Umpteen reasons I am so uncertain about growth 

It is almost fifteen years since I first blogged about growth. My opinions have become more and more uncertain since the earliest “just boost demand already” days.  Since then I have contorted in all sorts of ways. Here are some barely connected thoughts. 

Having opinions on growth is a little bizarre. The more I have read and thought about GDP, the more uncertain and sceptical I have become. Uncertain, because it is easy to find paradoxes, contradictions, arbitrary judgments of definition; sceptical, because with such a slippery concept it is plain bizarre that anyone normal might have a strong opinion about it. You don’t see GDP, it is numbers in a spreadsheet.  So when people profess a strong view about its trend, my first reaction is often “really? How?”. You don’t have an opinion, you just think you have. How can you have a clear view on whether the UK’s potential ability to combine future labour, capital and technology into additional economic product will grow at 1.5% or 2.5% in ten years’ time? 

This must sound like a cop-out, or worse: an introduction to yet another of those tedious diatribes about there being more to life than money, growth and GDP.  So onto some of the things I find weird. 

Shifting relative prices through time There are wildly different trajectories for the productivity of different activities through time.  Being a concert pianist, waiter or hairdresser is not much more efficient now than in 1900. The ability to discover information, light a dark room, watch a drama or communicate across a continent has increased exponentially. Shifting relative prices tie these things together, and fix what we see as the actual value of what is produced. So the price index for casting a lumen of light has collapsed exponentially; even since the millennium, some deflator for IT-sector output has been cut by 90%. 

I find this marvellous and unsettling at the same time. Depending on how you choose to fix value, you can paint a fantastical and almost entirely useless picture of continuing massive growth. Just value an Internet search at the pre-Internet cost of learning something, or an email at the cost of sending a letter. 

Bargaining power is good and bad. A key consequence of these shifting relative prices is how professions that see no persistent tendency to become more productive (say, a high-class lawyer) nevertheless gets to partake in economic growth, the result of productivity gains elsewhere. (see William Baumol’s cost disease).  But not everyone does to the same extent, whichis often a reflection of bargaining power. The top lawyer, banker or lobbyist somehow keeps up, the miner or social care worker does not. I am forever tickled by this insight in Ryan Avent’s book about human scarcity (or otherwise): better to be in a low productivity business proximate to high economic demand and with some protective walls around you. The artisanal cheesemaker theory of prosperity. 

Lots of innovative/investment effort goes into enhancing bargaining power, not productivity. The branding genius who finds a way to make teenagers love the same mass-produced sneaker for a higher price. The investment in high-rent offices to telegraph prestige to your clients.  The first lesson in MBA school is Michael Porter’s Five Forces: fight off the threat from substitutes, new entrants, existing competitors, suppliers, customers. Invest in protective walls so you can keep a profit.  It captures the tension that drives the economy forward. But GDP is often higher when the monopolists are winning! Being able to charge a lot more for a product than you put in is value-added. In contrast, really successful innovation can have a first-order effect of lowering GDP. If an activity such as maintaining a bank’s leger once needed 1000 sweating clerks, and now requires a simple software programme, the effect might be a smaller direct GDP footprint.

Market size matters for potential GDP, do we discuss it enough? The gap between US and UK productivity is longstanding and much commented upon. There are plenty of reasons for it. The most convincing I know is the size of the US market, which brings home a really important factor for productivity – operational gearing. Finding a bigger market for the same fixed asset base is the simplest way to get more bang for your buck. Hence also the magic of export-led growth, and one of countless reasons to be pro free-trade. I think this is under-emphasised in the “People, Capital, Ideas” schema that Sunak pushed, a good expression of the orthodoxy. 

Productivity growth was more reliably strong when manufacturing was pre-eminent. At first this feels odd. Physical activities have real resource limits that you don’t see in more intangible services. It takes ten times more steel to make ten cars than one. Assisting in the sale of 10 houses should not take ten times as many estate agents. But the highpoint of (Western) growth coincided with the highpoint of manufacturing, and I can think of good reasons why.  Physical processes are amenable to constant improvement. Innovations like electricity, computerisation, containerisation, the assembly line, just-in-inventory management all have a long way to go. Tradable goods are very hard to hide from competition, the great driving force. So there is reason to think that the grand shift from manufacturing being 30% of the economy to 10% (and future 5%) must have consequences.

Hence a nagging feeling that the shift to a more intangible economy is not good for GDP growth. The excellent book of Westlake and Haskell deserves a much fuller appraisal than this one point. My hazy concern: intangible investment is less spillover-rich and therefore less growth-rich than one might imagine. It isn’t all inventing Google (which obviously the authors explain). Often it is about company’s own private productivity enhancements, or reputation or brand, and I don’t see it spreading all over the economy like, say, a new invention. On the input side, I can easily picture intangible capital as a fast-depreciating asset. Consider the trillions that the the financial sector must spend software just to keep the wheels turning. It is also subject to cost disease – intangible investment is human-heavy. All unquantified thoughts, but they mean I see no contradiction between “growth in productivity may be slowing” and “we are heading into a more and more intangible economy”. 

Another wrinkle that bugs me: how should we think about the concept of (what I call) fake GDP? What is the right approach to value, for example, all the incomes that were generated in the ecosystem around a busted cryptocurrency? It now turns out it was just a few thousand fools throwing real or fake money at one another, consulting, meeting, emailing, writing software, and now it is all bust. Was it real GDP at the time, and now not? Never real in the first place?

I wonder how much of the economic activity that led up to 2007-8 should be revisited as “not actually GDP”, and whether our growth trends before 2007 were not sustainable – but how? It wasn’t shown through inflation …

And what about demand? For about 10 years I felt that the slow pace of demand growth had caused low productivity. See the point about operational gearing: underemployed resources are less productive. Now we are seeing an inflationary episode, does that mean I was wrong? Or should we be MORE optimistic now, knowing that every productivity gain will free up labour resources that the economy is more likely to need?

GDP/consumer surplus is not as fungible as being a single figure in a spreadsheet implies. Think about the challenge of elderly care. Care homes are incredibly expensive: property costs plus labour costs in a risky environment. I may once have felt good about the prospects for technology to improve this radically: the aged relative surrounded by iPads, remote delivery of services, constant connection. Now I’m aware of how irreplaceable are the services of younger people. Technological advance in one part of the economy doesn’t just translate into higher welfare in another part. Cheaper video streaming doesn’t solve loneliness or the need for physical nursing. What you need is a political means by which the surplus production is transferred from advancing to stagnant sectors.

Any longer-term growth pessimism I have, in summary, is fuelled by concern about how a more services-heavy, aged, environmentally-challenged world can use innovation to address its problems, when innovation is often geared towards #rent-seeking, the provision of low- or zero-marginal goods, meaningless growth in consumer surplus, and not the really hard constraints in energy, the environment and human services. But since the UK is not at the frontier, this is only partially relevant – we can surely do better.  And I have a very crude thought on prospects for that, to which I now turn. 

So what can public policy do? Escaping the average is hard

A friend told me that a prominent former Cabinet minister read my blog about why you can’t just “unleash growth” and liked it. It made me think, however, about  how I would respond if this statesman asked me for actual positive ideas, and whether I am just in the “too hard” camp. Well, this is what I think:

  • There are good ideas that can increase potential GDP. Every government should be trying to promote them, and fight the opposite sort. If you want a representative list of the sort of buffet from which future Growth Ministers might graze, take this lovely blog* post from Tom Westgarth and Andrew Bennett (hat tip, Stian Westlake
  • If (straw man?) anyone is suggesting such a list can get us to 2.5/3.0% growth then my questions would be about baseline and about scale.  

In terms of scale, I made this point in the earlier blog, and will again in a business investment piece. Do not underestimate the vast stock of what is already there, and the relatively small flow of what you are adding. If you increase government investment by a massive £20bn, that is still very small compared to the £4.6trn of existing UK capital.  If you do something truly wondrous about skills, remember that there are 30m+ workers, most of them out of the education system. It is an oil-tanker. 

In terms of baseline, let me try to put it figuratively. Suppose the pessimistic view is the OBR’s – that we are heading for 1.5% annual GDP/head growth. And then the optimist comes along with his growth-boosty things.   This is how I imagine an optimist seeing it:

“You thought growth was stuck at 1.5 – but what if we carried through my good ideas of building more houses, boosting R&D and something or other with data? NOW what do you think?”. 

And my response is: don’t you think any good ideas were in the baseline that got us to 1.5? 1.5 is a pretty good growth rate by historical standards, and will have included a lot of policy improvement. It is a lot higher than we have recently enjoyed, despite this being the era of the Smartphone and the Internet – two wondrous general purpose technologies. Do we know what the OBR assumes the government will do for the next 20 years – is it assuming no good policy whatsoever? Maybe it doesn’t have all your ideas (maybe they aren’t all good) – but maybe a lot of other ones.

Keeping it figurative, this is how I instead picture the job of the embattled, pro-growth policymaker in government, thinking about the ideas coming along: 

Even this is idealistic. The ideas do not sit independently (so you cut taxes, but have to cut investment too, making it a wash). And they are not neat dots, but smeary puddles. Your idea to create a giant investment bank? It might help things, it could badly mess them up! 

The point I am laboriously making: you think it is a game of pushing two or three big Pro Growth policies, and maybe fending off a few bad ones? I wish! Politics isn’t pro- or anti-growth, that is way too simple (though read Duncan on this). Politics is above all hectically busy. It is busy doing hundreds of things that are pro- or anti-growth, and you need a tireless machine to be fighting the bad ones, pushing the good ones (this is why you need the Treasury. They stop bad stuff!) But there are many, many bad ideas, and your good ones each require effort. On average,  if you left the politicians alone, they will do bad things. And so, in the end, like any game of multiple dice throws, you need to be very lucky to do much more than hit the middle of the bell curve. 

The average. It is a tyranny. 

*I am not endorsing all of these blog ideas. They feel like they are scattered across my bell curve, entirely uncosted (as the authors acknowledge) and in many cases require the kind of statist intervention that just isn’t executed well. Am particularly amazed at the call to plonk so much mass transit everywhere. But it is a good buffett

Unseriousness did not start with Johnson

One of the legacies of the soon-to-be-former prime minister (STBFPM) is a somewhat scrambling of the political spectrum.  As Ian Mulheirn observes, the fiscal approach he precariously allowed is far from right-wing, at least neutering the standard Labour attack on under-funded public services.  Remember, he supported higher taxes to pay for more money for the NHS and social care. But his was also a government proud of an appalling deportation policy, clumsily picking culture war fights, and damagingly nationalistic in trade policy.

Hence I found myself drawn to a different political line: that of seriousness. This might stand for a certain principled consistency on policy matters – are you liberal about immigration or not? Do you support action on climate change, or do you think wind turbines couldn’t knock the skin off a rice pudding? Which oped really represents your view on the EU? But it is also a style of governing. Talk to enough people about what it is like to work with a politician, and you can pick up indications, such as “he is interested in what actually works”, or “she read her box meticulously”. (You may be rightly appalled that this is such a distinguishing mark).

Very few politicians are judged on whether what they caused to happen made things better – they don’t hang around long enough, and the case is usually disputed.  But some act as if they will be so judged.  Many others appear to judge policy by the sound it makes coming out of their mouths (“policy by mouth-feel”): whether it gets them through parliamentary questions or gives them a good rebuttal line. Another sign is when they are known to go with whoever last spoke to them. Then there are those too quickly convinced of a position who love the sense of being decisive that accompanies an impatient refusal to dive into the policy detail.  I see this as a sort of intellectual nihilism – “oh, this is hopelessly complicated and no one really knows the right answer, so let’s just back whatever horse sounds plausible”.  

Maybe some of this is knowingly cynical – we may not know the right policy, but neither does anyone else and no one can pin it on us.  This contains a barely hidden disdain for the entire policymaking function. “These wonks, they make everything too complicated when the answer is really obvious.  It just needs me, the Decisive Politician, to ride in and Get On With It”.  I may have labelled this the Paradox of Nuance.   You will have your own favourite example (“Just cut the civil service by 20%/Build More Houses/Double R&D and spread it around/Invest to Boost the Economy/End Short-Termism by making Buybacks Illegal/Set up a giant investment bank/etc etc”)

The past three years have seen a mishmash of all these flavours of unseriousness.  Setting out rules for a pandemic and then not following them with sedulous care deserves mention for being the one that finally cut through to the public. But Brexit was the gold standard, the ultimate example of a policy where the details were meant to follow. Don’t we just want control of our borders, laws and money? I would also include Levelling Up; a worthy objective and now dressed up with a White Paper stuffed with theory – but it was launched without a definition, a methodology or even much of a budget. Then there was the disrespect for institutional constraints, and the tunnels, bridges, yachts and other monuments.

While the departure of the STBFPM may finally mark the ebbing of this tide of unseriousness, his arrival did not start its flow.  In 2011 the Cameron-led coalition government (in which I was a spad) thought a smart growth policy towards Europe was to produce a short pamphlet called “Let’s Choose Growth” and hand it around. Seriously. I remember sitting in the room where my boss, Vince Cable, somewhat shamefacedly handed a copy to a bemused looking Michel Barnier. Europe was about to wrestle with the existential dilemmas of a single currency unbacked by a fiscal union, and he was having to look at a PDF full of exclamation marks. The same Downing Street thought the way to encourage more socially conscious behaviour in the corporate world was … by putting another PDF called “Every Business Commits” on the chairs at some Business in the Community event. “We cut your taxes, now you must Improve Skills and Create Jobs.  Also do more car sharing”.  In similar vein, there was a bizarre suggestion to scrap most business support and replace it with a new organisation called Start Up Britain – no doubt worthy enough, but all business support?

OK, OK, I know: this reflects one particular maverick whose shenanigans I was forced to write about in 2015. The spasms above were mostly annoying but nothing more – usually someone could stop them. Pity the single official whose job was to ‘do’ Every Business Commits. But there were so many other examples. The attempt to change employment rules with a review led by a single, party donor businessman (detailed at more length in this IFG pamphlet).  The hasty and politically charged decision to scrap the Audit Commission. Getting rid of the RDAs and Government Offices in the Regions, before we had even asked what would take their place in case, you know, serious economic disruptions took place in the Regions.  In fact, the whole attitude towards austerity was shot through with an unserious, details-to-follow approach.  The timetable itself, I was told, was determined by the simple rule that it should be done with a year to go before the next election. The departmental pain allocations – 0%, 10%, 20% or even more – were determined in a way that seemed ultimately unserious. No sense of what each spending function needed, just crude headline numbers that had to be made to work.  Want to stop further education being cut to zero? You had better raise tuition fees on HE.  The whole method by which spending for unprotected departments was determined was mad, and led to the Conservatives publishing headline fiscal plans that just literally couldn’t work (see my workings here).  Going into the 2015 election, the Bagehot columnist called Cameron’s approach “wilfully slapdash”.

I only really experienced the last 12 years of government. I don’t know if things were better under Labour. I do vaguely remember stupid moments, such as “British Jobs for British Workers”. But even in their wrong decisions they appeared serious, an impression reinforced by those of their advisers I have met. One of my first wonk experiences: in 2008 I helped to staff a seminar intended to update “Options for Britain”, a book written in the 1990s that was highly influential for the incoming Labour government. My main memory of it is how dense and worthy and serious it was. Boring, even. The way politics should be.

So let us hope the tide is beginning to ebb.  But the way so many of the candidates to be our actual Prime Minister have launched with a vow to cut taxes, without any explanation for how to fill the gaps, is not encouraging.  The STBFPM may have looked at his school rival and predecessor and assumed that winging it is fine. I hope his successor isn’t of the same mind.

 

I don’t think John Major was more unpopular than Johnson

So I saw this tweet from the esteemed John Rentoul

and thought it worth pushing back a little. I remember the mid 1990s very well; they were a formative time for me politically, as I voted Conservative in 1992 and New Labour in 1997, I felt part of a very big movement indeed.

(obviously watch the event too)

And what I strongly remember was that while there was a gigantic movement against the Conservatives, politically, Major himself was generally regarded as OK. Much mocked, seen as weak, sure – but always seen as personally alright. But we are often reminded that even though Johnson has now hit a nadir (so far) of Minus 46, this is not as bad as Major reached.

What does the data say? Ipsos Mori has net approval data going waaay back that allows us to put this in context. First, let us look at the raw polling data for that time, and it is spectacular.

For years, pollsters had the Labour party consistently on OVER FIFTY, and the Tories regularly struggling to break 30. Now, we all know that the 1992 polls had badly exaggerated Labour’s chances, and people talked a lot of Shy Tories, so Conservatives felt they still had a chance. But these were spectacular leads, all the time. And they were reflected in the Government and Prime Minister approval ratings. In June 1993, 10% of respondents approved, and 84% disapproved, of the Government’s performance. The figures for Major himself were 19 and 74, so minus 55 (I think he hit a personal nadir just after Blair got to power, at minus 59).

But the government was consistently less popular than he was, on this measure. And although that is a normal pattern, Major’s popularity relative to his government’s was pretty good. Let’s see how he looks, compared to Cameron and then Johnson. All on one chart:

Dotted lines are the governments, solid lines the PMs. For true blue Major, there was always a pretty large gap. So, too, for Cameron most of the time. For Johnson, he enjoyed a giant gap at the beginning, when everyone appeared to hate the government but had hopes for the new guy …. but that appears to have disappeared by June 2020. And since then, the two have moved in lockstep.

Here, finally, is a slightly geekier way of seeing it. Taking the Tory lead over Labour on the horizontal, and PM net approval on the vertical, you can see that Johnson appears to have broken a recent pattern for the Conservatives of having more popular leaders than they are as a party. The big red triangle is the last reading.

I am not an expert like Rob Ford, Matthew Goodwin, Will Jennings et al, so I don’t know how enduring the switch of working class voters to the Conservatives is. And I don’t know what we can learn about how a leader taints a party from this. The worry for Conservatives is that rather than Johnson catching up with their (relative!) popularity as a party, the party catches up with his relative unpopularity instead …

My view? John Major was not more unpopular than Johnson. The only times he scored lower, the pollsters would have been hitting the same sampling errors that put Labour on 55-60% for voting intention. His party was off the scale unpopular, and that tainted him.

Lord Frost, and whether/how lower trade makes us poorer

I am very far from being any kind of an expert in trade. My policy is to rely on comparative advantage; spend less time on it and rely on others to do the work, more efficiently.  My familiarity with the topic goes only as far as some of the obvious signposts: apart from Ricardo’s comparative advantage, a knowledge that geography matters (double the distance, half the trade, or something), some vague awareness of what Paul Krugman showed (a combination of agglomeration and economies of scale lead to a lot more international trade than you’d expect from pure CA) – and whatever I can pick up reading Trade Secrets by Alan Beattie et al, and rubbing shoulders with the experts at the FIG.

I ought to know more – as someone who has banged the drum for a closer trading relationship with Europe, and tends to agree that friction will cause productivity problems. As a lazy gotcha polemicist, I have tended to quote Nigel Lawson on the advantages of being in the Common Market – increased competition in a larger market forces business to “wake up or go under”.  I have also relied on the OBR, which has documented the fall in trade post EU and (Box 2.5) says “this reduction in trade intensity drives the 4 per cent reduction in long-run potential productivity we assume will eventually result from our departure from the EU”.

Anyway, I had parked this in the “issue settled” box, till I read Oliver Lewis’s encomium to Lord Frost on ConHome and his recommendation that we all read Frost’s speech of February this year, which he said should be “a key source for future historians of this period” – which seems reasonable. Frost is a significant figure, this is what he thought, and he sets it out quite seriously.  And, talking of Brexit studies that foresee a fall in productivity from less trade, it has this bit:

But, in brief, all these studies exaggerate – in my view – the impact of non-tariff barriers they exaggerate customs costs, in some cases by orders of magnitude. Even more importantly, they also assume that this unproven decline in trade will have implausible large effects on Britain’s productivity. Yet there is at least as much evidence that the relationship is the other way around – that it is actually productivity which drives trade. The claims that trade drives productivity are often in fact based on the very specific experience of emerging countries opening up to world markets, beginning to trade on global terms after a period of authoritarian or communist government – these are transitions that involve a huge improvement in the institutional framework and which make big productivity improvements almost inevitable. And I think the relevance of such experiences drawn from that for the UK, a high-income economy which has been extremely open for over a century, seems highly limited to me.

So I thought I would try to trace back why the OBR feels so confident asserting the opposite.  Starting with the most recent EFO, we have that quote above, which is preceded by the statement that “Since our first post-EU referendum EFO in November 2016, our forecasts have assumed that total UK imports and exports will eventually both be 15 per cent lower than had we stayed in the EU”.  But dive back to November 2016, and this is what the OBR said:

exiting the EU will reduce growth in exports and imports during the transition to a less trade-intensive economy. We have not modelled the effect of specific post-exit trading regimes, but have instead drawn on a range of external studies to calibrate a downward adjustment to exports and imports that we assume would be complete by 2025. We have assumed that exports and imports are similarly affected, so that the effect on net trade and GDP growth is broadly neutral. We have not revised trend productivity growth lower explicitly to reflect lower trade intensity (as the Treasury did in its pre-referendum analysis) given the lack of certainty around this link

My italics.  So they (correctly) foresaw lower trade, but did not back then use this as the reason to lower productivity, and see the link between trade and lower productivity as less well understood. Instead, they lower their estimates for productivity growth because of the sharp drop in business investment (see this much-noted tweet).

Eighteen months later, they addressed this question in a standalone piece – which, while mentioning many of the common sense reasons openness leads to productivity gains (less competitive pressure, less knowledge transfer) actually foreshadows some of Frost’s caveats.  Studies that link increasing trade to increasing productivity have seldom covered Brexit-like moments where trade is actually reduced, leading to this arch observation: “one of the ways in which increased openness is thought to increase productivity is through knowledge spillovers, but reducing openness by introducing trade frictions should not lead businesses to forget what they already know”.

Yet, by November 2020, discussing the risk of last year’s no deal scenario (there have been so many), the OBR writes

a ‘no deal’ Brexit could reduce real GDP by a further 2 per cent in 2021, due to various temporary disruptions to cross-border trade and the knock-on impacts. As these abate, the longer-term effects of lower trade intensity continue to build such that output is 1.5 per cent lower than our central forecast after five years, and 2 per cent lower in the long run

With a trade deal in the bag, the next (March 2021 EFO) keeps with its cut to productivity growth, but now pins it more specifically on services

the introduction of non-tariff barriers in services, which accounted for 42 per cent of the UK’s exports to the EU in 2019, is far more significant. It is this channel that accounts for much of the long-term reduction in productivity, in line with the findings of some of the studies that informed our previous assessment

I looked for the studies, and found this by the World Bank – which looks like an excellent paper, but is largely concerned with (what looks like quite correct) predictions about the fall in trade because of Brexit.  For the links between that falling trade and productivity/living standards, I had to look in ITS footnotes, and found this: “Dhingra, Swati, Gianmarco I. P. Ottaviano, Thomas Sampson and John Van Reenen. 2016. “The Consequences of Brexit for UK Trade and Living Standards” – which states the effect very baldly – “In the long run, reduced trade lowers productivity” – and lists familiar effects (reduced competition, smaller size of markets, less incentive to innovate).  It is another excellent paper.

But here I find myself at a dead end.  The Dhingra et al paper is pre-referendum, essentially, and the OBR immediately after the referendum decided not to count these dynamic effects. I am not sure why they didn’t, nor do I understand why now they do, in light of that earlier acknowledgement that the discussion is much less settled than in other areas. 

In the meantime, Lord Frost has stated the Brexiteer position quite baldly: paraphrasing, “We don’t think reduced trade with the EU does in fact hurt our productivity, and all the evidence out there in the real world is in fact about different scenarios to this”.  The second bit may well be right – no other country has ever done anything like Brexit.

So I end this with a plea. I tend to think the connection between damaged trading links with the EU and lower productivity should be pretty strong.  We have lower trade, less investment since the vote, and we have had poorer GDP outcomes. It is all very suggestive. But Lord Frost captured the blithe, Brexiteer contrary view well: this stuff is all for other economies, other situations (and fails to capture the benefits of our new, free-wheeling nature).  Does anyone have any more up-to-date and definitive study that I can look to?[1]              


[1] Since starting this, I found this paper https://www.wto.org/english/res_e/reser_e/gtdw_e/wkshop18_e/manova_e.pdf which finds that “exogenous shocks to both export demand and import competition generate large gains in aggregate productivity. Decomposing these gains, we that both trade activities increase average productivity, but export expansion also reallocates activity towards more productive, while import penetration acts in reverse” – but I am otherwise impressed by how little strong evidence there is out there.

We can also see that businesses that trade are more productive – https://www.ons.gov.uk/economy/economicoutputandproductivity/productivitymeasures/articles/uktradeingoodsandproductivitynewfindings/2018-07-06 – but selection effect?

No, the Chancellor cannot just ‘unleash growth’

but it’s work enough just to avoid causing damage

In the wake of the recent Budget, I was asked the impossible question: what does this mean for UK growth? Has the Chancellor unveiled something that will boost Britain’s economic prospects?

Impossible, and quite reasonable. The question is the counterpart to the demand you see commentators make of Chancellors every Budget: where is his big plan for growth? How can the economy be expected to do all that growing if the man in charge doesn’t have a plan for it? I can provide loads of examples, but the absolute classic comes from The Economist in March 2013 (“A little faster, George?”) which said

Government borrowing costs are still low, because investors trust Mr Osborne, but Britain was downgraded because of worries about medium-term growth. Where can he find some?

Note the implication: he has to find some. Growth is a thing Chancellors look for and somehow devise in the small hours, with dedicated officials in the Treasury. Maybe they are helped by wise advisers at The Economist: the edition was stuffed with good ideas like a new NGDP remit for the Bank of England, and that hardy perennial, Do More Infrastructure. But the funny thing is the growth just happened anyway – as the ink was drying on the editorial, things started motoring a bit for the UK economy.

Chart 1: monthly growth 2008-2019

I was as highly amused by the editorial as they were irritated in the Treasury. But there was sense to it: we were coming out of a deep demand-side recession, and there was an urgent need to see businesses and consumers spending again.[1] GDP figures made us think we were in an actual recession in 2012 (they were later revised up, steeply). Ed Balls kept doing that “flat-lining” gesture, and the Guardian even unveiled a Triple Dip-Diplodocus cartoon.

Within days of the editorial, growth just returned. Maybe Funding for Lending did it. Maybe it was Mario Draghi bringing an end to the Euro crisis. Just as likely it was always going to happen.  The UK had a normal growth speed – about 2.0-2.5% per year – and absent horrible things happening, its economy was going to grow like that – adding workers to the workforce, capital to the workers, just trundling upwards.  

The Coalition period marked a high point for public arguments about how politicians ‘produce growth’, because of that demand-side slowdown and genuine differences about whether fiscal policy was to blame.  With demand-side arguments, you can expect to see the results quite quickly – within a couple of years, and certainly before the next election.  But – my first point – often these arguments labour under a delusion of control.  Most things happen regardless of any immediate action of the government. The media narrative demands that we assume agency for the state, and at some critical times that assumption is absolutely right – the failure to stop the vertiginous drop in NGDP growth in 2008, say, or Trichet’s disastrous tightening of policy in 2011.  But often stuff just happens.

Since ceding macro control to the Bank, the regular calls to “unleash growth” have generally meant supply-side measures: steps to improve our long-term potential. Which, until recently, is a very dull and unshifting variable. Here is another chart, this time taking the OBR’s Historical Forecast database and showing what the government’s average forecast of medium-term GDP growth has been since the 1980s.[2]

Chart 2: evolving average growth forecasts

It is easy to be drawn to the stories told by the wiggles in the line. There is the rapid drop from March 2008, as we went from assuming 2009 would be a 2.5% Up Year to learning it was a 5% Down Year. There is also that steadier subsidence upon the arrival of the Coalition in 2010, which saw the OBR replace years of predicted 3.5% bounce-back growth with something lower, which then got lowered again through all those demand-side hits (austerity, Greece, etc).

But on the supply side, what this chart shows me is a picture of stability – until recently. Once through any demand-side squall, until 2015 policymakers always foresaw years in that 2.0-2.5% range. This was regardless of whatever the government could announce, such as a giant programme like Funding for Lending, the rebirth of industrial strategy in 2012, a massive subsidy like Help to Buy, a big expansion of higher education, or a gazillion smaller ideas.

This brings me to my next point: it is very hard to shift that long-term supply-side picture. As I explain in my recent IFG blog, the OBR just never does it in response to Budget announcements. A priori, they are absolutely right to be so conservative.  In spending terms any Budget announcement is a shift of some small number of billions between the columns marked tax, spending and borrowing, or within categories of these. These shifts may be wise or foolish.  On average, they will be something in the middle. The economy, meanwhile, is a creature of £2,100bn in gross value added, over £10,000bn in wealth, vastly more in terms of actual transactions, sitting in a mesh of interlocking, intra- and inter-national exposures, determined by millions of different incomes, business plans, markets and prices.  Why should a 90-minute speech fiddling with small change divert it from its path?

At the macro level, what the Chancellor announces is usually a rounding error, and already factored in Bank of England calculations. Supply-wise, to change your mind on what the economy can produce, you need to change radically your assessment of some gigantic things: the stock of trillions in capital investment; the number and skill level of 31 million actual workers, or our scientific capability, a thing of accumulated quality generated from decades of investment, learning, international interaction and toil within universities, businesses and institutes.[3] 

Maybe you think you can transform the institutions, tax rates and ownership structure of a big chunk of the UK economy, like Margaret Thatcher did over a decade. Marginal income taxes dropping from 80 to 40%, massive utilities privatised, the Single Market created … and yet what can you see in the growth figures? If you are generous, perhaps a rise of half a percent or so, boosted by a clearly out-of-control boom in the late 1980s. 

Chart 3: UK growth outturns over 70 years

And if you are not so generous, and look through the cycle, and the result is flat:

Chart 4: UK growth outturns, 30 years

So what is my assessment for what any Budget does for our growth prospects? Absolutely nothing, of course! Hence my predictable irritation every time I read some tweet, column or think tank report demanding that the Chancellor do XXXX in order to Unleash Growth.  No, he can’t. That option is just not on the table.  Tot up the full impact of what you are proposing, O Think Tanker, and honestly I will challenge you if you think it is 0.1%.

Which is why I find the right-hand side of Chart 2 so deeply dispiriting, still – and the insouciance with which the Government sets aside concerns about the damage caused by the choice of too harsh an exit from the EU.  Up until 2016, all the big shifts in Chart 2 were caused by a big recession that then blew through – leaving significant scars, for sure, but not altering the OBR’s assessment that the UK can grow at 2.0%+ in the medium term.  And these courses were not chosen. Then over 2016-18, the OBR cut annual growth estimates by almost a full percentage point – more than all the positive growth story that the Thatcherites can lay claim to – and twice the effect of that pandemic. This is a big deal, and conscious policy!

Maybe, if you are an optimist, you hope that the OBR has got it badly wrong. More realistically, maybe you agree with Professor Vollrath that the long term trends are all very much downward anyway, and our choice of a much harsher relationship with Europe is a coincidental accompaniment. But even if you are sympathetic to that point, bear in mind that his excellent book is largely about the frontier economy, the United States, and there is no cast iron rule that the UK should be wilfully falling further behind it.

This brings me to my last point. Clearly, I don’t believe Chancellors can just announce extra growth, long term. I also think many of the short term fluctuations that determine whether they have a good Budget day are out of their control. But this is NOT a call for policy nihilism.  Good policy clearly matters! What I have learned is that governments of a developed country have to maintain excellent economic policy just to keep growth on track.  And, for anyone who thinks it can’t get worse, there is a one word answer: Italy.  Mess up your institutions enough, and there is a very long way you can fall. One last chart:

Chart 5: long term growth figures for France, UK and Italy


[1] Park, for now, the question of how much this austerity plan had caused the growth problem. Looking at the graph, it is clear that growth did fall from 2010, and the fierce noises and VAT rises emanating from HMT may have played a small part. But the economy also faced a rapidly slowing EU economy, a crisis that was not resolved till late 2012; the US debt-ceiling shenanigans; and oil prices ramping up after the Arab Spring.

[2] Compiled by the OBR, but only OBR forecasts from 2010. Generally including 5-6 years. Important not to take too seriously the gyrations in the early 1990s – largely determined by the removal of the bad years (1991, 1992) as the forecast moves forward.  Much of that recession was almost entirely revised away in the figures, amazingly

[3] Hence my somewhat scepticism when Stian reacted so forcefully to the downshift in R&D spend

Britain is trying to shrink its way to prosperity. It doesn’t work.

You may not realise it, but those empty shelves, the unfuelled car of Kirstie Allsopp, and thousands of pointlessly culled pigs all mark the “birth pangs of a new economic model.” Get over it, we are heading to prosperity, this is what it looks like.  

Prosperity, here we come!

The gist of the idea is simple, and much-rehearsed in various protectionist quarters. Britain has in the past “reached for the same old lever of uncontrolled immigration to keep wages low”.[1]  Instead we should control immigration, and as a result business will invest in people, skills and capital and so make native Britons richer and better paid.

It sounds simple. In its crudest form, it even sounds like it has some economics to it! “Basic supply and demand, duh” as some on Twitter claim: fewer people, more prosperity per person! All these years, we could have been fixing productivity simply by cutting the supply of workers! While we are at it, why not a French-style shorter working week, and insist that everyone retires at 60?

There are any number of ways of attacking this. Most don’t work politically, even if they are perfectly valid. Here are a few:

  • I thought you were free traders, but this is protectionism. This charge has been thrown at some on the right for a while (US Republicans, anyone?), and it never sticks.[2]  Free trade in goods and capital, fine. People, no, yuk. Politics gives few marks for ideological consistency
  • What is with the sudden urge to protect workers’ rights? I really get this. I spent a lot of time in Government (2010-14) fighting a Conservative attempt to water down rights, called the Beecroft Report; read my Spad’s Eye View here. But Conservatives reversed course on this as long ago as 2016, with support for the Taylor Report instead. And remember the point above about ideological consistency.
  • Since when did Conservatives fight for the Producer Interest over the Consumer? All these ministers so pleased with lorry drivers’ wages going up, and customers suffering the higher prices and worse service – it is quite the reverse of what Margaret Thatcher fought for.  It’s a version of favouring the more visible over invisible interests (see p19)

But the one that I really believe, which Danny Finkelstein alludes to here, is this:

  • You can’t make people prosperous when shrinking the pie. I remember the arguments as a schoolboy in the 1980s. Labour lefties just wanted to redistribute, give a bigger slice to the people they thought deserving (back then, union-members). Tories instead wanted to grow the whole pie, and see everyone get a larger slice.  

Let’s not argue about whether Thatcher succeeded, but simply marvel at the transformation wrought by 30 years. Thatcherites would applaud companies that sought markets and suppliers far and wide, and fought to provide them that right. Now, to search for the best person for a job is “taking the easy way out”.

To illustrate how wrong headed I think this may be, consider this caricature.  Two managers, Maynard and Mellon, are charged with raising the productivity of their respective company divisions. 

They take a very different approach. Maynard devises a strategy based upon growing production, using all and any inputs to get there.   He cuts prices to chase sales, introduces incentive schemes to encourage work, funds research into new products and sends staff onto red-eye flights to find new markets. It works, and soon the place is buzzing – demand pressing against supply. He also needs to hire a lot more – some locally, but a lot from all around – which frees up staff to work on growing sales. Pay rises.

Mellon takes a lazier and more negative tack. He looks around cuts, and soon orders a hiring freeze, cancels use of the outsourced caterer – people can make their own sandwiches! – and culls the list of approved suppliers, removing anyone further than 50 miles away. He also lets prices rise a bit.

In the short term, Mellon succeeds. Demand again bumps against the now-diminished supply. The staff that remain, disgruntled at the loss of perks, face less competition from outsiders and so feel they can demand more. But in the years afterwards, things go wrong. With less choice of suppliers, quality suffers, new markets are harder to find. Staff are also wasting time on work they used to pay someone else to do.  Soon, Mellon finds himself forced to choose between a pay freeze and redundancies.

You get the picture. The expansive Maynard is like a fast-growing Asian economy in their miracle growth years – find new markets, capture share with cost efficiency, expand, innovate, expand more! In this way Korea and Japan catapulted themselves from poverty to modernity in a few decades.  Mellon’s way is closer to the protectionist, special-interest-captured, import-substitution model, as followed by Argentina – which sagged from the richest country on earth to a continuous crisis soap opera.  It is also the sort of economy I picture when I hear that cutting overseas supply is the path to prosperity.  

Is it a fair analogy? Perhaps defenders of the government line would argue that I should portray Mellon as encouraging his staff to train up more and become more productive. Taking away the easy option of other sources of supply provides that incentive. Is that reasonable?

I don’t think so, because I still share the market-oriented outlook the Conservatives used to have. When pro-EC Tories like Nigel Lawson called for entry in the 1960s, they welcomed what Lawson called “the cold douche of competition”.  Protecting British companies and workers had not worked. Incentives needed to change. The best source comes from competition on all sides: the Five Forces of Michael Porter: new entrants, suppliers with bargaining power, industry competitors, substitute products, empowered customers.  It was a call for more – more markets, more competition, more variety.

More is better than less. I find myself having to repeat a view so basic it is hard to articulate. Supply is good! What the “shortages to prosperity” crew ignore is the basic value of what is being supplied.  Cut the supply of overseas nurses, and what you definitely experience is … less nursing! Forcibly remove choice from the market, and you end up with less supply. The set of possibilities when you are allowed options A to Z is simply greater than when you arbitrarily take out letters J to V. Your horizons contract.

All this is before you consider the other advantages provided by variety and choice: innovation-by-emulation, the exploitation of economies of scale, all of that.  Every time I go from a busy city (London) to one less busy (all of the rest), and whinge about the paucity of cafes, bars and shops, I am experiencing this.

The world has been suffering from a curtailment of supply on massive scale, everywhere and in all sorts of ways. The major vectors of it have been energy, semiconductors, shipping containers, and the right workers. No matter whether some special interests benefit, overall the effect is bad. It could end up posing the most difficult challenge for policymakers since Covid burst upon us. Not the least of this is the possibility of a major central bank mistake, tightening too soon or too late. (Either should scare the wits out of our Treasury, given the shortening effective maturity of our debt.) But even without monetary policy mistakes, supply shocks are the most fundamental economic problem there is. You Can’t Get The Stuff You Want. It is rationing, it is queues, it is making less and having less and everything being worse.

Britain is suffering this as badly as anyone, possibly worse. Brexit is not the sole impulse.  But it is the only major policy programme that apparently revels in curtailing supply! With goods markets bunged up, we in the UK face the risk of more import controls.  With industries everywhere hunting for the right staff, we are meant to welcome new barriers on free movement.  And now the government is justifying this by acting like there is a lump of economic prosperity, and the fewer people we let grab at it, the more prosperous each be. 

Meanwhile, subtle thinkers try to imagine ways in which curtailing supply just encourages an economy to find smarter and better ways to re-establish it.  Destroy all the coaches, and then people will invent cars!

I just don’t think that is how matters turn out. Maybe Tim Harford is right that sometimes great creative achievements come out of adversity, like Keith Jarrett producing marvels from a tinny keyboard. But it is a dodgy theory for entire economies. Cutting supply so that demand pushes up against it is not like running the economy hot. It means less of everything.   Poorly supplied places don’t become inventive and productive out of sheer necessity. Things become more inconvenient (see Julian Jessop in this clip). Businesses sometimes just go out of business. Rationing didn’t lead to an explosion in UK culinary quality post war[3]. Protecting our companies didn’t make them world leading and productive. English football didn’t soar in quality when banned from competing in the 1980s. Hermit kingdoms don’t create marvellous inventions.  Wakanda isn’t real. Korea absolutely destroyed Argentina, economically.

Britain doesn’t have a fixed lump of prosperity, a fat pie to share out to the deserving. Deliberately hobble its supply, and the markets it can serve overseas will shrink, and the services it can provide itself become less. It needs functioning markets and abundant, diverse supplies of labour and capital to keep growing.  Conservatives do really understand this. I know many who do. I can understand the political impulse to portray shortages as part of a clever plan. Their deeper instincts surely know better than to fall for it. Conservatives need to get behind the supply side once more.


[1] Quoting from the PM’s speech

[2] I even put this one to Vote Leave when they came to the FT: how do you campaign on protectionist slogans, but then do this Global Britain thing? Cameron’s problem, apparently.

[3] Elizabeth David bringing back ideas from Provence did that, I understand. 

Shortages are really not such a good thing

I am writing this because my liberal instincts appear to be in conflict.  But probably not. Let me explain.

First, I am a fan of running the economy hot, and think this can be good for productivity and helping the less well-off.  Second, I am pro-economics, and happen to think that means being in favour of actions that increase the supply capacity of the economy.  Third, I am pro-immigration, and see it as a subset of being pro-economics.  Immigration broadens the market, increases effective labour supply, and provides opportunities to all sides of the bargain.

The problem is that these can appear in conflict with each other. “Running the economy hot” is (in some eyes) synonymous with “operating above your short-term labour supply”. For some commentators, it follows that it is good to do this by interfering in the labour market to cut supply, such as putting limits on immigration. (It does not have to be immigration – rules that insist on absurd qualifications to operate in a particular profession, or social rules banning certain types from working, or default retirement rules – all would achieve the same hit to the supply side.)

I don’t think my fundamental views are in conflict, but first I thought it worth just expanding on them a little.  

  1. I like the idea that running the economy hot might lead to improvements in productivity. I pushed this somewhat coyly in my piece about sectors and productivity, published a month back.  It was hard not to see a suggestive link between higher levels of activity and productivity. On a year-by-year basis, the pattern is clear.  See the IT sector in the chart below.  Big up-years like 1999 saw massive increases in productivity. The top-line is clearly in the driving seat:

The pattern can also be seen sector-by-sector.  Higher GVA growth sectors are higher productivity growth sectors (see figure 13 in the report).

That hot demand growth might drive productivity is also a half-spoken premise of Biden’s economic programme. Read this by Claudia Sahm, an outspoken critic of the “but we’re overheating” school. Her side would argue that the big mistake after the Great Recession was to run the economy too cold – “a timid policy response in the face of the Great Recession led to immense damage in our productive capacity”.  Lowball your guess of the economy’s true potential and, tragically, your weak response may make your under-estimate come true. Janet Yellen in a 2016 speech laid out some of the mechanisms by which a high-pressure economy can unlock productivity-growing behaviour: “additional capital spending … a tight labor market might draw in potential workers who would otherwise sit on the sidelines … higher levels of research and development spending and increasing the incentives to start new, innovative businesses”.  In short: necessity is the mother of invention, and demand that runs far ahead of supply forces provides that necessity, so companies raise supply by investing, training and so on.

2. Economists should be wary of ideas that cut supply. If your policy goal is higher output, it is almost axiomatic that should be very wary with ideas that restrict supply. Sometimes, sectional interests blind us to this rather fundamental point.  A society with more corn is better off than one with less, even if a few domestic corn-producers would rather the supply coming from everyone else were restricted. I have always struggled to applaud Roosevelt’s decision to slaughter animals and plough up the cotton crop.  Surely there are other ways of supporting prices in a hungry society? The whole story of economic growth, told over the long term, is of increased supply.  More capital, more labour entering the workforce, better technology enabling it to combine for more output – that is what we are aiming for.

3. But I have been sympathetic to the idea that over-supplied/over-loose labour markets can bias us to low-productivity outcomes. A good statement of this case can be found in Martin Sandbu’s Free Lunch blog, and his book The Economics of Belonging.  Low-wage, high-employment economies generate less incentive to enhance the value of each worker. Martin uses the example of car washes, which in the US involve a few people on the minimum wage crawling over your motor, and in Norway just one worker and a very fancy machine.  I found good suggestive evidence in international comparisons of how different countries (with different labour rules) recovered from the Great Recession. The lightly-regulated, such as the UK, went the high-employment, low-output-per-head route, when compared to France, say.  In this line, I have been very influenced by Ryan Avent’s The Wealth of Humans, which (inter alia) documents the multiple effects of the explosion in aggregate labour supply seen in the 20 years up to writing.  Here is my review of it.

A glib way of expressing points 1 and 3 is on a simple supply-demand curve. If your object is higher wages, then generate higher demand for and lower supply or labour. This is the basic model underlying the argument made by Larry Elliott here – that Brexit is great for the low-paid in the casual labour economy: vote leave, tighten the labour market, get wage rises.   

So does the “supply is good” rule break down when what is being supplied is labour? Avent and Sandbu are not simplistic one-period supply and demand curve people. Their arguments are more dynamic, looking more at the incentives provided by tighter labour markets, and also the special role played by labour in the economy; as well as being a factor of production, labour is the means by which people lay claim to a portion of the value produced.  There are, after all, a huge number of factors of production. Buildings, land, energy, semi-conductor chips, spectrum, lorry driver capacity, cobalt – depending on what you are producing, any of these might be scarce and therefore a matter of concern for a production manager*.  But labour is the one that is most directly, most intimately connected to pay, to welfare outcomes.

I see the case. Flood the market with too much labour, and you end up with over-staffed, low-paid car washes, and a society biased towards lower productivity industries. I have read accounts of how Britain enjoyed an Industrial Revolution, and not China, because Britain suffered labour-scarcity, and China’s problem was land.  When it comes to immigration, I have even heard the argument raised around the Cabinet table (in committee): a Secretary of State cheerfully reported how the Arts sector was being forced to look domestically for its labour force in the wake of Brexit. The PM applauded.  

But if memory serves, neither Avent nor Sandbu are immigration hawks, and nor are economists such as Jonathan Portes who have produced brilliant work looking closely at its effect on native labour.  Read Jonathan’s co-authored piece (page 2) for an object lesson in how this is about so much more than pure supply and demand.  Immigrants affect labour market outcomes in multi-faceted ways. Don’t fall for batting-average fallacies**, for starters. Look at how new workers change the possibilities for the existing ones.  Look at spillovers, geographical effects, incentives, the knock-on effects of economic demand, and more.  The net result? Immigration does very little to lower native wage outcomes (see BOE report).

I also think one should distinguish different means by which labour supply might be curtailed.  A decent minimum wage is fine – there is monopsony power in the labour market, and it is quite acceptable for society to decree that employers should strive to create jobs that have a floor to their productivity. If some economists see this as an artificial curtailment of the supply of labour willing to work at <£5/hour rates, then that is a curtailment I am fine with.  Against this, rules telling people they are not allowed to work in different geographical locations, beyond a certain age, or an unduly limited number of hours are not.  The medieval guild system, which prevented out-of-towners from practicing their trade and presumably putting downward pressure on pay, was not altogether a good thing, even if it helped maintain some local wages.

This leads to another point. One-eyed analyses that seek to maximize outcomes for just one group – the incumbent worker, say – can come down in favour of damaging supply limits because they fail to include other relevant groups. My musings on this subject were triggered by the lorry driver shortages. A very narrow analysis might look at the upward pressure on HGV driver wages and, like Larry Elliott appears to, stop there. Higher wages good! Hooray for Brexit!  But the shortage of HGV drivers is clearly not a good thing, and any actions that are preventing new drivers entering this hot market are damaging. Consumers are suffering from higher prices and empty shelves. More broadly, to the degree that the economy is suffering from shortages because of artificial restrictions on the movement of labour, post Brexit, that is also damaging to the workers that might have come here, earned money and helped the economy.  Without them, the whole economy is less efficient.  The pie is being shrunk.

So, cutting to the chase in an already overlong post, I am comfortable with all my views, still. Run the economy hot but only by raising demand. Higher demand that raises the value of labour, and induces employers to find ways of getting more from each hour worked, is a good thing. Restrictions on labour supply that cut the potential of the economy and damage people’s opportunities are not.  Self-induced privations are not a good policy tool, even if they give you some incentive to innovate. After all, perhaps the best known example of lower labour supply raising wages was meant to be the Black Death (1346-8?), which I was taught was great news for the peasants that survived, as it boosted their bargaining power (although this work suggests wages didn’t start rising for 30 years.)  But, seriously – can anyone really sit back and say the Black Death was a Good Thing?

*this is one reason I find the sole interest in productivity as measured by “value produced per unit of labour” as a little maddening – there are many cases where it is some other factor that is the limiting one.  Semi-conductors for the car industry, say? Energy, for the world as a whole? Carbon

**This is what I would snappily call the All the Averages are Lower and Yet People are Better Off Paradox (that spoilsport Chris Dillow reminded me it is actually Simpson’s Paradox). When a talented immigrant who at home earns a higher-than-average income travels to a richer country, where his pay rises to a level below the prevailing richer-country-average, the average per-head incomes in each country falls, yet world income/capita rises.  Averages mislead: this is another lesson I learned writing about UK productivity and sectors

Sectoral boasts, or a few dumb ways of sizing up the economy

This morning’s perusal of the Guardian’s brought forth a small sigh, as there just below the A level story sat the headline “UK green economy four times larger than manufacturing sector, says report”.  

Now, I have been marinating myself in sectoral data for months to write this monster, and pretty much know every sector backwards by now.  Manufacturing in 2018 was a £182bn GVA sector – a number that is actually disappointing, as it is no larger in real terms than in 1998. In terms of sales – a nonsensical way of measuring it, for reasons to be set out below – it is £545bn, and it employs 2.5m people or thereabouts.  Anything four times that large is going to be … massive, basically employing half of your family. Certainly, a lot more than the 1.2m people apparently employed in the low-carbon industry, according to the same story.  

For me, the moral of the story is that people should apply some sort of sense check when confronted with sectoral boasts.   

Sectoral boasts are a constant feature of the government adviser’s life. A typical meeting request will begin with a polite email, attached to a sector description setting out quite how ginormous is the sector you are about to meet, in terms of jobs, taxes, exports, Levelling Up Power and so on. If you collect a sheaf of these over a parliamentary term, you will usually have enough sectoral GVA to create at least a dozen United Kingdoms.

Advisers learn to cock an eyebrow at this, and most journalists do as well. The sense check I would most recommend is this: production needs income. If a sector is producing £X of value, then someone is buying that much. So are they? I was struck by the figure in the report for Wind. If the wind industry is producing £33bn, as that report implies, then customers of wind – electricity customers– are paying that much.  A glance at Drax Electric Insights can tell you that Wind is around 25% of the electricity mix.  So does the whole lot come to £130bn? I don’t think so – £5000 per household is steep* … dividing through by households is also quite a good way of thinking through a number**. The report saws Low Carbon sales are £200bn. Does it feel like you spend £8000 of your budget on this (there are ~25m households)?

But what really bugs me is anu confusion of sales with GDP. A sale is not GDP.  If you buy a piano for £200, fix it up and sell it for £300, you have generated £100 of value add, not £300.  Some industries naturally have high sales-to-value-add ratios. Financial traders! Or the auto/aero industry, which has £117bn of sales, £28bn of value add. Without making this distinction, you can spin up an economy of almost infinite size. Imagine the full production chain of the piano, all the creation of wooden and metal parts, all the purchases and labour along the way. If each of those gross purchases were counted separately as final production, as well as the piano sale at the end, then you would end up with a lot more than £300.  But that is all you have at the end – a £300 piano.  

That’s one poor way of evaluating the economy – but I didn’t intend to write about that at length, it should be the job of the ONS in an explainer.  I am a fan of the green economy and don’t think it deserves a kicking for being exuberantly over-described.

Which brings me to the other topic: this foolish way of attacking green investment on the Gaia/Guido blog.  In short, it starts with how the government is providing a £95m grant to help upgrade ports for offshore wind production and delivery, rounds that up to £160m, the full size of the fund from which this £95m is drawn (because ‘secrecy’) then divides through by the jobs created (1,340 apparently), and runs away with it from there: £119,400 per job, what a ripoff, imagine how many years of income tax is needed for that, etc etc!

There is plenty of chicanery in this, but what really bugs me here is the method. The money the government is spending is for capital. It is a capital intensive business. What you get out of it in the end is capital – infrastructure, plant, machinery, that sort of thing.  Investment is not meant to be a job creation scheme.  If all you wanted to do was target investments in industries with a low capital-to-job ratio, then you would be subsidizing restaurants, advertising and leather goods, apparently (see table).  But then you would be coming up against the other idiocy, which I covered at more length in my report – the belief that the only good policy is one that automatically chooses the industries with high GVA per job – which are generally capital intensive.

Looking across all the industries, it appears that the sector in which you find electricity-supply has £128bn invested, and 145,000 employees, or £885,000 per job (see the table below).  In those terms, producing new jobs for a cost of £119,400 each is good value – but not if the comparator sector is manufacturing.  But I don’t really care.  Job creation is a dumb way of evaluating this.  The point is to encourage capital investment, and the point of the capital is not JUST to employ people, but also to produce whatever the capital produces – in this case, wind turbines, and eventually zero carbon electricity.  

I know these blogs are written cynically, but I think they reflect a trap that the promoters of green investment have set up for themselves.  Making out that your industry is really BIG is a mistake, when you remember that someone else pays for your big-ness. Jobs are a cost as well as a source of income for someone.  Greening the economy is going to be highly capital intensive, and if you portray it as being a way of boosting the size of the economy in terms of jobs, you will be hoist by your own petard.

*OK, OK, you can just google it, that offshore wind has £6bn of turnover according to the ONS

** yes, households are not the only electricity users. They are maybe half of it. But we do know not much more than half their £1300 utility bills are electricity …

Services matter, or more on productivity

I miss the speed and spontaneity of blogging, even if it comes at the expense of rigour and completeness.  More on those last two later.

A blog feels like the right medium for a quick postscript to the much slower report I published last week, on what sector analysis can tell us about the UK’s productivity problem.  The report was inspired in polemical fashion; someone on Twitter argued that the UK’s weak productivity performance reflected its poor industrial policy, and I thought, instantly, “This is surely (dis)provable with data”.  Put another way, if we had had a different industrial structure, could we have grown faster and better? Did we put too much into the lower-value, slower growing sectors?

It did not take long to realise the answer was, fundamentally, no.  Anyone with good instinctive maths can get this. It is about averaging. For the average of the whole to be altered by a shift into a fraction of it, either that fraction must be MUCH better than the rest, or the shift into it needs to be massive. Taking Manufacturing as the sector most people have in mind, its GDP per worker is only about 40% above that of the rest of the economy. Only 8% of workers are in manufacturing.  The productivity gap we are looking at since 2008 is around 17%.  There is no amount of shifting of workers out of manufacturing that can explain that much.*

So I set out to write a 2 hour blog, went looking for data, stumbled upon the massive OECD STAN structural database, and instead emerged 3 months later with a 12,000 word piece investigating pretty much everything I noodled on.  I realised in so doing that, as well as the trivial matter of proving the initial point (something already well covered by the Industrial Strategy Council and its multiple sources), this kind of data deluge provides a lot of the raw stuff needed to amplify a few other policy prejudices.  These ended up landing in the report, including:

  • That there is not a simple relationship between extra technology and innovation on one side, and jobs, growth and GDP on the other
  • That “low-value” sectors are important to the economy to a degree that is not captured by the simplistic averaging technique mentioned above
  • That breaking the economy into sectors spreads a misleading impression of how the economy works (we are not sitting there like a product manager, deciding whether to sell more computers, socks or ice cream) …
  • … and it neglects the important role of aggregate demand in explaining the emergence and persistence of the UK’s productivity disappointment.  

In the Twitter feedback, easily the most applauded thought was the last, and rightly so: if weak aggregate demand has helped to cause weak aggregate supply, the UK (and the world in general) has rejected the greatest free lunch of all (I say this as someone who thinks that nominal aggregate demand can always be raised, with sufficient determination).  I would like to return to that topic in a later blog, because it is too massive to be a mere sub-heading. 

And the first is the one that has most fascinated me, not least because we are persistently ruled by policy wonks obsessed with the idea that technology policy is the most important part of economic policy.  Even the smartest of them appear to translate the question of productivity into one of technology stagnation, and while the two topics are surely related, they are just not the same. Again, for another day.

But the middle two are what I want to discuss, thanks to some reading thrown my way since publication. In preparing my report I encountered a wide spectrum of views on the significance of low-value sectors. Sometimes people say that they cannot ever become more productive. Think of the piano lesson, which requires one piano teacher sitting with one kid. Fantasise all you like about this shifting online, you can see that the basic product of one-on-one piano-teaching is not infinitely improvable.  To which my response is: sure, but that is not typical of the EIGHTY PERCENT of the economy that is services.  More typical are the kinds of service Martin Sandbu talks about here – comparing how the UK and Norway carry out Covid tests very differently (the example he uses in his book, of car washes in the US vs Norway, is just as striking).  There are clearly large improvements possible, with different levels of trust and technology.  Don’t just think haircuts, think logistics.

Another odd view I heard was that non-tradeable services productivity doesn’t matter because it is not traded.  So what if your supermarket is more sluggish and ill-stocked, or your gyms run badly or electrical supply a bit intermittent – it isn’t competing on the international market and so it doesn’t lose the UK valuable ‘business’. This again feels straightforwardly wrong. Services are provided to the rest of the economy, and if they are provided badly then the rest of the economy gets a bad deal – essentially, the rest of the economy sees its income reduced, in real terms.  This might make the rest of the economy less competitive, if international competition is your obsession, but more fundamentally it is still a loss of real income and real productivity.  This touches on my third prejudice above – don’t (ever) look at a sector in isolation, but as part of the whole economy it serves, and indeed the wider society.

Which brings me to this interesting paper by Julie Froud, Colin Haslam and Sukhdev Johal, sent to me after I published mine, and which if I had more rigour and completeness I would have spotted earlier. Titled “(How) does productivity matter in the foundational economy?”, it in many ways rows in the same direction as mine, and draws attention to other works that argue against the “fetish of the frontier” (to quote from a Nesta paper).  As its title suggests, it questions whether productivity as measured by GDP per head is even the point when it comes to ‘foundational’ sectors, those needed for the functioning of the rest.  It is also eloquent in highlighting the heterogeneity of services sectors (which spread from capital-intensive utilities to labour-intensive personal services) and, consequently, the difficulty of producing generalised policy answers. I was struck by their warnings about the perverse consequences of a blind pursuit of “GDP/L”:

in mature retail businesses, output per worker hour can be improved by working on the numerator and/or denominator to improve the efficiency ratio, while also leaving unserved or mis-sold customers and dissatisfied workers providing worse service with no regard for social needs. Sales revenue can be boosted by confusion marketing which makes price comparisons difficult, as in supermarket special offers or multiple tariffs in utilities; or mis-selling and cross-selling of mortgages, pensions and personal protection insurance in high street banking, with closure of retail branches or the pruning of product lines to save costs

And perhaps the key point of all: higher productivity does not necessarily lead to (proportionally) higher wages.  You can all imagine your own examples of technology-transformed industries that have also transformed the power of its worker-producers to command a decent economic rent.  I was a kind of journalist once, you know.

The major criticism I am waiting to confront is: “so what do we do?” It is easy to establish that lower-value sectors matter, aggregate demand is important, and technology is no magic bullet. What is the policy answer? I won’t pretend there is an easy one, but on such a topic, it at least helps not starting in the wrong place.

*I also question those who think the way the economy works is “shift workers into that sector, watch the sector’s output rise in proportion”.

Is all GDP created equal?

Scott Corfe of the Social Market Foundation* has with his team produced an eye-catching report about gambling regulation**. The major headline: while gambling supports thousands of jobs in the economy, clamping down on it is nothing to worry about, because the spending currently diverted to gambling would go elsewhere. In fact, it would probably go to places that have a better overall economic effect.  This is because other industries on the whole have a larger ‘footprint’ and higher economic multipliers, so when the spending is diverted back to, say, retail, the knock on to the rest of the economy is greater.

This brought back to mind a 2018 argument I had in the Policy Unit with a colleague who was railing against a cut in the maximum stake on Fixed Odds Betting Terminals (FOBTs); I remember gently arguing that you cannot take the full jobs number from the industry at face value. Yes, a lot of people work servicing these terminals, but the money spent on them would be spent elsewhere, generating different jobs.  I even prepared a thought experiment: suppose every town had roadblocks, which you had to pay £5 to pass, and which needed manning. The Town Roadblock Industry would protest against the removal of the roadblocks and use the job losses of road-block-workers as part of their argument. But it is basically mafia economics: keep our protection racket, because the racket hires people.  It is pure economic rent.

Glad I didn’t send that email.

The report also brought to mind a passage I saw in Thomas Phillipon’s recent book The Great Reversal about competition and productivity, which also talks about ‘footprint’. It is making a different point to Scott, however.  When asking which companies really matter to productivity of the whole US, Phillipon writes

“The notion that the biggest tech firms are somehow the pillars of the US economy is false on its face.  The defining feature of the new stars is not how much money they make or how high their stock market values are.  If we exclude amazing, the defining feature of the new stars is how few people they employ and how little they buy from other firms …. Because their footprint is small, whatever happens to the GAFAMs does not matter a lot for the overall productivity of the US economy.  If GM’s productivity had doubled in 1960, people would have noticed the difference.   Cars would have become cheaper, safer and more fuel efficient, and the entire supply chain of GM consequently would have become more productive”. 

He goes on to say, naming a modern tech company, that if its productivity had doubled you would not really notice much, since it isn’t spending that much in the US economy. If you are interested in his whole argument, he and a co-author set it out more in this NBER working paper. The major point I see Phillipon making, however, is this: don’t equate “building a company or industry with a high equity value”  with “boosting the overall productivity of the economy”– a point I have laboured in posts like this for the IFG and the article “Companies can thrive without creating tech billionaires”.

What about Scott’s argument? On the face of it, it conflicts with basic economic sense (see the tweet of Renkitt). The view that we should choose policies that divert spending into industries with a bigger ‘footprint’ sounds awfully like urging the economy to move down the productivity curve. Borrowing off a message from a critical friend, it would be like arguing that it is better to eat heavily processed food (because of the employment) than just pluck an apple off the tree. Or, taking the Simpsons as one should, it would be like looking at their imagined bowling-pin system and applauding it.  

There is force to this argument. We should not (as a car lobbyist once tried on me) resist the growth of the electric car industry, because its internal combustion predecessor employs more people.  Absent a serious demand problem, shifting demand to industries that use fewer factors of production (i.e. are more productive) is a good thing, because any labour freed up is assumed to have a good use elsewhere.

But. Is it possible to stretch this thinking too far? I am particularly interested in thinking about it when the industry in question has a really high, owner-kept mark-up (a bit like the industries Phillipon is so preoccupied with in his book).  Allow me another thought experiment.

Imagine an economy where the main leisure activity is watching people dance.  There are a lot of dancers – say, 10% of the population – and the rest of the economy gladly hands over, say, 11% of their income to watch dances.

Then a new technology comes along – a single superb dancer, videos, very cheap distribution.  As a result, the population no longer paid 11% of their incomes, but only 5%, and this time to the single provider of all the dances. That single provider is now a billionaire and takes the money to spend himself: on having lots of houses, building a giant island complex in the sea, owning the politicians, all sorts. The people who were hitherto dancing for a decent salary are now stuck in service-level jobs that pay less well, because that is what the structure of the economy allows.

In such a scenario, would a regulation aimed at reversing some of this be a ‘good thing’? In economic terms, perhaps not; it would shift spending from the very high productivity activity (watching the genius dancer) to the lower, more artisanal past. In terms of actual prosperity, it may well work though. It messes with the distribution of economic rent in the economy, in a way that is broadly positive (given diminishing marginal utility curves and the way the billionaire wasted money on vanities).

Back to reality. Is the dancer-economy fairy tale remotely applicable? Some industries could claim that the parable captures what they have gone through in the last 30 years – lower employment, lower revenues, vastly more consumer surplus, a radically different distribution of economic rent.  Ask any grizzled journalist from the era of long lunches and six week Sunday Magazine assignments, or recording stars from a few decades ago.

In the case of the gambling analysis, a pure examination of the cost structure of gambling compared to retail in providing the service is probably not enough alone. I would want to know where the economic rent goes too, and think more about dynamic effects like what each industry invests in.  Gambling produces more revenue per worker than retail, and at less cost.  Once I would have assumed that this makes a shift from retail to gambling a straightforwardly good thing.  Now I wonder if we need to look at more than just that.  Read the report.

*disclosure: I sit on their Advisory Board, although I had no input in the production of this report

**second disclosure: I sort-of worked in this business from 1996-2006, though in truth our sector was more about financial derivatives than gambling as currently understood.  Insert your own snarky comment on what’s the difference.