Tag Archives: recovery

Solving the productivity puzzle

10 Oct

In recent days, there has been much “I told you so” in the air. The IMF has revised its forecast for growth in the UK, predicting that the British economy will grow more than it had expected in earlier forecasts. The French chief economist at the IMF, Olivier Blanchard, had raised something of a storm in the UK earlier this year when he criticized the government’s austerity drive. Now that the UK appears to be growing more than expected, the British Chancellor George Osborne feels vindicated.

This squabbling over numbers points us to one of the problems with the austerity debate as it stands. Much of it has rested on forecasts and estimates. Projections of growth trends and government revenues three or four years down the line are notoriously difficult and yet both sides of the debate have claimed that their estimates make the most sense.  

This focus on numbers is particularly problematic in the UK as it detracts from the main issue. Newspaper headlines and public debate tend to focus on interest rate movements, the UK’s government-fuelled housing price bubble, the revision of growth forecasts that we have seen in recent days. What is not being discussed is the real mystery in the UK since the beginning of the crisis: the marked dip in productivity. Writing in the Financial Times, Chris Giles rightly points out that being so focused on the ups and downs of fiscal policy has meant we have missed the big issue of the UK’s productivity puzzle. Looking back at forecasts made in 2008, the main finding is that growth is much lower and inflation higher than was predicted.

 According to Giles, this tells us that the main problem in the UK is not a lack of demand due to austerity policies. Rather, “it suggests that something has gone wrong with the supply of goods and services in Britain” – this is what economists are calling the productivity puzzle and few have any explanations for it. Steve Nickell, a member of the UK’s Office for Budget Responsibility committee, recently admitted that whilst there are many theories about this puzzle, there is still no coherent explanation for it (FT, 10/10/13).

One idea (see Charles Goodhardt’s article here) is that if employment is held roughly constant, then falls in demand will lead to falls in output, which will then depress productivity. Logically this holds: if the same number of people are producing fewer things, then their productivity (output per worker) will fall. Compared with previous recessions in the UK (early 1980s and early 1990s), employment has held up well. We have not seen the collapse in manufacturing employment that we saw in the early 1980s, for instance, which had the effect of boosting productivity. A feature of the 2008-2013 downturn in the UK has therefore been the protection of manufacturing capacity and the avoidance of massive liquidation and bankruptcies. The result has been a fall in productivity. In other countries, like Spain, where unemployment has mushroomed, productivity has risen noticeably. Why this job-rich recession in the UK? And what about other countries like Germany, who have also managed to hold up employment? Has productivity fallen there too?

Goodhart’s is one explanation amongst many others and it may not convince everyone. After all, unemployment in the UK rose from just over 5% in 2008 to 8% in 2010. Isn’t that enough to keep up productivity levels? If not, then how much is enough? Compared to the petty points scoring of Osborne and co, though, and the fixation on forecasts and projections that has characterized both sides of the austerity debate, this is what we should really be thinking about.

Whither monetary policy?

26 Sep

Last week, we posted on the Fed’s “Operation Twist”, its latest attempts at stimulating the US economy through manipulation of borrowing rates. There was much to be said about this, both in terms of its limited effect and the ways in which it was going about its business. Moves by Central Banks, even if limited in their overall impact, still have the potential to redistribute wealth. We noted that in so far as the Fed’s approach has been to moderately inflate away debt, this also means inflating away wage increases achieved over this period.

This discussion about inflation and the Fed’s interventions in the crisis is worth extending further. One important point is that for all of its creativity in manipulating interest rates, the Fed’s overall approach has involved a conservative assessment of its own mandate. A graphic produced by The Economist a couple of weeks ago provides a useful illustration of this.

Formally speaking the Fed is meant to pursue the twin goals of low inflation and low unemployment. In the policy wonkery literature on central banking, this makes the Fed a less “hawkish” institution than, say, the European Central Bank, whose own mandate only extends to price stability and not to growth as such. A feature of the current crisis in Europe has been that the ECB has had to venture well beyond its mandate, playing a role in managing the crisis that has little to do with inflation in the Eurozone. The Federal Reserve, in contrast, has appeared more concerned about prices than about jobs. In this crisis, the low unemployment goal of the Fed has been breached dramatically, with unemployment over 3% points above what economists consider to be the US’s “natural” (i.e. non-inflationary) level of unemployment (around 6%) for the last two years. Had the Fed overshot to the same degree on its inflation goals, Bernanke would have been subject to the most scathing of criticism. There is evidently a bias, both in the Fed and outside, towards keeping a lid on prices, even at the cost of rising unemployment.

In the discussion about the Fed’s quantitative easing program, it is worth keeping this in mind. It points to the broader issue of the Fed’s mandate and its particular interpretation of that mandate. It also points the fact that today, for all the manipulation of interest rates downwards, we are perhaps beginning to reach the limits of what low interest rates can achieve (see here and here for discussion of what monetary policy options are available under liquidity trap conditions). Can the Fed really stimulate the US economy in the way that it would like through reducing borrowing costs? One reason why the Fed may be reluctant to modify its existing inflation targets in favour of a higher rate or to switch to the monitoring of nominal GDP instead (see rational for this here) is that it may not think it will help in bringing unemployment down. We may have reached the limits of what interest rate policies can achieve but the Fed doesn’t seem to have anything else up its sleeve.

Austerity in Europe

31 Aug

In France, the word rigueur is associated with political failure: it brought down the government of Raymond Barre in the late 1970s, marked the abrupt end to François Mitterrand’s experiment with “socialism in one country” in 1983-4 and coincided with the downfall of Alain Juppè’s government in 1997. Unsurprisingly then, current president Nicolas Sarkozy and his finance minister, François Baroin, are refusing to employ the term rigueur to describe their own recently announced austerity plan. Looking at the details of the plan, there is little doubt that rigueur is what lies ahead. Strikingly, though, France’s plans are relatively restrained compared to some others undertaken by national governments across Europe. Le Monde recently detailed these different austerity plans, reproduced below.

Europe’s Austerity Plans

Country Size of cuts Methods include…
France 12 bn Euros (2011-2012) Exceptional 3% tax on highest earners; tax hikes on alcohol and cigarettes
Greece 28 bn Euros of cuts (2011-2015); 50 bn Euros raised through privatisations Cuts in salaries of public workers; rise in retirement age; freeze on pensions; rise in VAT; lengthening working week of civil servants
Italy 45.5 bn Euros (2012-2013) Freeze on hiring and salaries in public sector
Portugal Approx. 20 bn Euros Privatisations
Germany 80 bn Euros (2010-2014) Tax rises, privatizations
Spain 65 bn Euros (2011-2013) 5% cut in public sector salaries; pension freeze
Ireland 15 bn Euros (2011-2014) Reduction in welfare spending and cut in minimum wage; cut in public sector employment
United Kingdom 95 bn Euros (2010-2015) End of fiscal opt-outs and modification of regime of family benefits; freezing of public sector salaries

Source: Le Monde (27/08/11)

Compared with a few months ago, governments and economists seem to have realized that if austerity is applied universally across Europe then it will lead to a collapse in growth. Medium-term fiscal rectitude combined with short-term stimulus is the message from the IMF, but not heeded by many European governments.

Those critical of austerity have tended to focus on its equity effects. Do the plans hit the rich more than the poor? This we saw was the line of attack of France’s Front de Gauche, led by Mélenchon. The theme of fairness also drives those out in the streets protesting against cuts. At issue for protestors is not the need to balance budgets so much as a desire to shift responsibility from ordinary taxpayers to risk-loving bankers. It is less a question of ‘should we pay’ so much as ‘who should pay’.

The size and nature of the plans listed above tell us two things. The first is that the approach taken by governments has been to freeze wages and cut social security. Exceptional taxes on high incomes have been levied in some cases but they are, as is made clear to everyone, only exceptions. The second is that those voices critical of the cuts have little by way of their own growth model to propose. Export-led growth demands a buyer of last resort to soak up exports. Austerity plans demand a laggard of last resort able to show by virtue of his own profligacy how well other governments are doing. These are all zero-sum options. Hiding behind the collective and consensual appearance of the Eurozone is competition between national capitals, referrred to by many as the “asymmetry” of the Eurozone. Whether or not this competition will be transformed into conflict will depend on whether the Eurozone is able to return to growth.

The social cost of deficit spending

8 Aug

In a recent article, Robert Barro, professor of economics at Harvard, takes up the problem of the US debt deal and its long term consequences. He chides the Obama administration for using an “unrealistically high” spending multiplier when predicting the effects of its expenditures on the national economy. The concept of the multiplier, developed by economists Kahn and Keynes, claims that government spending will add something more to the economy than just debt. The sum, if you like, is more than the value of its parts: individual “pump priming” government projects will together push the private sector to start investing again, with the multiplier a measure of how much more production can result from a given amount of government stimulus. In practice, 800 billion US dollars have been channeled into the economy via the Fed’s quantitative easing policy, with more in the pipeline, and yet the US economy remains in the doldrums. As Barro points out, this spending is now having a contractionary effect on the economy as it takes the form of an unwieldy debt burden.

A standard critique of Keynesian pump priming is that its long-term impact is nil and all it does is burden individuals with higher taxes as governments seek to pay off their debt. Another is that spending by the state has the effect of “crowding out” private sector investment. This presumes that there is a dynamic private sector out there, being stifled by government intervention – one of the main arguments made for rolling back the British state in the early years of Thatcherism in the 1980s.

Whether or not there is a dynamic private sector in the US being held back by the Fed’s quantitative easing will be a matter for future posts. For the moment, it is worth considering Barro’s proposal for dealing with the US debt burden. His arguments illustrate well the way in which the effects of pump priming can be regressive in the long run, hitting those very people neo-Keynesians think they are helping. Barro recommends that reducing the US debt burden should start with setting US corporate tax and estate rates at zero. He also argues for the phasing out of tax expenditure ideas, like tax preferences for home-mortgage interest and employee fringe benefits. He also recommends the lowering of the structure of marginal income tax rates, stressing that rates on higher incomes are already high enough. His final recommendation is perhaps the most important: a flat-rate value added tax. A rate of 10%, he writes, would raise about 5% of GDP.

Barro’s proposals are highly regressive. It would represent an added tax burden for lower earners relative to higher earners. The rightwing critique of government spending is that it only leads to higher taxes. But the bit they don’t mention is that those taxes, when they come around, will hit lower earners hardest. It may seem crazy to be talking about cutting spending during a recession but increasing spending is no solution either. As well as failing to stimulate an anemic private sector, it risks leaving lower earners with the burden of paying off the debt. Austerity budgets may be no solution, but neither is pump-priming.

Finance and Recovery

30 Jun

Tuesday I mentioned the difficulties of re-regulation given the strength of the financial class. In fact, the problem is considerably wider than just a matter of being able to get the right regulations in place. It is also a matter of what we think a recovery is, who benefits from the recovery, and who does not. The mainstream conception of what counts as recovery is determined by financial markets – rising stocks supposedly float all boats. Resistance to this way of thinking is beginning to seep into mainstream discussions, with liberals like Krugman noting that the recovery is largely for the people at the top. A recent graph, found at naked capitalism, points out that, at the bottom, things are slow to improve.

The jobless recovery, of course, has been part of the news, but few have bothered to connect this joblessness to the financial character of the bubble, not to mention the ‘recovery’ itself. Doug Henwood is one of the few to point out the connection between the two as general feature of financial bubbles.

The implication of Henwood’s analysis, and the steady stream of facts supporting it, is not just that somehow financial interests have managed to seize control of the state and economy and use it to their benefit – though they have managed to do a good deal of that. It is that the general model of growth and job creation, starting in the 1970s, is defunct. Cheap credit, debt-financed consumption, readily available mortgages, rising debt-income levels, alongside stagnant wages, rising inequality, and asset bubbles were at least some of the key features of this model. It was, significantly, not just a model of growth and job creation in the narrow economic sense, but a kind of tacit social compact. Post-war living standards would be maintained, not through high wages, public provision, and regulation of the economy, but through the instruments of the market – which effectively meant credit. This was sometimes called a ‘neoliberal’ model, though notably the concept neoliberalism rarely includes mention of the financialization of the economy. Whatever the name, it is that model of capitalism in general that would have to be replaced before any real recovery takes place – at least a recovery in which everyone recovers.

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