Table 6.7 Labour productivity growth in the market sector, 1995–2007 (% per year)
a) Growth accounting
Labour quality ICTK/HW Non-ICT K/HW TFP Labour productivity growth
UK 0.4 0.8 0.4 1.0 2.6
France 0.3 0.3 0.4 0.9 1.9
Germany 0.0 0.5 0.5 0.7 1.7
USA 0.3 0.9 0.3 1.1 2.6
b) Sectoral contributions
ICT production Goods production Market services Reallocation Labour productivity growth
UK 0.5 0.7 1.6 –0.2 2.6
France 0.4 0.8 0.7 0.0 1.9
Germany 0.5 0.9 0.4 –0.1 1.7
USA 0.8 0.3 1.8 –0.3 2.6
Source: van Ark (2011).
The diffusion of ICT has been aided by complementary investments in intangible capital and in high-quality human capital. Expansion of higher education has helped the United Kingdom but especially notable is a strong volume of investment in intangible capital (cf. Table 6.3). The international evidence is also that the diffusion of ICT has been significantly inhibited in countries which are heavily regulated (Cette and Lopez, 2012). Research at OECD indicates that restrictive product market regulation deterred investment in ICT capital directly (Conway et al., 2006) and the indirect effect of regulation in raising costs was relatively pronounced in sectors that use ICT intensively. Notably, employment protection has been shown to deter investment in ICT equipment (Gust and Marquez, 2004) because it increases the costs of reorganizing working practices and upgrading the labour force, which are central to realizing the productivity potential of ICT (Brynjolfsson and Hitt, 2003). Since these forms of regulation have weakened over time, the story is not that European regulation became more stringent but rather that existing regulation became more costly in the context of a new technological era.
For the United Kingdom, the 1980s’ deregulation of services that are intensive in the use of ICT (notably finance and retailing), which reduced barriers to entry, was important for its relatively successful response to the new technology, as the OECD cross-country comparisons reveal.7 It is also clear that investment in ICT is much more profitable and has a bigger productivity payoff if it is accompanied by organizational change in working and management practices (Crespi et al., 2007). This would not have happened with 1970s-style industrial relations in conditions of weak competition. For example, Prais (1981, pp. 198–199) noted the egregious example of the newspaper industry where these conditions precluded the introduction of electronic equipment in Fleet Street although an investment of £50 million could have reduced costs by £35 million per year.
Putting this recent experience into longer-run perspective, three points deserve to be made. First, Britain has been relatively good at the diffusion of ICT in market services whereas in the earlier post-war period it was relatively bad at the diffusion of Fordist techniques in manufacturing. Second, ICT is a disruptive technology which requires quite radical changes in the ways companies operate if it is to be exploited well. This may help to promote faster adoption of ICT in LMEs rather than CMEs given the greater flexibility and greater reliance on college education of the former compared with the latter. Taken together, these points suggest that relative social capability varies according to the technological epoch. Third, success in ICT diffusion was an unintended consequence of the deregulation and resistance to further pursuit of corporatism in the Thatcher period.
6.4 Implications of the Financial Crisis
On the eve of the crisis, the growth performance of the United Kingdom economy was generally seen as quite satisfactory (Van Reenen, 2013). A long period of relative economic decline vis-à-vis other European economies seemed to have come to an end under the auspices of the supply-side policies initiated under the Thatcher government, and continued in most respects by New Labour. Subsequent developments during the financial crisis and its aftermath have come as a rude shock. Labour productivity growth over the period 2007–2016 was just 0.09 per cent per year and growth of real GDP per person was only 0.19 per cent per year, in each case at least 2 percentage points below the rates achieved in 1995–2007 (cf. Table 6.2).
In the context of an optimistic account of late twentieth century British economic growth, the early twenty-first century productivity slowdown raises several related questions. Was pre-2007 growth performance unsustainable? Is slow growth post-2007 mainly a result of the financial crisis? Does the very fact of the crisis imply that seemingly decent growth was actually a ‘mirage’?
The Office for Budget Responsibility believes that the trend rate of labour productivity growth continues to be 2.2 per cent per year, i.e., more or less what was achieved pre-crisis. A less-optimistic interpretation might be that the average productivity growth rate of 2.1 per cent per year over the period 1995–2007 was a bit above the medium-term trend rate at the end of the period. Nevertheless, there is every reason to think that growth of output per hour worked around 1.5 to 1.75 per cent per year was sustainable – enough to keep pace with the major European economies and way ahead of the actual rate since 2007.
When Labour won a landslide victory in the 1997 election, it was possible to wonder whether in government it would revert to ‘Old Labour’ policies. The answer soon became apparent and was a resounding ‘No’. 1970s-style policy was conspicuous by its absence: there was no nationalization programme, no move to subsidize manufacturing investment, no counterpart of the National Enterprise Board, no return to high marginal rates of direct tax, no attempt to resist de-industrialization by supporting declining industries and no major reversal of industrial relations reform. Implicitly, the Thatcher supply-side reforms had been accepted. The changes that Labour made were to strengthen some aspects of horizontal industrial policies with a new emphasis on education, R & D, investing in public capital and strengthening competition policy. There was a strong element of continuity in supply-side policy in terms of strengths (competition, regulation), weaknesses (innovation, infrastructure) and areas where further improvement was desirable (education, tax system). There is no reason to think growth was being undermined by policy errors.
The economy probably had a small positive output gap in 2007 but not big enough seriously to distort perceptions of pre-crisis performance.8 It can fairly be pointed out that a more heavily regulated and somewhat smaller financial services sector may well contribute less to productivity growth in future than in the pre-crisis years but, it is not correct to see its pre-crisis contribution as a mirage.9 It is also apparent that productivity growth weakened somewhat after 2003 to a pre-crisis average of about 1.7 per cent per year compared with 2.6 per cent per year in the previous five years.
It is well-known that financial crises can have permanent adverse direct effects on the level of potential output. Thinking in terms of a production function or growth accounting, there may be direct adverse effects on capital inputs as investment is interrupted, on human capital if skills are lost, on labour inputs through increases in equilibrium unemployment and on TFP if R & D is cut back or if innovative firms cannot get finance. The transition period while the levels effect materializes and during which growth rates are depressed may be quite long. Moreover, recovery is often slow; Reinhart and Rogoff (2014) estimated that the median length of time before real GDP per person returns to its pre-crisis level is 6.5 years.
This could imply that recent labour productivity performance basically reflects a large levels effect resulting from the financial crisis but does not imply that long-term trend growth has been reduced, in which case log labour productivity would maintain a trend path parallel to what would have been expected in 2007.10 Oulton and Sebastia-Barrel (2017) found a long-run impact on the level of labour productivity of 1.1 per cent per year that the crisis lasts. There is good reason to think that the crisis also had significant temporary effects on productivity performance which may not yet have completely evaporated. Exit of low productivity firms has been slowed down by a period of exceptionally low interest rates.11 Misallocation of labour appears to
have been a key issue as new hires and employment growth have been disproportionately concentrated in low productivity sectors with an impact estimated to account for as much as two-thirds of the shortfall in labour productivity compared with a pre-crisis projection (Patterson et al., 2016).
Banking crises reflect market failures in the banking sector combined with a failure of regulation to address them effectively. The problems arise from moral hazard and coordination failures in a context of asymmetric information. The typical pre-crisis symptom is rapid expansion of credit coupled with excessive risk-taking. The likelihood of bank failures increases as leverage goes up and the ratio of equity capital to assets falls. Banking crises happen even in economies with very strong growth fundamentals if banks are badly regulated and under-capitalized. The classic example is the United States where about a third of all banks failed in the years 1929–1933 but nevertheless, as was noted in Chapter 4, TFP growth in the 1930s was impressive.
The financial crisis of 2007–2008 in the United Kingdom matches this familiar pattern. Regulation was deficient and leverage soared following the deregulation of the 1980s with the median ratio of total assets to shareholder claims increasing from around 20 in the 1970s to almost 50 at the pre-crisis peak (ICB, 2011). In effect, there was a huge implicit subsidy to risk-taking by banks that were too big to fail and were allowed to operate with inadequate equity capital. This was a major failure of the policy reforms undertaken in the 1980s. That said, it should not be inferred that pre-crisis growth was predicated on unsound finance even though the cost of capital would have been higher with resilient bank balance sheets. Miles et al. (2013) offer an illustrative calculation which suggests that the lower capital intensity entailed by the introduction of appropriate capital-adequacy regulation would have reduced the level of GDP by about 0.2 per cent.
In sum, the financial crisis does not imply that pre-crisis growth was somehow illusory. The crisis was a result of inadequate financial regulation rather than weak productivity performance. The shock of the near collapse of the banking system has led to a ‘lost decade’ in terms of economic growth but it is too soon to tell what its implications for future long-term trend growth will be.
6.5 Conclusions
After the Golden Age, the United Kingdom’s relative growth performance improved. United Kingdom productivity growth was slower than pre-1973 but growth in other countries fell by more. The contributions to productivity growth from capital deepening and TFP were now similar or slightly better than in France and Germany rather than significantly worse. A notable success for the United Kingdom was its rapid adoption of ICT which played to its strengths in human capital and light-touch regulation.
The reforms of the Thatcher government were a radical response to the poor performance of the United Kingdom economy during the 1970s. The general thrust was to improve the functioning of a struggling LME. The big success stories were the strengthening of competition and the ending of the trade union veto on supply-side policies. Reductions in high marginal income tax rates, the downsizing of selective industrial policy and the expansion of college education were other notable positives. On the other hand, infrastructure and innovation policies left a lot to be desired. With regard to the institutional legacies of the early start, the industrial relations problem which had seemed intractable during the 1970s was largely neutralized, but the separation of ownership and control continued to be problematic, as witnessed by the short-termism of investors.
The financial crisis in 2007 brought an end to a long period of respectable growth. The crisis should not be taken as evidence that this growth was unsustainable but as an indictment of a policy framework that paid too little attention to financial stability. The impact of the crisis on productivity growth was severe and protracted and far exceeded the relatively modest slowdown of the last years before the crisis. Better regulation of the banking system could have averted the crisis without undermining growth.
1 These calculations are at purchasing-power-parity-adjusted exchange rates. As is noted in the table, this conversion is done in a different way for the last two rows of the table using 2015$EKS whereas the first two rows are measured in terms of 1990$GK. If this method had also been used for the later years, the United Kingdom comes out better relative to France and Germany and would in fact be ahead of West Germany in 2007. The comparison with the United States is only marginally affected. There is clearly a significant index number problem here which deserves further research. The comparisons presented in the table are chosen to guard against overstatement of the United Kingdom’s improved position.
2 Investment in intangible capital comprises computerized information (including software), innovative property (including R & D and design) and economic competencies (including advertising, training and reorganization).
3 In this context ‘consensus’ should be understood as a concept of the set of policies regarded as feasible by senior politicians and civil servants given presumed political constraints (cf. Kavanagh and Morris, 1994). This had implied a high degree of policy convergence but did not connote ideological convergence between the main political parties (Hickson, 2004).
4 PMR is an acronym for ‘product market regulation’ and denotes an OECD index of the extent to which competition is inhibited by regulation.
5 This comes entirely from more entry and exit rather than a greater productivity impact from entry and exit, see Criscuolo et al. (2004, Table 2).
6 For a full discussion of why institutional passivity was rational in the circumstances see Short and Keasey (2005).
7 The sensitivity of productivity performance in retailing to regulation is underlined by the sharp reduction in TFP growth in this sector in the United Kingdom after the introduction of stricter limits on out-of-town supermarkets in 1996 (Haskel and Sadun, 2012).
8 The output gap is always measured with difficulty but the best guess is that it was about 2 per cent in 2007 according to the detailed analysis in Murray (2014).
9 It is sometimes claimed that mismeasurement of financial services output distorted the pre-crisis picture; Oulton (2013) shows that any such effect is very small – at most 0.1 per cent per year during 2000–2007. According to the EUKLEMS database, output per hour worked grew at 4.23 per cent per year between 1997 and 2007 and, weighted by the sector’s value-added share, contributed 0.19 per cent per year to total labour productivity growth.
10 This would actually be quite similar to what analysis based on time-series econometrics suggests for the experience of the United States in the context of the massive financial crisis during the Great Depression (Ben-David et al., 2003).
11 A Bank-of-England simulation suggests that had normal interest rates prevailed, the level of overall labour productivity would have been 2 or even possibly 3 per cent higher (Haldane, 2017).
7
Concluding Comments
Detailed conclusions have been presented at the end of each chapter and they will not be repeated here. Rather, this is the opportunity to reflect on the big picture and to be a bit provocative. I want to review some lessons, both about analysing economic growth performance and about designing policy conducive to economic growth, which I take from the historical account in earlier chapters. Then, I wish to elaborate my (idiosyncratic) hypothesis about the implications of the ‘early start’, namely, that its adverse impact was felt most strongly during the Golden Age of economic growth after the Second World War.
The key to evaluating growth performance is, not surprisingly, to establish suitable reference points which underpin an assessment of how much changed and what was feasible. Of course, this has to be based on an adequate database that facilitates inter-temporal and international comparisons but it also requires an analytic framework based on growth economics. An important aspect of this is growth accounting which provides useful diagnostics. These points are exemplified by my discussion of the Industrial Revolution. Estimates of the rate of economic growth show that there was a notabl
e acceleration in the late eighteenth and early nineteenth century which produced sustained economic growth in the face of considerable demographic pressure. This was unprecedented. However, by later standards the rate of economic growth was unimpressive and TFP growth was quite modest even though new technologies, notably including steam power, came along. Recognition of the limitations of the Industrial-Revolution economy provides an important context for later relative growth performance.
International comparisons offer benchmarks which guard against misleading interpretations based on a parochial assessment of performance. The interwar period provides a good example. For a while a quite optimistic view, especially of the 1930s, prevailed. The statistical basis for this was an account of United Kingdom productivity performance through time which described a U-shaped curve with the low point in Edwardian times and a revival between the wars. Compared with outcomes in the United States, however, TFP growth in the United Kingdom was increasingly disappointing. The acceleration in American TFP growth was about three times larger. The gap between the United Kingdom and the USA in levels of labour productivity in manufacturing actually increased during the 1930s even though the impact of the depression was much more damaging on the other side of the Atlantic.
Forging Ahead, Falling Behind and Fighting Back Page 13