Productivity statistics expose deep weaknesses in theoretical economics

I hadn’t intended to post for another couple of weeks, but this article in the Financial Times is too good to miss. It tackles one of the central issues in modern economic debate: why productivity growth is so slow. Productivity lies at the heart of the conventional view of public policy – and yet it is very poorly understood. This article sheds light on what is happening in the UK – and it should give politicians and economists pause.

Productivity is in principle a very simple idea. It is the amount produced by a unit of labour in a unit of time – the number of widgets per person per hour, for example. This immediately conjures up a clear mental picture of a factory producing cars, say. Count the number of cars produced, and the number of hours of labour required and it is easy-peasy, surely? Alas in a modern economy  it is a much more difficult idea. What if your car factory is producing both Ford Fiestas and Mondeos, and switches to the smaller car? Has productivity gone up if more are produced? And how do you distinguish product enhancement from inflation?  And then there are problems treating capital outputs and inputs, research and development, and so on. In the end the productivity measured across an economy is a bit of a balancing figure, as we accountants would call it – or a bit of a dustbin – what’s left when you’ve taken everything else out. It is just a number relationship without a coherent meaning in its own right. It is not like the concepts that physical scientists are used to dealing with – such as the temperature and pressure of a gas. Macroeconomics is heterogeneous, to say nothing of being subject to capricious social forces that tend to corrupt all attempts at measurement.

Now, what is the productivity puzzle? It is that productivity growth, as measured by macroeconomic statisticians, has slowed markedly since 2008, when the financial crash caused a dislocation in measured income. This applies to all developed economies, but to the British economy most of all – UK productivity growth, according to the article, fell from 1.6% per annum before 2008 to just 0.3% after. This has profound implications, since in the long term productivity growth is what drives income per head, alongside the average hours people work (influenced strongly by workforce participation – such as how many women are in paid employment). And this drives tax revenues, from which public services are funded. Since we assume that quality of life is mainly driven by income, and that public services can constantly be enhanced by extra spending (apart from occasional periods of “austerity”), this has profound implications. Prior to 2008 most economists assumed that productivity growth of 1-2% pa was a law of nature and  main driver of “trend growth”, which could be baked into economic models. The corollary was that weak growth since 2008, and the failure of GDP to catch up with the pre 2008 trend-line, was a failure in macroeconomic policy.

But given the dustbin nature of the productivity statistics, it is very hard to drill down into them to find out just where the problem is – though that there is a problem of some sort is clear. This is licence for all manner of people to project their speculations into a fact-free zone. Mostly these are based on the intuitively obvious idea that the changes to the productivity figures represent trends in the efficiency of workers. Recently Bank of England bigwig Andrew Haldane moaned that the problem was that efficiency was stuck in a rut, especially in a swathe of mediocre firms. He based this on sectoral analysis which showed that the productivity had stagnated across all sectors – with economic growth mainly attributed to rises in employment, not efficiency.

The FT article, authored by Chris Giles and Gemma Tetlow, challenge that. A close examination of the numbers shows that the crash in productivity growth arises from changes in a small number of economic sectors, accounting for just 11% of income. These are banking, telecoms, electricity and gas, management consultancy, and legal and accounting services. Actually Mr Haldane’s and Mr Giles/Ms Tetlow’s analysis can be reconciled. Mr Haldane was taking a general view across the economy since 2008, where productivity growth is now very limited. The FT writers are looking at the transition from before and after 2008. The curious point is why productivity growth was so high in that small number of industries before 2008 – and the realisation that this is what was driving so much of the figures for productivity growth before that date.

And that leaves this blogger asking whether that pre-crash productivity growth – and by implication the pre-crash trend rate of overall economic growth – was in any sense real, other than statistically. In banking we know that in 2008 massive state resources were required to keep the industry alive, and that since then the industry has been much better controlled. This suggests that “productivity” would more correctly be described as “recklessness”. And in each of the other industries you can point to factors that demonstrate that growth was not simply incremental improvements in efficiency. For example in electricity and gas productivity was based on high inputs of fossil fuels and nuclear energy – and the switch away from these destructive sources of power has caused a decline in measured productivity. And how on earth do you assess the output of management consultancy, and accountancy and legal services? The transition may simply be from high margins in boom economy conditions to higher scrutiny when times were harder – or to put it another way, what was supposedly economic growth prior to 2008 was in fact concealed inflation.

All this supports the narrative that I have been promoting for quite a few years about the transition from growth to austerity. This is that the supposed growth of the economy of the early to mid noughties in the UK was down to excess demand, of which reckless fiscal policy was a part  – though you might alternatively argue that it was reckless borrowing by the private sector that the government turned a blind eye to. It also suggests that the lacklustre economic performance of the UK economy since 2008 reflects a lot more than just weak demand management: it is chickens coming home to roost.

This takes me to two very important conclusions. The first is that we have to be very careful about the recommendations of macroeconomists – and the eco-system of commentators and policy types that use macroeconomics as their starting point. The bandying about of aggregate statistics is all very well – but the aggregates hide as well as reveal – and we need to base economic prescriptions on the complexities of the real economy. That is hard, but necessary.

The second point is that overall productivity is indeed stuck in a rut, and has been since well before 2008. It must reflect structural issues in real economy – and not simply laziness amongst mediocre firms or poor macroeconomic management. There is no shortage of potential culprits: demographics; the nature of modern technology; the temporary nature of gains from trade with Asian economies. The world may still be becoming a better place – but because of things that are not captured in GDP, and hence productivity statistics. The problem for public policy is that tax revenues are largely driven by GDP (which is why it is an important statistic) – so we can’t expect an ever increasing flow of tax revenue to fund public services. In the long run we must either reduce the demand for public services (healthier people, fewer crimes, less skewed income distribution, etc.), raise taxes, or compromise what level of services and benefits we think that a civilised state should provide.

And that is a completely new way of thinking about public policy. The political right have grasped this (for the wrong reasons, perhaps) – but the left has not.

13 thoughts on “Productivity statistics expose deep weaknesses in theoretical economics”

  1. “so we can’t expect an ever increasing flow of tax revenue to fund public services. ”

    I’m not sure if you’ll ever get it that tax revenue doesn’t fund public services for the Westminster Government. Though it may do for the Welsh assembly or Local councils. They aren’t currency issuers!

    But could Local councils could issue their own currency? Theoretically yes providing they have the ability to levy taxes. In the case of my own council, Lancaster, it could be called the Lanc. The council would issue a tax on every able bodied person of, say, two Lancs per week. Of course the Lanc doesn’t exist. No-one has any. That’s easily solved. The council just creates the Lanc and offers a job paying one Lanc per hour to anyone who rocks up at council offices. The exact details of just how much labour is needed could be decided later. Maybe it could be just one hour and the tax could be just one Lanc. They’d have to do whatever was needed like provide meals to the elderly, mow the grass in the parks, help out in the libraries etc.

    Anyone could work all week if they wanted and earn 2 Lancs to pay their local tax and have, for a 35 hour week, 33 Lancs left over to sell to others who didn’t want to be bothered doing any work themselves. So the Lanc would acquire a value. There would be an exchange rate between the pound and the Lanc of something like £7 = 1 Lanc. Whatever the local market would price for one hour of work. If the Lanc became too cheap, in terms of pounds, then more people would be happy to pay for the Lanc in pounds. If the Lanc rose in value, paid work would become a more desirable option. Everyone would always have the option of paying for some Lancs or putting in a couple of hours work. The Lanc could never get that cheap though. The only source of Lancs into the market is by someone working for the council and being paid in them.

    The Lanc would become a parallel currency. Some shops would take them directly in payment for goods. Others would buy them for pounds.
    It is worth noting that Lancaster council would always be in debt or deficit in terms of Lancs. They would never get back more Lancs than they created. That would be impossible. So, besides solving the problem of local unemployment and the run down of local services, the introduction of the Lanc would provide us all with a useful lesson in how fiat currencies actually work. For instance the issuer of the currency, the council, doesn’t impose taxes because it needs the money. It imposes taxes because it needs people to work for it!

    This would be different to the local currencies which already exist. The best known one is the Bristol Pound. This is simply an IOU supported by Bristol Council and the local business community, denominated in pounds. The Lanc would be a floating currency with no guaranteed link to any other currency or precious metal.

    It wouldn’t necessarily mean an increase in the total amount of local taxation. It could well mean a decrease. If more workers could be paid in Lancs there would be less need to raise taxes in pounds. The local council would simply be utilising an available resource, the local unemployed, which would otherwise be unused.

    I’m sure someone will say this would be all highly illegal. Maybe. And if central government was doing its job properly there would be no need for it. But, it could work in principle.

    I don’t think there is any mystery why productivity falls after a crash. If a skilled person loses their job they’ll probably be able to find something to do which pays less than before. So their productivity, by definition, must have fallen. While economists fail to grasp the basics of how money works and how important it is to a modern economy they’ll have a lot of unnecessary difficulty with these kinds of questions.

    1. I’ve been on the move – and at the moment I am unable to post to the blog through my iPad. So my reply is a bit late! I think you are taking an interesting idea and turning it into a religion. it would help if you could spend more time thinking about the awkward logistics.

      You can certainly quibble with my phraseology on tax and spend, but I think the basic proposition is rather obvious. In a properly functioning economy any increase in the use of resources by the public sector must either come via net imports or by restraint on the private sector. Taking the import position out of the picture for now, the best way to achieve such a restraint on the private sector is the levying of tax. Otherwise you risk inflation, financial bubbles or other things that will eventually hurt public welfare (something that applies to excessive net imports too, I think). Also, a point that you have made elsewhere, the cycle of tax and public expenditure is the foundation of the money economy. Spending is the way governments put money into the economy, tax provides monetary units with their primary usefulness. Otherwise you get a Zimbabwe – where the government pays its public servants with its own money, but the public would much rather hold USD. (Or perhaps a Bitcoin – which is useless as a store of value) Thirdly, most people feel the need to put the issuance of currency under severe political constraints, to prevent abuse. Politically the idea that taxes need to fund public spending is based on these three foundations. Now I understand that you feel that we are not at the moment in what I have called a “properly functioning economy” – in that we have a chronic lack of demand – a version of the secular stagnation hypothesis. And there is some good evidence for that. But I tend to view this a temporary dysfunction that needs a temporary solution, rather than something that can be treated as an enduring fact of life.

      And as for local currencies, some scepticism is in order. It starts with the big obstacle that local authorities levy little of their own tax – something, incidentally, that I don’t think is a good thing. That’s a bigger issue than it being merely illegal! I don’t think any nation has tried it, in spite there being some very large and diverse economies out there (USA, India and China especially). And small countries often set restraints on their own currency freedom – especially by tying their rates to other countries, and occasionally forgoing a separate currency altogether. All this points to practical problems with separate currencies. A further problem comes from the idea of a hierarchy of currencies (from that professor in the video you shared). The Pound outranks the Lanc, so people will naturally tend to hold it instead. And it would be more than hard for the Lancashire government to stop people paying their local taxes in Pounds. And I think the problem with regional economies in a highly centralised polity like England, runs deeper than macroeconomic management. The capital keeps flowing back to the centre as fast as you pump it in.

      But I wonder? Perhaps as we move towards a cashless society, the difficulties of running local currencies might diminish? Perhaps a multiple currency economy is becoming more feasible? And certainly if local governments could issue their own currency then that is an enormous injection of political power – and lack of political heft is a big part of the problem. So I might be being a tad hasty?

  2. I should probably have said that the above idea isn’t mine. It’s been done before so isn’t pie-in-the-sky.

    “Furthermore, it has been obvious to the students that:
    The buckaroo is a (simple) case of a public monopoly;

    The UMCK’s buckaroo fiscal deficit is exactly equal to the buckaroos saved by the students and their associates;

    The value of the buckaroo is a function of what the students have to do to earn a buckaroo from the UMKC work doing one hour of community service;

    The buckaroo functions first to move student labor from private to public domain and

    The buckaroo has operated and sustained its public purpose independently of foreign central bank policies.”

    1. Yes that helps me a bit with the idea. I think I read a more sceptical review of it in the Economist – but it could have been a different scheme.

      Surely the 20 buckaroo tax places a restraint on the amount of community service UMCK can commission and vice versa? If they paid out vastly more than they taxed (so students were earning 30 buckaroos a term on average), the scheme would collapse? A balanced budget underlies the whole thing. I don’t really see how UMCK could be said to be running a deficit. So this is an interesting idea to promote community service rather than telling us how currency can be managed in a diverse economy?

  3. I’ve given your productivity question a little more thought and in particular your point about:

    “And how do you distinguish product enhancement from inflation? ”

    And that in itself is an interesting question. The PC ‘s we use now which cost a few hundred pounds just weren’t available in the past, at any price, so how do we factor in technological progress? And what about property price increases? I’m always sceptical that they aren’t included properly in the figures.

    Nevertheless Governments do produce various indices which do purport to measure inflation. The best known ones are the CPI (the most commonly quoted) and RPI.

    I doubt we’d ever all agree on just how inflation should be measured but the Office of National Statistics do their best. So lets assume we can measure inflation and that it is y% pa.

    The GDP of the UK is $2.86 trillion. Which at the current exchange rate works out at £2.32 trillion. Which poses another question. Should we use pounds or dollars when calculating productivity?

    So next year if GDP is the same in real terms it will be
    £2.32*(1 +y/100).

    We also need to factor in the number of hours worked and the population level to get a measure of the productivity per capita per hour. PPCPH = GDP/(Pop *Average no of hours worked)

    It all gets a bit difficult. If we want to utilise the working capacity of the population we want to eliminate unemployment and underemployment. So how to we count the hours wasted when anyone has no work? Do we count them and say that effectively their productivity is zero or do we just ignore them and only count the production and time spent for those in work? If we assume zero productivity then its hardly surprising that overall productivity falls when unemployment and underemployment rises in a recessionary period.

    I think the best that Governments can reasonably do is to just look at the bigger picture of GDP per capita which works out at £35,700 per person. This sounds rather a lot. Many would suggest that if we aren’t happy with earning that, why would an increase to, say, £40k per person make any difference?

    But nevertheless if that’s what we earn then that’s what we need to spend too. I don’t know about you but I’m not pulling my weight as far as keeping the economy going! I’m not spending enough! So that means the Government has to step in and spend more to make up for people like me, otherwise everything that is for sale in the economy just won’t get sold and we’ll end up back in recession. In other words, the trick Govt has to perform is to fine tune the economy by spending and taxing at just the right amount to keep it from falling into recession but not too much so as to create inflation. Once it gets the balance right we’ll have growth (in GDP per capita) and that must mean that productivity will increase too.

    1. Some philosophically hard questions there about economics! The inflation versus enhancement issue is an old one, most agree that it usually works the other way. The price index does not reflect enhancements fully – so the standard of living is generally rising while GDP per head is stagnant. Our homeless may have smartphones these days. In my blog I am interested in a special case – where there is excess demand in an environment when the inflation route for this to express itself materially is constrained for one reason for another (such as the mid-noughties in Britain, I believe). And I agree, on the whole the statistics agencies do a good job.

      I do challenge myself whether higher GDP per head is necessarily a good thing. There is no good done by people consuming things they don’t want, surely? It confers a false dignity on those that produce those unnecessary goods. These days do not do much to add to the production side of the economy, and consume more than I produce. I do quite a bit for the voluntary economy (school governing and politics) though. Does that make me a bad guy? Or am I ahead of the game in constructing a significant part of my personal life without money?

      1. I’m sure you know that doesn’t make you a bad guy! And I do agree that an ever increasing GDP isn’t the cure-all to our economic problems. When I was a young student, in the early 70s, I crossed swords at with Sir Keith Joseph at a talk he was giving over student grants.

        The theme of his talk was that the left were far too concerned with how wealth was shared out and what the country needed to do was get away from all that and concentrate on increasing wealth. If the cake was bigger we’d all get a bigger piece. Trickle down economics in other words. He anticipated, correctly, that us lefties would be arguing that student grants hadn’t kept pace with inflation. So increase GDP he was arguing and the government can afford to give you higher grants.

        Fast forward 40+ years and GDP is now 2.5 times higher than it was then. We probably wouldn’t have thought such an increase would be possible, but if we had anticipated that we’d have all thought that the UK of 2017 would have had no economics problems at all. We certainly wouldn’t have thought that there’d be no grants at all!

        We now know that how the wealth is shared out is just as important as creating it. I instinctively knew that at the time. But Sir Keith was presenting a plausible argument then and many of us are still taken in by it.

        1. I was quite taken with Keith Joseph in my youth. The best that can be said was that much of his criticism of the then conventional wisdom was well-founded. But his ideas for replacing it have not stood the test of time.

          1. Yes I remember him talking about the ‘money supply’. The idea being that inflation was simply the result of too much money in the system. My subject was Physics but even at that time I was interested in economics. In our first year we had to choose a non-science module and for some reason Economics wasn’t counted as a science so I opted to do that. It was pretty basic and very easy as I remember. Just had to trot out a few essays!

            So, even then I suspected that Sir Keith wasn’t up to any good but I hadn’t quite got my arguments right to counter them.

  4. “If they paid out vastly more than they taxed (so students were earning 30 buckaroos a term on average), the scheme would collapse? ”

    Not necessarily. You need to ask yourself why the students would want to earn the extra ten. They’d want to do that for one of two reasons. They might want to save the buckeroos for future use. Or they might wish to sell them. If the exchange rate was 1 buckeroo = 2 dollars, they’d probably not want to bother putting in the extra time. They might not want to bother putting in their 20 hours to begin with. They might just decide to shell out $40 and buy the buckeroos to pay their tax.

    So the system would be self regulating. The number of hours available to the uni (H) would be dependent on the number of students (N) and the net average savings of each students (S):
    H = N(20 + S)

    So your example of 30 buckeroos per student would mean that each student, on average, wanted to save 10 buckeroos per semester. Or someone else wanted to save the buckeroos to bring the average up to 10. This may be unlikely but it is theoretically possible.

    The system as described is actually a special case of the work being produced having no commercial value. But we could add that into the model. Say the university set up a farm or a factory and sold the produce. They could still offer the students as much work as they wanted but now they’d have an income which would help maintain the value of the buckeroo on the exchange markets. If the farm was successful and sold a lot of produce at high prices, this would keep the buckeroo high on the exchange markets, the students would find working for one buckeroo more appealing that if it were less successful.

    So the buckeroo does show us exactly how a currency does work and how the issuer of a currency can provide full employment. But you seem to have some trouble seeing it? That’s why you are being dismissive with your mention of a “religion”?

    1. In fact I suspect that the buckaroo has a fairly tight budget constraint – but I take your point that it has still created work (but is that by creating a tax or by printing money?), and that the constraint may simply be a function of its limited scope. But I think it is more difficult than you suggest – and I remain sceptical that it is in fact dealing with the economic fundamentals of underemployment, while creating major political risks.

  5. There’s always political risks. Leaving the EU/ Staying in are both risky.

    But consider the idea that instead of a university we have a small nation state which issues its own currency. It also offers jobs to everyone who wants one for one currency unit per hour. So as Mosler shows it is the taxation that creates a demand for the currency and therefore a value. So that currency means that anyone can set up business and offer jobs to others. So not everyone has to work for the State.

    And of course just how well off everyone ends up depends on what the economy produces. So we don’t want everyone working for the government. But its better that they do work, even if the criticism is that the jobs are just made up jobs. The longer anyone is out of work the less employable they become. The economy can be regulated so that these minimum wage jobs are no more than about 4% of the workforce.

    So we’d have no unemployment but we would have a pool of workers on a guaranteed income. There would be no inflation as the experience of the buckeroo shows.

    The problem isn’t so much economic as political. From a left perspective we’d have to tackle the issue that the guaranteed income, which also pegged the currency, was sufficient to allow everyone a reasonable standard of living.

    1. Well I have to say that it’s a better idea than a universal basic income because at its core there is a two way relationship between the state and the recipient – and it would not undermine wages in the private sector. It reminds me a bit of some of the schemes contemplated by the Indian government – where the problem (if I remember correctly) has not been affordability (as predicted) but corruption (the wages being appropriated by middle-men) – which their new ID system may be able to resolve.

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