10 Jul 2013 03:43pm

Measure for measure

UK employment is rising, but GDP is not moving, leading some people to conclude there is a productivity gap. Jane Simms asked senior economists to explain what is happening and why

DOUGLAS McWILLIAMS is Gresham professor of commerce, and executive chairman of the Centre for Economic and Business Research

“There are three main reasons for the fact that employment appears to be rising while GDP remains fairly static.

First, our productivity track record up to 2007 was way out of line with both past experience and other countries, and the figures were inflated by allegedly high productivity in the financial sector. That business ultimately made no money, so while the figures were bumped up at the time the losses are being attributed to the current period. So we were not as good as we thought we were then and are probably not as bad as we think we are now.

Many of these so-called zombie companies may be treading water in a stagnant market, but they are surviving and profitable

Second, we are living in a changed world. GDP can’t grow as fast as it once did because there is less opportunity. Western economies are facing competition from countries with marginal costs, which serves both to hold down wages and push down prices. This, combined with the effects of the financial crisis in the UK, means that real per-household income in this country has gone down eight percentage points since the peak in 2007.

We have taken a hit to productivity rather than employment, which is largely a good thing, because even a ‘bad’ job gives someone a start in the labour market. The arguments about poor quality jobs being created and “zombie” companies being kept artificially alive by low interest rates and quantitative easing are nonsense. Quantitative easing is an appropriate response to banks not being in a position to lend.

Many of these so-called zombie companies may be treading water in a stagnant market, but they are surviving and profitable; they are fulfilling their fiduciary responsibilities and an important social role in keeping people employed. Their biggest single problem is the lack of choice in the lending market: they daren’t get into a position where the bank pulls the plug on them.

The third reason is that some of the figures are a bit distorted. In the area that we at the CEBR have dubbed ‘the flat white economy’ – essentially IT, communications, media, software development, internet marketing and so on – a lot of what people do is not being picked up properly in the official figures. There has been an increase of around 100,000 jobs in this sector in London alone over the past seven years, and the UK sector as a whole comprises about 1.2 million people – which is already half the size of the manufacturing sector.

Over the past two years, numbers have gone up very sharply. And while employment numbers get picked up straight away, it typically takes a couple of years for the productivity from start-ups to feed into the official figures. This factor alone could account for 2-3% of the productivity gap – the difference between where we are and where we would expect to be had previous trends continued, which is currently around 12%.

We will see an upturn, but it will be gradual, and we are already in it. This year and next year productivity will grow by between 0.5% and 1%, but within the next three or four years we will see a big statistical correction, which will make the figures look a lot better. But if living standards in the UK are to rise the challenge remains the same as ever – to improve the skills of the labour force and to facilitate increased productivity through capital investment.”


DIANE COYLE runs the consultancy Enlightenment Economics

“It’s not helpful to separate out manufacturing and service productivity, as the official figures do. Manufacturers have outsourced lots of activities – such as payroll and software development – over the years, which undermines the value of comparisons. Also high-level manufacturing now involves lots of service-type characteristics. James Dyson is a manufacturer but recently became provost of the Royal College of Art because of the importance of design in his products.

What I find most worrying about the official figures is the lack of investment in capital. British companies have invested less than those in the US, France and Germany, so our productivity is relatively low. Yes, in the short term capital investment could reduce employment levels, but we need to look to the future because our ageing population means there will be fewer people to do things.”


IAN STEWART is Deloitte’s chief economist in the UK

“The more you look at GDP or National Accounts numbers the more you realise all this stuff is not a science – there are strengths and weaknesses in the way we do things. On the whole, though, labour market data tends to be a fairly reliable measure.

But if UK productivity is weak, as the figures suggest, that implies a competitiveness problem, which would show up in the trade numbers. And indeed, trade performance has been very disappointing. The UK current account deficit has widened in recent years and export growth has been weak despite a devaluation of sterling of around 30% in 2007/08.

The US is a more flexible economy than the UK. They packed a lot more adjustment into the downturn than we did: they had a milder recession, cut more jobs, had faster insolvency rates and house prices fell faster. That led to a faster rebound.

I don’t blame the Bank of England: it was right to collapse interest rates and it was logical to try to mitigate the scale of the downturn. But that may have had a dampening effect on recovery. The policy is to help companies through a period of extreme weakness so they can prosper on the other side.

Over the next five years I expect the output from high value sectors such as North Sea oil and financial services to improve. Companies will invest more, because bank finance will be easier to come by and credit conditions will improve and rising output will help productivity.

There will also be stronger demand. The picture in Europe is likely to improve a bit next year, the US is making a strong recovery and Japan is in decent shape. On the domestic front, consumers will benefit from lower inflation.”


DR EAMONN BUTLER is director of the free-market think-tank the Adam Smith Institute

“It is a thoroughly bad thing that companies are kept alive artificially. When interest rates get back to sensible levels, many of the activities they’re engaged in will collapse and banks will pull back their loans.

The problem is, we’ve not really had the big pain yet. Yes, the public sector has been making adjustments and companies are getting their balance sheets in shape, but at this stage in the economic cycle things should be a lot worse than they are. Assets are all in the wrong place: human and physical capital has to be allocated somewhere more useful. We would recover more quickly if we swallowed the bitter medicine now. What we’ve got at the moment is like the hair of the dog – it doesn’t cure the hangover, it just makes you feel better for a while.”


JONATHAN HASKEL is professor of economics at Imperial College Business School

“Labour hoarding would explain the initial fall in productivity between 2008 and 2009. But it seems highly unlikely that firms are still carrying underutilised workers four years on. So it must be something else, and we think that intangibles may be part of the explanation.

While investment in tangibles – plant, vehicles, buildings and so on – has fallen and remained low, investment in intangibles – specifically research and development and software – has risen since the recession. So a firm might reduce production, but maintain its investment in intangibles. Its average skill level rises but its measured output falls, as the output of R&D projects, for example, might not manifest itself for a few years. Superficially, labour productivity is seen to fall in a pattern that looks just like labour hoarding.

If the official statistics captured these intangible measures (as they will soon) they would increase annual output by around 0.5% – which, when the economy is flat, is very significant. Clearly, the intangible aspect only solves part of the productivity puzzle, but I spend enormous amounts of time puzzling over such ‘tiny’ numbers because, accumulated, they add up to real money.

I think the productivity slowdown can reasonably be accounted for by this and lots of other little factors rather than immutable long-run factors. For example, I don’t think we lack fundamental productive capacity. Profoundly depressing, however, is the lack of opportunity to do something on the demand side: would more or less austerity make things better?”


ANDREW GOODWIN is senior economist at Oxford Economics

“We don’t necessarily agree that the crisis this time round is unprecedented. It is at the upper end of the scale in terms of severity because of its global nature and the UK economy’s exposure to financial services.
But, according to the figures, the economy has flatlined for about 18 months, which is unlikely. We believe the true level of GDP might be as much as three percentage points higher. Only about half of the 14% productivity gap (the difference between where we are now and where we would have been had the pre-recession trend continued) is the result of genuine damage from the crisis, but the remaining 7% worries us more.

To an extent, the measures have not kept pace with the changed economic landscape. It’s hard to measure the output of a service company, and it’s hard to measure the inflation rate given the variety of products sold at different prices to different customers. There are also changes in quality year to year – witness the advances in computer technology. It is very difficult to decouple such factors from price shifts. The data could also be struggling to capture the meteoric rise of e-commerce over the past decade.

But we have been through crises and periods of technological change before, and have still managed to sustain an average growth rate of just over 2.5% for the past 40 to 50 years. It will be two or three years before we get a solid idea of what really happened in 2011 and 2012, but we predict that growth will have been stronger than the current figures suggest.

We think a sustainable (albeit not ‘normal’) recovery is already under way. It is fragile but moving in the right direction. Household income is increasing and people are spending more; business investment is picking up as a result of better access to finance; and the export picture is improving – not within the eurozone, but in the US and emerging markets.”


STEPHANIE FLANDERS is BBC economics editor

“What has been different about this recession was the financial crisis that precipitated it. So it makes sense to look at the factors that were associated with the financial crisis rather than longer-term trends such as the shift to a service economy, the rise of e-commerce and the growth of intangibles.

Ben Broadbent, a member of the monetary policy committee at the Bank of England, looked at the history of financial crises last September. He found that because they get in the way of how people raise money,

It is no surprise that the economy is behaving so oddly at the moment.

 productivity hits tend to be a characteristic. The hit to our financial system means that banks are concentrating on rebuilding their balance sheets. So there is a shortage of capital, companies have less money to invest, there are fewer machines per person, therefore we get lower productivity.

Labour hoarding was a factor in the beginning, but a bigger issue now is that real wages have fallen over the past three or four years and, because wages are increasingly flexible, that has kept people in work. From a social perspective, the pain has been spread more equally this time: most of the population have taken a hit to living standards, whereas in the 1980s and 1990s a small proportion lost their jobs completely.

The output from North Sea oil is shrinking; this sector had high productivity growth before the crisis and a big output for relatively small numbers of employees, which was also true of financial services. These two big sectors accounted for between 2% and 3% of the labour force, but had a GDP share about three times that. So while both have suffered a big hit to output, that hasn’t translated into lost jobs.

So why has the US performed so much better than the UK in productivity terms, particularly as the US subprime problem was the epicentre of the crisis? The simple answer is that the financial sector accounts for a far smaller proportion of their economy than it does in the UK, so they took a smaller hit.

US businesses are also not as reliant on the banking sector as UK businesses. Even smaller companies have more options for raising money – the corporate bond market, for example. Germany is similar to the US but their recession was as steep as ours in 2009 because they were so reliant on exports. Unlike the UK though, they didn’t also have to fix a massive deficit.

To judge by history, the economic picture probably is a bit better than we think. The ONS does systematically under-measure output, and typically revises upwards, particularly coming out of a recession. The crisis we went through was exceptional so it is no surprise that the economy is behaving so oddly at the moment.

But most people think things will get better – and the fact that the better companies have hung onto people, which keeps them close to the labour market and positions the companies themselves for an upturn in demand, is good.”


KAREL WILLIAMS is professor of accounting and political economy at Manchester Business School

“One of the main problems with the figures is that they are very broad aggregates. It is amazing that we see the quarterly GDP figures disaggregated by sector but not by geographic region. The sectoral split is intellectually interesting – we know broadly that services grew and manufacturing didn’t, for example – but the regional split would be politically explosive.

Growth is happening in the south-east but the disparity with the rest of the country is growing – as is the disconnect between what the political classes and media in the London ‘bubble’ and the population in the rest of the country think.

What’s more, the composition of employment is changing, so apparently static productivity is actually the result of losing one sort of job and gaining others. During the whole period from the early 1980s to 2008, over half of the increase in employment came from the public sector, with most of the rest from private services where productivity growth is lower than in manufacturing.

In the 1970s there were seven million manufacturing workers, and productivity was increasing at close to 3% a year. Now we have just over 2 million manufacturing workers and we are substituting poor-quality, low-paid service jobs in sectors like retail and fast food, which have low productivity. So it is not surprising that output and employment are disconnected.

So the headline figures are ‘voodoo’. Voodoo is an object of worship and to ward off evil spirits. The headline count of unemployment is worshipped by George Osborne and wards off Ed Balls. But it is not a robust measure of what we want. We need to measure employment in a more discriminating way so that we can see the quality of employment.

GDP won’t grow again quickly or easily. There is no consensus among the political classes about what to do. Osborne and Balls are both victims of voodoo economics – they believe mistakenly that if we get the measures going in the right direction we’ll be OK.”


JOHN VAN REENEN is director of the Centre for Economic Performance at the London School of Economics

“The main explanation for the puzzle of high employment and low productivity is labour market flexibility. There has been a larger fall in real wages than in previous recessions, which while it is tough for people means that employment hasn’t had to fall as far as it would otherwise have done. And this is likely to be due to weaker union power and welfare reform.

At the time of the last big recession, in the early 1980s, two-thirds of people had their wages determined by union contracts. Now it’s only about 25%. So it’s easier to impose things like wage freezes, and employers can price workers back into jobs that would have been lost in earlier downturns. Also, welfare changes of the past 30 years mean that people are being pushed to find jobs because benefits are now less easy to secure. This creates more competition in the labour market, and puts downward pressure on wages.

As real wages fall you also get ‘capital shallowing’ as people are substituted for structures and equipment. This effect – which reduces productivity in the short term – is particularly pronounced for SMEs, given the high cost of capital as banks restrict their lending in order to repair their balance sheets.

However, two pieces of evidence suggest that the fall in productivity will be temporary. One, the UK is not unique. Other European countries experienced a similar fall in labour productivity. The US has rebounded much more strongly, but it is much easier to hire and fire there and they shook out lots of less skilled, less experienced people very quickly at the beginning of 2009, which meant that their ‘batting average’ went up. But the corollary was a sharp rise in unemployment – 4.4% before the crisis to over 10% at its peak.

In addition, it is unlikely that the dramatic improvements to UK economic capacity during the 1980s, 1990s and 2000s would disappear so quickly.

The UK economy is not fundamentally the victim of a large supply-side shock but rather a very severe demand-side shock. We should not be complacent, but the demand problems are amenable to conventional solutions of fiscal and monetary stimulus. There is room for structural policies too – not least strategies to improve the way credit markets work, and measures to improve the investment in human capital, infrastructure and innovation.”


Jane Simms