by earning returns on successful real local investment.

A SW bank for a SW economy would start to get us out of this mess.

 

Don’t get me wrong

In writing about current economic policy in the year-to-date, I have been emphasising this is not the time for inaction.  The economic patient is very ill and intervention is necessary to keep it alive. That intervention should involve investment in the future capacity of the economy to grow – in infrastructure, skills and innovation, and in export markets.  Until the private sector is emboldened to make these investments, and that will only come when uncertainty about future demand is lowered, it has to come from the state.  Leadership in action is required just now.

What I have been questioning is whether the current stabilisation mix of loose monetary policy and tight fiscal policy will bring the growth and recovery that the patient needs.  I think not … mainly because it is not working.  Right now, we need pragmatic activity to boost confidence by creating real capacity for growth rather than a theoretical debate about rebalancing.

But, please don’t take this to mean I favour ‘big government”.  One of the key problems that caused, and makes it hard to get out of, the downturn is that the total scale of government in the economy (including ‘too big to fail’ banks) is out of kilter with the scale of the real private economy that supports it.  The economic patient will be a lot healthier, when it is back on its feet, if it can lose the excess weight of the unproductive parts of the state.

It is right to want to reduce the scale of the public sector to more manageable levels – not just because of the sustainability that brings to the public accounts but also because, in the long run, smaller government will mean more innovation and efficiency in the private sector and that will raise growth rates and living standards more and better over time.  The Euro-zone teaches us how “big government” can go wrong.  Rebalancing is desirable.  The irony, however, is that, right now, we need “big government” (a net spending stimulus in appropriate areas through lower taxes and directed expenditure) to make sure we recover and won’t need “big government” in the future.

So, don’t get me wrong.  Wanting policy action to stimulate growth on the edge of a depression is not the same as wanting the state to dominate the economy forever.