Latest resesarch from the independent American think tank The Conference Board paints a worrying picture about the growth of UK labour productivity. While global growth in labour productivity has weakened following the financial crisis, its weakness in the UK is singled out in the Board’s 2019 Productivity Brief. It finds that amongst large mature economies the decline in labour productivity growth rates has been greatest in the UK. This has important implications for the country’s longer-term well-being and, specifically, it peoples’ living standards.
The UK saw the growth in real GDP (national output) fall from 1.8 per cent in 2017 to 1.4 per cent in 2018. The Conference Board predicts that this will fall further to 0.8 per cent in 2019. In the context of living standards, the growth in real GDP per capita is particularly important. An increase in the population will, other things being equal, lower living standards because more people will be sharing a given amount of real national income. The growth in real GDP per capita fell from 1.1 per cent in 2017 to 0.7 per cent in 2018 and is predicted to fall to just 0.1 per cent in 2019.
Chart 1 shows the annual rates of growth in real GDP and real GDP per capita from the 1950s. The average growth rates are 2.4 and 1.9 per cent respectively. The other series shown is the annual growth in real GDP per person employed. This is a measure of the growth in labour productivity. Its average annual growth rate is also 1.9 per cent. This illustrates the intrinsic long-run relationship between labour productivity growth and the growth rate of GDP per capita and hence in general living stanadards. (Click here to download a PowerPoint copy of the chart.)
In the short term, rates of growth in output per worker (labour productivity) and GDP per capita (general living standards) can be less similar. For example, when unemployment rates rise labour productivity rates may be little affected despite GDP per capita falling. Nonetheless, the important point here is the close long-run relationship between the growth in labour productivity and GDP per capita. This then raises an important question: what factors contribute to the growth in output and labour productivity?
An approach known as growth accounting helps to identify four key contributors to the growth of total output. The first is the quantity of labour, commonly measured in labour hours. The second is the quality of labour, also known as labour composition. Third is capital services which are physical inputs into production and include machinery, structures and IT capital. Capital services are affected by quantity and quality, but, unlike labour, it is practically more difficult to separate out these dimensions. Fourth, is Total Factor Productivity (TFP).
TFP it is essentially the residual contribution to output growth that cannot be explained by changes in the quantity and quality of the individual inputs. Hence, in principle, it is capturing changes in how effectively the labour and capital inputs are being employed and combined in production. The Conference Board’s Productivity Brief describes the growth in TFP as providing ‘a more accurate picture of the overall efficiency by which capital, labour and skills are combined in the production process’.
Chart 2 shows Conference Board estimates of the percentage point contribution of these four sources of growth since 1990. Over this period, output growth averaged 2 per cent per year. The contribution of capital services and, hence, what is known as capital accumulation is particularly significant at 1.5 percentage points per year. This has been significantly larger than the contribution of labour hours which averaged only 0.3 percentage points per year since 1990. This evidences the importance played by capital deepening for output growth in the UK. (Click here to download a PowerPoint copy of the chart.)
Capital deepening captures the growth in capital services relative to the growth in the labour input. It takes on even greater significance when we think about the growth in labour productivity since, after all, this is the growth in output relative to the quantity of labour. It is significant though that since 2015 the growth of capital services has contributed only 1 percentage point to output growth while the growth of labour hours has contributed an average of 0.7 percentage points. This points to a slowdown in capital deepening and hence in the growth of labour productivity.
Chart 2 also illustrates the importance of TFP growth to overall output growth. It is also important (along with capital deepening and the growth in labour quality) for the growth in labour productivity. Interestingly, we observe significant fluctuations in the growth of TFP. This is thought to reflect fluctuations in the utilisation of inputs. For example, if the utilisation of inputs falls (rises) when output falls (increases) this will be mirrored by a disproportionately large fall (increase) in TFP. In the longer-term, however, changes in TFP capture aspects of technological progress and advancement that enable more effective production methods and techniques to be deployed. In other words, the growth of TFP captures the ability of production to benefit from the advancement in ideas, products, processes and know-how.
A decline in the growth in TFP growth following the financial crisis is found quite widely in mature economies. The annual rate of growth of TFP across mature economies fell from 0.5 per cent year in 2000-2007 to 0.2 per cent in 2010-2017. In the UK this fall was from 0.5 per cent to -0.1 per cent. Hence, the decline in TFP growth of 0.6 percentage points between 2010 and 2017 was double the 0.3 percentage point fall across all mature economies. In 2018 the Conference Board estimate that TFP in the UK fell by 0.1 percent further exacerbating the downward pressure on labour productivity.
As our final chart shows, it is the magnitude to which labour productivity has eased following the financial crisis that sets the UK apart. While across all mature economies the growth of output per labour hour (another measure of labour productivity growth) fell from an average of 2.3 per cent per year in 2000-2007 to 1.2 per cent in 2010-2017, in the UK the fall was from 2.2 per cent to 0.5 per cent per year. (Click here to download a PowerPoint copy of the chart.)
While the productivity problem facing the UK is not new, the latest figures comes as a very timely reminder of the extent of the problem. To some extent the uncertainty around Brexit and the negative impact on capital accumulation has only helped to exacerbate the problem. But, this may mask a more systemic problem facing the UK. Getting to the root of this problem matters. It matters most significantly for our long-term wellbeing and prosperity. The productivity gap with our major industrial competitors is a gap that policymakers need not only to be mindful of but one that needs closing.
- What do you understand by the term labour productivity. How could we measure it?
- Why is it important to look at the growth of output per capita when assessing the benefits of long-term growth?
- Why is labour productivity important for the long-term well-being of a country?
- What do you understand by the method of growth accounting?
- What is the distinction between capital accumulation and capital deepening?
- What might explain why the growth of labour productivity has been lower in the years following the post-financial crisis?
- What do you understand by Total Factor Productivity (TFP)?
- What does the long-term growth of TFP attempt to capture?
- If you were an economic advisor to the government, what types of policy initiatives might you recommend for a government concerned about low rates of growth of labour productivity?
Consumer credit is borrowing by individuals to finance current expenditure on goods and services. Consumer credit is distinct from lending secured on dwellings (referred to more simply as ‘secured lending’). Consumer credit comprises lending on credit cards, lending through overdraft facilities and other loans and advances, for example those financing the purchase of cars. We consider here recent trends in the flows of consumer credit in the UK and discuss their implications.
Analysing consumer credit data is important because the growth of consumer credit has implications for the financial wellbeing or financial health of individuals and, of course, for financial institutions. As we shall see shortly, the data on consumer credit is consistent with the existence of credit cycles. Cycles in consumer credit have the potential to be not only financially harmful but economically destabilising. After all, consumer credit is lending to finance spending and therefore the amount of lending can have significant effects on aggregate demand and economic activity.
Data on consumer credit are available monthly and so provide an early indication of movements in economic activity. Furthermore, because lending flows are likely to be sensitive to changes in the confidence of both borrowers and lenders, changes in the growth of consumer credit can indicate turning points in the economy and, hence, in the macroeconomic environment.
Chart 1 shows the annual flows of net consumer credit since 2000 – the figures are in £ billions. Net flows are gross flows less repayments. (Click here to download a PowerPoint copy of the chart.) In January 2005 the annual flow of net consumer credit peaked at £23 billion, the equivalent of just over 2.5 per cent of annual disposable income. This helped to fuel spending and by the final quarter of the year, the economy’s annual growth rate had reached 4.8 per cent, significantly about its long-run average of 2.5 per cent.
By 2009 net consumer credit flows had become negative. This meant that repayments were greater than additional flows of credit. It was not until 2012 that the annual flow of net consumer credit was again positive. Yet by November 2016, the annual flow of net consumer credit had rebounded to over £19 billion, the equivalent of just shy of 1.5 per cent of annual disposable income. This was the largest annual flow of consumer credit since September 2005.
Although the strength of consumer credit in 2016 was providing the economy with a timely boost to growth in the immediate aftermath of the referendum on the UK’s membership of the EU, it nonetheless raised concerns about its sustainability. Specifically, given the short amount of time that had elapsed since the financial crisis and the extreme levels of financial distress that had been experienced by many sectors of the economy, how susceptible would people and organisations be to a future economic slowdown and/or rise in interest rates?
The extent to which the economy experiences consumer credit cycles can be seen even more readily by looking at the 12-month growth rate in the net consumer credit. In essence, this mirrors the growth rate in the stock of consumer credit. Chart 2 evidences the double-digit growth rates in net consumer credit lending experienced during the first half of the 2000s. Growth rates then eased but, as the financial crisis unfolded, they plunged sharply. (Click here to download a PowerPoint copy of the chart.)
Yet, as Chart 2 shows, consumer credit growth began to recover quickly from 2013 so that by 2016 the annual growth rate of net consumer credit was again in double figures. In November 2016 the 12-month growth rate of net consumer credit peaked at 10.9 per cent. Thereafter, the growth rate has continually eased. In January 2019 the annual growth rate of net consumer credit had fallen back to 6.5 per cent, the lowest rate since October 2014.
The easing of consumer credit is likely to have been influenced, in part, by the resumption in the growth of real earnings from 2018 (see Getting real with pay). Yet, it is hard to look past the economic uncertainties around Brexit.
Uncertainty tends to cause people to be more cautious. With the heightened uncertainty that has has characterised recent times, it is likely that for many people and businesses prudence has dominated impatience. Therefore, in summary, it appears that prudence is helping to steer borrowing along a downswing in the credit cycle. As it does, it helps to put a further brake on spending and economic growth.
- What is the difference between gross and net lending?
- Consider the argument that we should be worried more by excessive growth in consumer credit than on lending secured on dwellings?
- How could we measure whether different sectors of the economy had become financially distressed?
- What might explain why an economy experiences credit cycles?
- Explain how the growth in net consumer credit can affect economic activity?
- If people are consumption smoothers, how can credit cycles arise?
- What are the potential policy implications of credit cycles?
- It is said that when making financial decisions people face an inter-temporal choice. Explain what you understand this by this concept.
- If economic uncertainty is perceived to have increased how could this affect the consumption, saving and borrowing decisions of people?
Growth in the eurozone has slowed. The European Central Bank (ECB) now expects it to be 1.1% this year; in December, it had forecast a rate of 1.7% for 2019. Mario Draghi, president of the ECB, in his press conference, said that ‘the weakening in economic data points to a sizeable moderation in the pace of the economic expansion that will extend into the current year’. Faced with a slowing eurozone economy, the ECB has announced further measures to stimulate economic growth.
First it has indicated that interest rates will not rise until next year at the earliest ‘and in any case for as long as necessary to ensure the continued sustained convergence of inflation to levels that are below, but close to, 2% over the medium term’. The ECB currently expects HIPC inflation to be 1.2% in 2019. It was expected to raise interest rates later this year – probably by the end of the summer. The ECB’s main refinancing interest rate, at which it provides liquidity to banks, has been zero since March 2016, and so there was no scope for lowering it.
Second, although quantitative easing (the asset purchase programme) is coming to an end, there will be no ‘quantitative tightening’. Instead, the ECB will purchase additional assets to replace any assets that mature, thereby leaving the stock of assets held the same. This would continue ‘for an extended period of time past the date when we start raising the key ECB interest rates, and in any case for as long as necessary to maintain favourable liquidity conditions and an ample degree of monetary accommodation’.
Third, the ECB is launching a new series of ‘quarterly targeted longer-term refinancing operations (TLTRO-III), starting in September 2019 and ending in March 2021, each with a maturity of two years’. These are low-interest loans to banks in the eurozone for use for specific lending to businesses and households (other than for mortgages) at below-market rates. Banks will be able to borrow up to 30% of their eligible assets (yet to be fully defined). These, as their acronym suggests, are the third round of such loans. The second round was relatively successful. As the Barron’s article linked below states:
Banks boosted their long-term borrowing from the ECB by 70% over the course of the program, although they did not manage to increase their holdings of business loans until after TLTRO II had finished disbursing funds in March 2017.
Whether these measures will be enough to raise growth rates in the eurozone depends on a range of external factors affecting aggregate demand. Draghi identified three factors which could have a negative effect.
- Brexit. The forecasts assume an orderly Brexit in accordance with the withdrawal deal agreed between the European Commission and the UK government. With the House of Commons having rejected this deal twice, even though it has agreed that there should not be a ‘no-deal Brexit’, this might happen as it is the legal default position. This could have a negative effect on the eurozone economy (as well as a significant one on the UK economy). Even an extension of Article 50 could create uncertainty, which would also have a negative effect
- Trade wars. If President Trump persists with his protectionist policy, this will have a negative effect on growth in the eurozone and elsewhere.
- China. Chinese growth has slowed and this dampens global growth. What is more, China is a major trading partner of the eurozone countries and hence slowing Chinese growth impacts on the eurozone through the international trade multiplier. The ECB has taken this into account, but if Chinese growth slows more than anticipated, this will further push down eurozone growth.
Then there are internal uncertainties in the eurozone, such as the political and economic uncertainty in Italy, which in December 2018 entered a recession (2 quarters of negative economic growth). Its budget deficit is rising and this is creating conflict with the European Commission. Also, there are likely to be growing tensions within Italy as the government raises taxes.
Faced with these and other uncertainties, the measures announced by Mario Draghi may turn out not to be enough. Perhaps in a few months’ there may have to be a further round of quantitative easing.
- ECB statement following policy meeting
Reuters, Larry King (7/3/19)
- European Central Bank acts to boost struggling eurozone
BBC News, Andrew Walker (7/3/19)
- The European Central Bank Tries to Avoid Repeating Past Mistakes
Barron’s, Matthew C. Klein (8/3/19)
- ECB pushes back rate hike plans, announces fresh funding for banks
CNBC, Silvia Amaro (7/3/19)
- Why the ECB Followed the Fed’s Flip-Flopping
Bloomberg, Mohamed A. El-Erian (7/3/19)
- Central Banks Don’t Have the Answer and Markets Know It
Bloomberg, Robert Burgess (7/3/19)
- Missing out on monetary normalisation
OMFIF, David Marsh (12/4/19)
- The ECB is attempting to get ahead of event
Financial Times, The editorial board (8/3/19)
- Explainer: What is the fuss about European Central Bank TLTRO loans?
Reuters, Balazs Koranyi (4/3/19)
- Investigate the history of quantitative easing and its use by the Fed, the Bank of England and the ECB. What is the current position of the three central banks on ‘quantitative tightening’, whereby central banks sell some of the stock of assets they have purchased during the process of quantitative easing or not replace them when they mature?
- What are TLTROs and what use of them has been made by the ECB? Do they involve the creation of new money?
- What will determine the success of the proposed TLTRO III scheme?
- If the remit of central banks is to keep inflation on target, which in the ECB’s case means below 2% HIPC inflation but close to it over the medium term, why do people talk about central banks using monetary policy to revive a flagging economy?
- What is ‘forward guidance’ by central banks and what determines its affect on aggregate demand?
How would your life be without the internet? For many of you, this is a question that may be difficult to answer – as the internet has probably been an integral part of your life, probably since a very young age. We use internet infrastructure (broadband, 4G, 5G) to communicate, to shop, to educate ourselves, to keep in touch with each other, to buy and sell goods and services. We use it to seek and find new information, to learn how to cook, to download music, to watch movies. We also use the internet to make fast payments, transfer money between accounts, manage our ISA or our pension fund, set up direct debits and pay our credit-card bills.
I could spend hours writing about all the things that we do over the internet these days, and I would probably never manage to come up with a complete list. Just think about how many hours you spend online every day. Most likely, much of your waking time is spent using internet-based services one way or another (including apps on your phone, streaming on your phone, tablet or your smart TV and similar). If your access to the internet was disrupted, you would certainly feel the difference. What if you just couldn’t afford to have computer or internet access? What effect would that have on your education, your ability to find a job, and your income?
Martin Jenkins, a former homeless man, now entrepreneur, thinks that the magnitude of this effect is rather significant. In fact, he is so convinced about the importance of bringing the internet to poorer households, that he recently founded a company, Neptune, offering low-income households in the Bronx district of New York free access to online education, healthcare and finance portals. His venture was mentioned in a recent (and very interesting) BBC article – a link to which can be found at the end of this blog. But is internet connectivity really that important when it comes to economic and labour market outcomes? And is there a systematic link between economic growth and internet penetration rates?
These are all questions that have been the subject of intensive debate over the last few years, in the context of both developed and developing economies. Indeed, the ‘digital divide’ as it is known (the economic gap between the internet haves and have nots) is not something that concerns only developing countries. According to a recent policy brief published by the New York City Comptroller:
More than one-third (34 percent) of households in the Bronx lack broadband at home, compared to 30 percent in Brooklyn, 26 percent in Queens, 22 percent in Staten Island, and 21 percent in Manhattan.
The report goes on to present data on the percentage of households with internet connection at home by NYC district, and it does not take advanced econometric skills for one to notice that there is a clear link between median district income and broadband access. Wealthier districts (e.g. Manhattan Community District 1 & 2 – Battery Park City, Greenwich Village & Soho PUMA), tend to have a significantly higher share of households with broadband access, than less affluent ones (e.g. NYC-Brooklyn Community District 13 – Brighton Beach & Coney Island PUMA) – 88% of total households compared with 58%.
But, do these large variations in internet connectivity matter? The evidence is mixed. On the one hand, there are several studies that find a clear, strong link between internet penetration and economic growth. Czernich et al (2011), for instance, using data on OECD countries over the period 1996–2007, find that “a 10 percentage point increase in broadband penetration raised annual per capita growth by 0.9–1.5 percentage points”.
Another study by Koutroumpis (2018) examined the effect of rolling out broadband in the UK.
For the UK, the speed increase contributed 1.71% to GDP in total and 0.12% annually. Combining the effect of the adoption and speed changes increased UK GDP by 6.99% cumulatively and 0.49% annually on average”. (pp.10–11)
The evidence is less clear, however, when one tries to estimate the benefits between different types of workers – low and high skilled. In a recent paper, Atasoy (2013) finds that:
gaining access to broadband services in a county is associated with approximately a 1.8 percentage point increase in the employment rate, with larger effects in rural and isolated areas.
But then he adds:
most of the employment gains result from existing firms increasing the scale of their labor demand and from growth in the labor force. These results are consistent with a theoretical model in which broadband technology is complementary to skilled workers, with larger effects among college-educated workers and in industries and occupations that employ more college-educated workers.
Similarly, Forman et al (2009) analyse the effect of business use of advanced internet technology and local variation in US wage growth, over the period 1995–2000. Their findings show that:
Advanced internet technology is associated with larger wage growth in places that were already well off. These are places with highly educated and large urban populations, and concentration of IT-intensive industry. Overall, advanced internet explains over half of the difference in wage growth between these counties and all others.
How important then is internet access as a determinant of growth and economic activity and what role does it have in bridging economic disparities between communities? The answer to this question is most likely ‘very important’ – but less straightforward than one might have assumed.
- Comptroller, New York City, Internet Inequality
- Czernich, N., Falck, O., Kretschmer, T. and Woessmann, L., 2011, Broadband infrastructure and economic growth, The Economic Journal, 121(552), pp.505–32
- Koutroumpis, P., 2018, The economic impact of broadband: evidence from OECD countries, Ofcom
- Atasoy, H., 2013, The effects of broadband internet expansion on labor market outcomes, ILR Review, 66(2), pp.315–45
- Forman, C., Goldfarb, A. and Greenstein, S., 2009, The Internet and Local Wages: Convergence or Divergence? (No. w14750), National Bureau of Economic Research
- Is there a link between economic growth and internet access? Discuss, using examples.
- Explain the arguments for and against government intervention to subsidise internet access of poorer households.
- How important is the internet to you and your day to day life? Take a day offline (yes, really – a whole day). Then come back and write about it.
With the UK parliament in Brexit gridlock, the Labour opposition is calling for a general election. Although its policy over Brexit and a second referendum is causing splits in the party, the Labour party is generally agreed that pubic expenditure on health, education and transport infrastructure needs to increase – that there needs to be an end to fiscal austerity. However, to fund extra public expenditure would require an increase in taxes and/or an increase in government borrowing.
One of the arguments against increasing government borrowing is that it will increase public-sector debt. The desire to get public-sector debt down as a percentage of GDP has been central to both the Coalition and Conservative governments’ economic strategy. Austerity policies have been based on this desire.
But, in the annual presidential address to the American Economics Association, former chief economist at the IMF, Olivier Blanchard, criticised this position. He has argued for several years that cutting government deficits may weaken already weak economies and that this may significantly reduce tax revenues and potential national income, thereby harming recovery and doing long-term economic damage. Indeed, the IMF has criticised excessively tight fiscal policies for this reason.
In his presidential address, he expanded the argument to consider whether an increase in government borrowing will necessarily increase the cost of servicing government debt. When the (nominal) interest rate (r) on government borrowing is below the nominal rate of economic growth (gn), (r < gn), then even if total debt is not reduced, it is likely that the growth in tax revenues will exceed the growth in the cost of servicing the debt. Debt as a proportion of GDP will fall. The forecast nominal growth rate exceeds the 10-year nominal rate on government bonds by 1.3% in the USA, 2.2% in the UK and 1.8% in the eurozone. In fact, with the exception of a short period in the 1980s, nominal growth (gn) has typically exceeded the nominal interest rate on government borrowing (r) for decades.
When r < gn, this then gives scope for increasing government borrowing to fund additional government spending without increasing the debt/GDP ratio. Indeed, if that fiscal expansion increases both actual and potential income, then growth over time could increase, giving even more scope for public investment.
But, of course, that scope is not unlimited.
- What do you understand by ‘fiscal illusion’?
- What is the justification for reducing government debt as a proportion of GDP?
- What are the arguments against reducing government debt as a proportion of GDP?
- Explain the significance of the relationship between r and gn for fiscal policy and the levels of government debt, government borrowing and the government debt/GDP ratio.
- Under what circumstances would a rise in the budget deficit not lead to a rise in government debt as a proportion of GDP?
- Does Blanchard’s analysis suggest that a combination of both loose monetary policy and loose fiscal policy is desirable?
- Under Blanchard’s analysis, what would limit the amount that governments should increase spending?