Productivity and potential 2003-2012: the UK decade that decayed

By Jeremy Smith

It’s time to return to the issue of overall “national labour productivity”. By this we mean, what is the level of productivity of the whole available labour force – not just those who happen to have employment? See here:

Chart 1

GDP per econ active 2003-12 (May18)
GDP per econ active 2003-12 (May18)

Data: ONS

Very recently, David Blanchflower and David Bell have published a new report which provides an index combining unemployment and underemployment, a welcome addition to labour market analysis. They conclude:

“There appears to be significant slack in the economy. The primary argument made by the supporters of the government’s current macroeconomic stance is that what’s going on in the labour market shows that the UK economy is primarily supply not demand constrained, that the output gap is small, and crucially that the labour market statistics show that we are now quite close to full employment or the NAIRU. The paper [shows] that there is very substantial spare capacity in the labour market; the implication being that if demand were higher, output could easily be higher… without exerting any significant upward pressure on real wages.”

This also reminds us of what J.M.Keynes wrote in a letter to The Times in 1935:

“All our ideas about economics, instilled into us by education and atmosphere and tradition, are…soaked with theoretical presuppositions which are only properly applicable to a society which is in equilibrium, with all its productive resources already employed. Many people are trying to solve the problem of unemployment with a theory which is based on a theory that there is no unemployment.”

And in Chapter 2 of the General Theory he also refers to

“The question… of the volume of the available resources, in the sense of the size of the employable population”.

The aim of this blog is not to offer a General Theory (phew) but to demonstrate graphically (sic) the impact of unused labour force human potential on UK productivity, in an age where demand is so far quite insufficient to enable a substantial part of the national labour force to find work or enough work – even though wages on average have been falling consistently in real terms and our labour market is one of the world's most deregulated.

In our report "Ailing economy, failing solutions" we put it like this:

"Curiously, the one measure of our national economy's productivity that seems to us by far the most apporpriate is one not even mentioned by the ONS, nor does it feature in most discussions around the 'puzzle' of the UK economy.  That is, to measure national productivity not as "value of outputs divided by labour input (in its various forms)" but as "Value of outputs divided by the sum of the actual and potential labour inputs", i.e. adding in the (wasted) potential of the unemployed." (NB we received a comment saying we should also include those defined as inactive but wanting a job; good point but we have kept it simple for now.)

We show - it is clear from Chart 1 above - that this failure to generate demand has had a severe negative impact on the UK’s economic performance and productivity, and that constant GDP per “economically active person” has fallen dramatically from its peak and is – in real terms – back to the level of 2003. Hence, the UK's decayed decade.

We also show that over a 10 year period, GDP per economically active person grew at a faster rate than GDP itself up to 2008.  This shows the benefits of employing a greater percentage of the available workforce. But from 2006, GDP has in general risen faster, or fallen more slowly, than the rate of GDP per economically active person, reflecting the opposite - a chronically high number of unemployed, around 2.5 million. Chart 2 shows the relationship between changes in in the index of GDP and of GDP per economically active person (2009 = 100 as this is the ONS base for productivity stats).

Chart 2

GDP and GDP per EA 2003-2012
GDP and GDP per EA 2003-2012

The classical methods of calculating overall labour productivity are output per hour, and output per worker. Chart 3 looks at the 15 year relationship from 1998 between their respective indices, also including the index of GDP change over the period.

Chart 3

measures of productivity 1998-2012
measures of productivity 1998-2012

Again, productivity seen in % terms of the whole potential and actual workforce (EA) rose fastest of all these indices up to 2008, and has now fallen back - more or less in line with the other measures.  Output per worker also rose faster than GDP itself till 2005, but has also now fallen back to its 2005 level.  Chart 4 looks at the same but over the last 10 years, which shows the recent changes more clearly, especially the opening of the "scissors" between GDP and the measures of productivity.

Chart 4

Measures of productivity 2 (2003-12)
Measures of productivity 2 (2003-12)

In conclusion, Chart 4 shows that UK labour productivity has indeed fallen back dramatically, whether looked at in terms of output per hour, output per worker, or output (GDP) per economically active person.  But the measures of productivity that focus on people in work are slightly less bad - output per hour in Q4 2012 is like that in mid-2006, while output per worker is at the level of late 2005.  But if you take the unused capacity of the unemployed into account, we are all the way back... to 2003.

Back to exactly where we were, 10 long years ago.

Nearly a year ago, we did several posts on this website (e.g. here) in which we explained the "productivity puzzle" as being significantly due to falling real wages, and the fact that more workers were working for less pay to produce "no more stuff".  In other words, labour was being substituted for capital in a context of a deregulated labour market.  This was not a fashionable view at the time - we challenged the Sunday Times' David Smith.  (And yes we got it partly wrong in assuming last year's growth in part-time self-employed was a secular trend).

But on the main point, it is good to see others coming round to our point of view.  John Van Reenen, Director of the Centre for Economic Performance at the London School of Economics, has recently posted an article "Jobs, wages and poor growth".  In it he says:

"The main explanation for the puzzle is that real earnings have fallen massively since 2008... Regular pay rose by only 0.8% this year – the lowest growth since records began. Cheaper labour means that employers do not have to lay off so many workers in spite of lower sales.

 This pattern of falling real wages in a recession is new: real wages did not fall in the early 1980s and early 1990s recessions. It is likely that this increased wage flexibility is due to the decline of union power and welfare-to-work reforms over the last three decades."

Amen!  What we are seeing is people desperate to take part in the labour market, but with private sector debt deleveraging, and without major new demand, they are having to "share" the available output between them.