Author: John Sloman

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Monetary policy: too much, too late?

In this third blog about inflation, we focus on monetary policy to deal with the problem and bring inflation back to the target rate, which is typically 2 per cent around the world (including the eurozone, the USA and the UK). We ask the questions: was the response of central banks too timid initially, meaning that harsher measures had to be taken later; and will these harsher measures turn out to be excessive? In other words, has the eventual response been ‘too much, too late’, given that the initial measures were too little?

Inflation rates began rising in the second half of 2021 as economies began to open up as the pandemic subsided. Supply-chain problems drove the initial rise in prices. Then, following the Russian invasion of Ukraine in February 2022 and the adverse effects on oil, gas and grain prices, inflation rose further. In the UK, CPI inflation peaked at 11.1% in October 2022 (see chart 1 in the first of these three blogs). Across the whole EU-27, it peaked at 11.5% in October 2022; US inflation peaked at 9.1% in June 2022; Japanese inflation peaked at 4.3% in January 2023.

This raises the questions of why interest rates were not raised by a greater amount earlier (was it too little, too late?) and why they have continued to be raised once inflation rates have peaked (is it too much, too late?).

The problem of time lags

Both inflation and monetary policy involve time lags. Rising costs take a time to work their way through the supply chain. Firms may use old stocks for a time which are at the original price. If it is anticipated that costs will rise, central banks will need to take action early and not wait until all cost increases have worked their way through to retail prices.

In terms of monetary policy, the lags tend to be long.

If central bank interest rates are raised, it may take some time for banks to raise savings rates – a common complaint by savers.

As far as borrowing rates are concerned, as we saw in the previous blog, loans secured on dwellings (mortgages) account for the majority of households’ financial liabilities (76.4% in 2021) and here the time lags between central bank interest rate changes and changes in people’s mortgage interest rates can be very long. Only around 14 of UK mortgages are at variable rates; the rest are fixed, typically for between 2 to 5 years. So, when Bank Rate changes, people on fixed rates will be unaffected until their mortgage comes up for renewal, when they can be faced with a huge increase in payments.

Only around 21% of mortgages in England were/are due for renewal in 2023, and with 57% of these the old fixed rates were below 2%. Currently (July 2023), the average two-year fixed-rate mortgage rate in the UK is 6.81% (based on 75% loan to value (LTV)); the average five-year rate is 6.31% (based on 75% LTV). This represents a massive increase in interest rates, but for a relatively small proportion of homeowners and an even smaller proportion of total households.

But as more and more fixed-rate mortgages come up for renewal, so the number of people affected will grow, as will the dampening effect on aggregate demand as such people are forced to cut back on spending. This dampening effect will build up for many months.

And there is another time lag – that between prices and wages. Wages are negotiated periodically, normally annually or sometimes less frequently. Employees will typically seek a cost-of-living element in wage rises that covers price rises over the past 12 months, not inflation in the past month. If inflation is rising (or falling), such negotiations will not reflect the current situation. There is thus a time lag built in to such negotiations. Even if higher interest rates reduce inflation, the full effect can take some time because of this wages time lag.

Other time lags include those involving ongoing capital projects. If construction is taking place, it will take some time to complete and in the meantime is unlikely to be stopped. Higher interest rates will affect capital investment decisions now, but existing projects are likely to continue to completion. As more projects are completed over time, so the effect of higher interest rates is likely to accumulate.

Then there is the question of savings. During the pandemic, many people increased their savings as their opportunities for spending were more limited. Since then, many people have drawn on these savings to fund holidays, eating out and other leisure activities. Such spending is likely to taper off as savings are reduced. Again, the interest rises may prove to have been excessive as a means of reducing aggregate demand.

These time lags suggest that after some months the economy will have been excessively dampened and that the policy will have ‘overshot’ the mark. Had interest rates been raised more rapidly earlier and by larger amounts, the peak level of rates may not have needed to be so high.

Perhaps one of the biggest worries about raising interest rates excessively because of time lags is the effect on corporate and government debt. Highly indebted companies and countries will find that a large increase in interest rates makes servicing their debt much harder. For example, Thames Water, the UK’s biggest water and sewerage company accumulated some £14 billion in debt during the era of low interest rates. It has now declared that it cannot service these debts and is on the brink of insolvency. In the case of governments, as increasing amounts have to be spent on servicing their debt, so they may be forced to cut expenditure elsewhere. This will have a dampening effect on the economy – but with a time lag.

The distribution of pain

Those with large credit-card debt and large mortgages coming up for renewal or at variable rates will have borne the brunt of interest rate rises. These people, such as young people with families, are often those most affected by inflation, with a larger proportion of their expenditure on energy and food. Other people adversely affected are tenants where landlords raise rents to cover their higher mortgage payments.

Those with no debts will have been little affected by the hike in interest rates, unless the curbing of aggregate demand affects their chances of overtime or reduces available shifts or, worse still, leads to redundancy.

Excessive rises in interest rates exacerbate these distributional effects.

Articles

Questions

  1. For what reasons might a central bank be unwilling to raise interest rates by more than 0.25 or 0.5 percentage points per month?
  2. What instruments other than changing interest rates does a central bank have for influencing aggregate demand?
  3. Distinguish between demand-pull and cost-push inflation.
  4. Why might using interest rates to curb inflation be problematic when inflation is caused by adverse supply shocks?
  5. How are expectations of consumers and firms relevant in determining (a) the appropriate monetary policy measures and (b) their effectiveness?
  6. How could a careful use of a combination of monetary and fiscal policies reduce the redistributive effects of monetary policy?
  7. How might the use of ‘forward guidance’ by central banks reduce the need for such large rises in interest rates?
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Tackling climate change: ‘Everything, everywhere, all at once’

The United Nations International Panel on Climate Change (IPCC) has just published its most comprehensive report so far. It finds that ‘human activities, principally through emissions of greenhouse gases, have unequivocally caused global warming’. This has led to widespread and rapid changes in climate and biodiversity and to more extreme weather patterns, such as droughts, floods and hurricanes. What is more, the distribution of these effects is uneven, with communities who have contributed the least to current climate change being disproportionately affected.

At the 2015 COP21 climate change conference in Paris (see also), it was agreed to adopt policies to limit the increase in global temperatures to ‘well below’ 2°C above pre-industrial levels and to make an effort to limit it to 1.5°C. Global temperatures have already risen 1.1°C above 1850–1900 levels and are set to reach 1.5°C in the early 2030s. Every increment of global warming will intensify ‘multiple and concurrent hazards’.

Deep, rapid and sustained reductions in emissions would slow down the rise in global temperatures, but even with such reductions, temperatures will still exceed 1.5°C in the next few years and, even under the best-case scenario, would not fall below 1.5°C again until the end of the 21st century. Under more pessimistic scenarios, global temperatures could rise to 2.7°C above pre-industrial levels by the end of the century under an intermediate greenhouse gas emissions scenario and to 4.4°C under a very high emissions scenario. Anything above 2°C would be likely to have catastrophic effects. The longer countries wait to take action, the greater the rise in global temperatures and hence the greater the damage and the more costly it will be to rectify it.

‘For any given future warming level… projected long-term impacts are up to multiple times higher than currently observed (high confidence). Risks and projected adverse impacts and related losses and damages from climate change escalate with every increment of global warming (very high confidence). Climatic and non-climatic risks will increasingly interact, creating compound and cascading risks that are more complex and difficult to manage (high confidence).’ (Paragraph B2)

But the report is not all ‘doom and gloom’. It is possible to limit global warming to 1.5°C or only a little over by making rapid, deep and, in most cases, immediate greenhouse gas emissions reductions in all sectors and reaching net zero emissions in the early 2050s. Science and technology have the answers – answers that are now much cheaper and more available than back in 2015 when the 1.5°C target was agreed. But what it does require is doing ‘everything, everywhere, all at once’. And that requires political will and the right economic incentives.

The politics and economics of achieving net zero

In terms of the politics, there is general global agreement by governments about the likely effects of climate change. And most governments agree that action needs to be taken. However, there are three key political problems.

The first is that the costs of action will be borne now, while the benefits of action will accrue over a much longer period of time. This links to the second problem – the mismatch between the lives of governments and the long-term effects of climate change. If governments put off doing anything now and merely promise that something will be done in the future, they will not have to take unpopular actions, such as raising taxes on energy, private transport and certain goods or banning various activities. Future governments will have to sort things out, by when, although the problems will be greater, the existing politicians will no longer be in power.

The third problem concerns the distribution of the costs and benefits of action. The major emitters of carbon are the rich countries, while the major sufferers are poor people in countries subject to drought, flooding and rising sea levels. Not surprisingly, who should cut down on emissions and pay for the mitigation necessary in many of the poorer countries is a difficult political issue, which is why it’s much easier to say what needs to be achieved overall than precisely what measures should be taken by which countries.

These problems reflect the fact that many, if not most, of the environmental costs of production and consumption are external costs – costs borne, not by the direct producer or consumer, but by other people at other places and/or in the future.

Nevertheless, the relative costs of moving to greener production and consumption are falling. The costs of renewable energy, including solar power, onshore and offshore wind and hydroelectric power are falling relative to that generated from fossil fuels. At the same time, the take up of electric cars is likely to continue rising as battery technology improves. This does, of course, require an increase in charging infrastructure. Domestic heat pump technology is improving and home insulation methods are becoming more efficient.

Persuading consumers and firms to take account of environmental externalities could in part be achieved by education. It makes it much easier for politicians to take appropriate action now if their populations are on board. There has been increasing awareness over the years of the environmental impact of people’s actions. People have become more willing to take responsibility for the world that future generations will inherit. This is helped both by education in schools and colleges and by frequent items in the media.

But incentives also have a major part to play. To internalise environmental externalities, external costs could be taxed and external benefits subsidised.

The effect of a carbon tax on production

The use of taxes to reduce activities with negative environmental externalities is illustrated in the diagram (click here for a PowerPoint). It takes the case of carbon emissions from coal-fired electricity generation in a large country. To keep the analysis simple, it is assumed that all electricity in the country is generated from coal-fired power stations and that there are many such power stations, making the market perfectly competitive.

It is assumed that all the benefits from electricity production accrue solely to the consumers of electricity (i.e. there are no external benefits from consumption). Marginal private and marginal social benefits of the production of electricity are thus the same (MPB = MSB). The curve slopes downwards because, with a downward-sloping demand for electricity, higher output results in a lower marginal benefit (diminishing marginal utility).

Competitive market forces, with producers and consumers responding only to private costs and benefits, will result in a market equilibrium at point a in the diagram: i.e. where demand equals supply. The market equilibrium price is P0 while the market equilibrium quantity is Q0. However the presence of external costs in production means that MSC > MPC. In other words, MEC = b – a.

The socially optimal output would be Q* where P = MSB = MSC, achieved at the socially optimal price of P*. This is illustrated at point d and clearly shows how external costs of production in a perfectly competitive market result in overproduction: i.e. Q0 > Q*. From society’s point of view, too much electricity is being produced and consumed.

If a carbon tax of d – c is imposed on the electricity producers, it will now be in producers’ interests to produce at Q*, where their new private marginal costs (including tax) equals their marginal private benefit.

But this brings us back to the politics of measures to reduce emissions. People do not like paying higher taxes. In his latest Budget, the UK Chancellor, Jeremy Hunt, decided not to raise fuel duties by the 12p that had been previously planned, despite fuel prices having recently fallen. Meanwhile, charging prices for electric cars have risen.

Other economic measures

A simpler method for dealing with environmental externalities is ban certain activities that omit CO2. For example, in the UK there will be a ban on the sale of new petrol and diesel cars and vans from 2030 (with the exception of some low-emission hybrids until 2035). In the EU there will be a similar ban from 2035. Clearly, such measures are only suitable when there are non-emitting alternatives.

Another alternative is a cap-and-trade system, such as the European Emissions Trading Scheme. It involves setting quotas for emissions and allowing firms which manage to cut emissions to sell their surplus permits to less efficient firms. This puts a price pressure on firms to be more efficient. But the quotas (the ‘cap’) must be sufficiently tight if emissions are going to be cut to desired levels. Nevertheless, it is an efficient way of cutting emissions as it gives a competitive advantage to low-emission producers.

Conclusion

If the problem of global warming is to be limited to 1.5°C, or only very little above, multiple solutions will need to be found and there must be a combination of political will, economic incentives and the mobilisation of scientific and technical know-how. As the Secretary-General of the United Nations, António Guterres, stated in launching the new report:

This report is a clarion call to massively fast-track climate efforts by every country and every sector and on every timeframe. In short, our world needs climate action on all fronts – everything, everywhere, all at once.

Report

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Questions

  1. Why might countries not do ‘everything, everywhere, all at once’ to avert climate change?
  2. What might an optimist conclude from the ICC report?
  3. To what extent is climate change an economic problem?
  4. On a diagram similar to the one above, show how a subsidy could be used to internalise positive externalities.
  5. How might countries reduce the consumption of fossil fuels in the most efficient way? Are they likely to want to do this? Explain.
  6. Is a ‘cap-and-trade’ (tradable permits) system (a) an effective means of reducing emissions; (b) an efficient system?
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A four-day week – a solution to sluggish productivity growth?

In two previous posts, one at the end of 2019 and one in July 2021, we looked at moves around the world to introduce a four-day working week, with no increase in hours on the days worked and no reduction in weekly pay. Firms would gain if increased worker energy and motivation resulted in a gain in output. They would also gain if fewer hours resulted in lower costs.

Workers would be likely to gain from less stress and burnout and a better work–life balance. What is more, firms’ and workers’ carbon footprint could be reduced as less time was spent at work and in commuting.

If the same output could be produced with fewer hours worked, this would represent an increase in labour productivity measured in output per hour.

The UK’s poor productivity record since 2008

Since the financial crisis of 2007–8, the growth in UK productivity has been sluggish. This is illustrated in the chart, which looks at the production industries: i.e. it excludes services, where average productivity growth tends to be slower. (Click here for a PowerPoint of the chart.)

Prior to the crisis, from 1998 to 2007, UK productivity in the production industries grew at an annual rate of 6.1%. From 2007 to the start of the pandemic in 2020, the average annual productivity growth rate in these industries was a mere 0.5%.

It grew rapidly for a short time at the start of the pandemic, but this was because many businesses temporarily shut down or went to part-time working, and many of these temporary job cuts were low-wage/low productivity jobs. If you take services, the effect was even stronger as sectors such as hospitality, leisure and retail were particularly affected and labour productivity in these sectors tends to be low. As industries opened up and took on more workers, so average productivity fell back. In the four quarters to 2022 Q3 (the latest data available), productivity in the production industries fell by 6.8%.

If you project the average productivity growth rate from 1998 to 2007 of 6.1% forwards (see grey dashed line), then by 2022 Q3, output per hour in the production industries would have been 21/4 times (125%) higher than it actually was. This is a huge productivity gap.

Productivity in the UK is lower than in many other competitor countries. According to the ONS, output per hour in the UK in 2021 was $59.14 in the UK. This compares with an average of $64.93 for the G7 countries, $66.75 in France, £68.30 in Germany, $74.84 in the USA, $84.46 in Norway and $128.21 in Ireland. It is lower, however, in Italy ($54.59), Canada ($53.97) and Japan ($47.28).

As we saw in the blog, The UK’s poor productivity record, low UK productivity is caused by a number of factors, not least the lack of investment in physical capital, both by private companies and in public infrastructure, and the lack of investment in training. Other factors include short-termist attitudes of both politicians and management and generally poor management practices. But one cause is the poor motivation of many workers and the feeling of being overworked. One solution to this is the four-day week.

Latest evidence on the four-day week

Results have just been released of a pilot programme involving 61 companies and non-profit organisations in the UK and nearly 3000 workers. They took part in a six-month trial of a four-day week, with no increase in hours on the days worked and no loss in pay for employees – in other words, 100% of the pay for 80% of the time. The trial was a success, with 91% of organisations planning to continue with the four-day week and a further 4% leaning towards doing so.

The model adopted varied across companies, depending on what was seen as most suitable for them. Some gave everyone Friday off; others let staff choose which day to have off; others let staff work 80% of the hours on a flexible basis.

There was little difference in outcomes across different types of businesses. Compared with the same period last year, revenues rose by an average of 35%; sick days fell by two-thirds and 57% fewer staff left the firms. There were significant increases in well-being, with 39% saying they were less stressed, 40% that they were sleeping better; 75% that they had reduced levels of burnout and 54% that it was easier to achieve a good work–life balance. There were also positive environmental outcomes, with average commuting time falling by half an hour per week.

There is growing pressure around the world for employers to move to a four-day week and this pilot provides evidence that it significantly increases productivity and well-being.

Articles

Questions

  1. What are the possible advantages of moving to a four-day week?
  2. What are the possible disadvantages of moving to a four-day week?
  3. What types of companies or organisations are (a) most likely, (b) least likely to gain from a four-day week?
  4. Why has the UK’s productivity growth been lower than that of many of its major competitors?
  5. Why, if you use a log scale on the vertical axis, is a constant rate of growth shown as a straight line? What would a constant rate of growth line look like if you used a normal arithmetical scale for the vertical axis?
  6. Find out what is meant by the ‘fourth industrial revolution’. Does this hold out the hope of significant productivity improvements in the near future? (See, for example, last link above.)
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Used EV prices fall

Prices of used fully electric cars (EVs) are falling in the UK, even though prices of used internal combustion engine (ICE) cars are rising. According to Auto Trader (see the first two articles below), in February 2023 the average price of used petrol cars rose by 3.3% compared with January and the price of used diesel cars rose by 1.4%. But the price of used EVs fell by 9.1%. This follows a fall of 2.1% in January.

But why are used EV prices falling? After all, the last few years has seen a drive to replace ICEs with EVs and hybrids, with many consumers preferring electric cars to petrol and diesel ones. What is more, vehicle excise duty is currently zero for EVs (and will be until 2025) and the sale of new ICEs will be banned from the end of the decade. The answer lies in demand and supply.

On the demand side, many existing and potential EV owners worry about the charging infrastructure. The number of EVs has grown more rapidly than the number of charging points. In 2020 there was one charging point per 16 cars; by 2022 this had worsened to one per 30 cars. Also the distribution of charging points is patchy and there is a lack of rapid and ultra-rapid chargers. Increasingly, people have to queue for access to a charger and this can substantially delay a journey and could mean missed appointments. There were many pictures in the media around Christmas of long queues for chargers at service stations and supermarkets. Poor charging infrastructure can be more of a problem for second-hand EVs, which tend to have a smaller range.

Also on the demand side is the price of fuel. After the Russian invasion of Ukraine and the rise in oil prices, the price of petrol and diesel soared. This increased the cost of running ICE vehicles and boosted the demand for EVs. But the war also drove up the price of natural gas and this price largely determines the wholesale price of electricity. With government subsidies for electricity, this constrained the rise in electricity prices. This made running an EV for a time comparatively cheaper. More recently, the price of oil has fallen and with it the price of petrol and diesel. But electricity prices are set to rise in April as government subsidies cease. The cost advantage of running an electric car is likely to disappear, or at least substantially decline.

Another substitute for second-hand EVs is new EVs. As the range of new EVs increases, then anyone thinking about buying an EV may be more tempted to buy a new one rather than a used one. Such demand has also been driven by Tesla’s decision to cut the UK prices of many of it models by between 10% and 13%.

The fall in demand for used EVs is compounded, at least in the short term, by speculation. People thinking of trading in their ICE or hybrid car for a fully electric one are likely to wait if they see prices falling. Why buy now if, by waiting, you could get the same model cheaper?

On the supply side, EV owners, faced with the infrastructure problems outlined above, are likely to sell their EV and buy an ICE or hybrid one instead. This increases the supply of used EVs. This is again compounded by speculation as people thinking of selling their EV do so as quickly as possible before price falls further.

In many other countries, there is much more rapid investment in charging infrastructure and/or subsidies for purchasing not only new but used EVs. This has prevented or limited the fall in price of used EVs.

Articles

Questions

  1. Draw a supply and demand diagram to illustrate what has been happening in the market for used EVs.
  2. How has the price elasticity of (a) demand and (b) supply affected the amount by which used EV prices have fallen?
  3. Identify substitutes and complements for used electric vehicles. How relevant is the cross-price elasticity of demand for these complements and substitutes in determining price changes of used EVs?
  4. Draw a diagram to illustrate the effect of speculation on used EV prices.
  5. What is likely to happen to used EV prices in the months ahead? Explain.
  6. How are externalities in car usage relevant to government action to influence the market for EVs? What should determine the size of this intervention?
  7. Devise a short survey for people thinking of buying an EV to determine the factors that are likely to affect their decision to buy one and, if so, whether to buy a new or used one.
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The UK’s poor productivity record

In its latest World Economic Outlook update, the IMF forecasts that the UK in 2023 will be the worst performing economy in the G7. Unlike all the other countries and regions in the report, only the UK economy is set to shrink. UK real GDP is forecast to fall by 0.6% in 2023 (see Figure 1: click here for a PowerPoint). In the USA it is forecast to rise by 1.4%, in Germany by 0.1%, in France by 0.7% and in Japan by 1.8%. GDP in advanced countries as a whole is forecast to grow by 1.2%, while world output is forecast to grow by 2.9%. Developing countries are forecast to grow by 4.0%, with China and India forecast to grow by 5.2% and 6.1%, respectively. And things are not forecast to be a lot better for the UK in 2024, with growth of 0.9% – bottom equal with Japan and Italy.

Low projected growth in the UK in part reflects the tighter fiscal and monetary policies being implemented to curb inflation, which is slow to fall thanks to tight labour markets and persistently higher energy prices. The UK is particularly exposed to high wholesale gas prices, with a larger share of its energy coming from natural gas than most countries.

But the UK’s lower forecast growth relative to other countries reflects a longer-term problem in the UK and that is the slow rate of productivity growth. This is illustrated in Figure 2, which shows output (GDP) per hour worked in major economies, indexed at 100 in 2008 (click here for a PowerPoint). As you can see, the growth in productivity in the UK has lagged behind that of the other economies. The average annual percentage growth in productivity is shown next to each country. The UK’s growth in productivity since 2008 has been a mere 0.3% per annum.

Causes of low productivity/low productivity growth

A major cause of low productivity growth is low levels of investment in physical capital. Figure 3 shows investment (gross capital formation) as a percentage of GDP for the G7 countries from the 2007–8 financial crisis to the year before the pandemic (click here for a PowerPoint). As you can see, the UK performs the worst of the seven countries.

Part of the reason for the low level of private investment is uncertainty. Firms have been discouraged from investing because of a lack of economic growth and fears that this was likely to remain subdued. The problem was compounded by Brexit, with many firms uncertain about their future markets, especially in the EU. COVID affected investment, as it did in all countries, but supply chain problems in the aftermath of COVID have been worse for the UK than many countries. Also, the UK has been particularly exposed to the effects of higher gas prices following the Russian invasion of Ukraine, as a large proportion of electricity is generated from natural gas and natural gas is the major fuel for home heating.

Part of the reason is an environment that is unconducive for investment. Access to finance for investment is more difficult in the UK and more costly than in many countries. The financial system tends to have a short-term focus, with an emphasises on dividends and short-term returns rather than on the long-term gains from investment. This is compounded by physical infrastructure problems with a lack of investment in energy, road and rail and a slow roll out of advances in telecoms.


To help fund investment and drive economic growth, in 2021 the UK government established a government-owned UK Infrastructure Bank. This has access to £22 billion of funds. However, as The Conversation article below points out:

According to a January 2023 report from Westminster’s Public Accounts Committee, 18 months after its launch the bank had only deployed ‘£1 billion of its £22 billion capital to 10 deals’, and had employed just 16 permanent staff ‘against a target of 320’. The committee also said it was ‘not convinced the bank has a strategic view of where it best needs to target its investments’.

Short-termism is dominant in politics, with ministers keen on short-term results in time for the next election, rather than focusing on the long term when they may no longer be in office. When the government is keen to cut taxes and find ways of cutting government expenditure, it is often easier politically to cut capital expenditure rather than current expenditure. The Treasury oversees fiscal policy and its focus tends to be short term. What is needed is a government department where the focus is on the long term.

One problem that has impacted on productivity is the relatively large number of people working for minimum wages or a little above. Low wages discourage firms from making labour-saving investment and thereby increasing labour productivity. It will be interesting to see whether the labour shortages in the UK, resulting from people retiring early post-COVID and EU workers leaving, will encourage firms to make labour-saving investment.

Another issue is company taxation. Until recently, countries have tended to compete corporate taxes down in order to attract inward investment. This was stemmed somewhat by the international agreement at the OECD that Multinational Enterprises (MNEs) will be subject to a minimum 15% corporate tax rate from 2023. The UK is increasing corporation tax from 19% to 25% from April 2023. It remains to be seen what disincentive effect this will have on inward investment. Although the new rate is similar to, or slightly lower, than other major economies, there are some exceptions. Ireland will have a rate of just 15% and is seen as a major alternative to the UK for inward investment, especially with its focus on cheaper green energy. AstraZeneca has just announced that instead of building its new ‘state-of-the-art’ manufacturing plant in England close to its two existing plats in NW England, it will build it in Ireland instead, quoting the UK’s ‘discouraging’ tax rates and price capping for drugs by the NHS.

And it is not just physical investment that affects productivity, it is the quality of labour. Although a higher proportion of young people go to university (close to 50%) than in many other countries, the nature of the skills sets acquired may not be particularly relevant to employers.

What is more, relatively few participate in vocational education and training. Only 32% of 18-year olds have had any vocational training. This compares with other countries, such as Austria, Denmark and Switzerland where the figure is over 65%. Also a greater percentage of firms in other countries, such as Germany, employ people on vocational training schemes.

Another aspect of labour quality is the quality of management. Poor management practices in the UK and inadequate management training and incentives have resulted in a productivity gap with other countries. According to research by Bloom, Sadun & Van Reenen (see linked article below, in particular Figure A5) the UK has an especially large productivity gap with the USA compared with other countries and the highest percentage of this gap of any country accounted for by poor management.

Solutions

Increasing productivity requires a long-term approach by both business and government. Policy should be consistent, with no ‘chopping and changing’. The more that policy is changed, the less certain will business be and the more cautious about investing.

As far a government investment is concerned, capital investment needs to be maintained at a high level if significant improvements are to be made in the infrastructure necessary to support increased growth rates. As far as private investment is concerned, there needs to be a focus on incentives and finance. If education and training are to drive productivity improvements, then there needs to be a focus on the acquisition of transferable skills.

Such policies are not difficult to identify. Carrying them out in a political environment focused on the short term is much more difficult.

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Data

Questions

  1. What features of the UK economic and political environment help to explain its poor productivity growth record?
  2. What are the arguments for and against making higher education more vocational?
  3. Find out what policies have been adopted in a country of your choice to improve productivity. Are there any lessons that the UK could learn from this experience?
  4. How could the UK attract more inward foreign direct investment? Would the outcome be wholly desirable?
  5. What is the relationship between inequality and labour productivity?
  6. What are the arguments for and against encouraging more immigration in the current economic environment?
  7. Could smarter taxes ease the UK’s productivity crisis?