Sunday, January 15, 2012
We need productivity, but first we need growth
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


My regular column is available to subscribers on This is an excerpt.

Maybe I spoke too soon. The appropriate response to the eurozone downgrades announced on Friday by Standard & Poor's is to ignore them. But that is not happening, so the eurozone is back in crisis.

This time last week I was celebrating the stronger than expected data we had seen since the start of the year. Then, three days ago, the Office for National Statistics came out with a gloomy set of industrial figures and we appear to be back to square one.

There is a difference. The surveys I was reporting on last Sunday applied to December, while the industrial numbers were for November, when we knew things were weak.

Even so, there is now a mountain to climb if Britain’s gross domestic product is to avoid a fall in the final quarter of 2011 when the statsitics are out on January 25. The arithmetic is straightforward. Industrial production taking October and November together was 1.2% lower than the third quarter.

That is enough, barring a December recovery, to shrink GDP by 0.2% in the fourth quarter. The service sector accounts for the lion’s share of the economy and could compensate but it too had a bad start to the quarter.

The National Institute of Economic and Social Research predicts 0.1% quarterly growth but it is in a minority. The City expects a small fall. Some of that will be down to temporary factors like the mild autumn which has reduced gas supply by 23.6% year-on-year (the weather is never right these days).

Some of it is explained by longer-run changes, including a 14.6% annual drop in “mining and quarrying”, which includes a sharp drop in North Sea oil production, Scottish Nationalists please note.

There is no doubt, however, that there was genuine economic weakness, which one hopes reached its peak in the autumn when fears of a eurozone catastrophe were at their height.

We also had figures for German GDP, “Bruttoinlandsprodukt” as they say in Wiesbaden. There was much to envy in these numbers, which showed 3% growth in 2011 after 3.7% in 2010. German GDP rose above pre-crisis levels during 2011, while Britain is still 4% below where we were. Even the German economy stalled at the end of 2011, however.

If growth in Britain has stalled, or worse - this week’s Ernst & Young Item Club report will talk of “ state of paralysis” for the economy - it will be regrettable, and not just for the obvious reasons.

The two fundamental questions for the economy in the next few years are first, whether growth in productivity - output per worker - can resume its earlier trend and secondly, whether the damage to the economy from the crisis and recession is as bad and as permanent as feared.

It is a big issue. Paul Krugman’s dictum, “productivity isn’t everything but in the long-run is almost everything” neatly captures the fact that without productivity there can be no sustained prosperity.

On the face of it, Britain has been living in a productivity vacuum for the past four years. Employment did not fall as much as feared in the recession but only because productivity did.

In a Policy Exchange pamphlet published at the end of last year, I pointed out that output per worker was some 14% to 15% below where it would be if the pre-recession trend had continued.

I offered some reasons for optimism. There has been no meaningful growth in public sector productivity since the mid-1990s. Rebalancing the eceonomy away from the public sector to the more productive private sector should automatically boost productivity. I also offered some policy advice around the coalition government’s five “drivers” of productivity: investment, innovation, skills, enterprise and competition.

Then, right at the end of last year, we had some modest grounds for optimism of productivity. Official figures showed output per worker rose 1.2% in the third quarter and was up on a year earlier.

The picture for manufacturing was particularly encouraging with productivity at record levels, up by 3.2% over 12 months on an output per job basis and 4.7% measured by output per worker.

Partly spurred by these numbers, Kevin Daly and Adrian Paul, economists at Goldman Sachs, published a rejoinder to the gloom on productivity and the permanent damage to Britain’s economy.

On the latter point, they noted that the economy has shown remarkably steady long-term growth, since about 1920, despite many shocks to the system along the way. As they put it: “Traumatic as the financial crisis has been, it is difficult to argue that it will have a more lasting effect on potential output than either the Great Depression or the Second World War.”

At the very least, it is too early to say that the economy has gone ex-growth, or entered a lost decade.

The Goldman Sachs economists were also optimistic on productivity. One commonly cited reason for productivity pessimism, that some of the highest growth in output per worker was in financial services and that will play a diminishing role in future, is balanced by the fact that so will the low-productivity public sector.

Not only that but Germany and Sweden, they noted, suffered bigger declines in productivity than Britain during the crisis and recession, but both have seen big improvements as their economies have recovered. A similar phenomenon is likely in Britain.

But this brings us back to those disappointing production figures and the prospect of a downbeat number for GDP. Economics can never be a laboratory experiment or merely a run on a computer model.

The test for productivity - and ultimately prosperity - will only come when the recovery is stronger. That will also provide a test of how much GDP was permanently lost and how much spare capacity remains.

A stop-start recovery does not provide the answers to these questions. It leaves us in limbo about where we will be as an economy in three, five or 10 years time.

We need productivity but first we need production. It is hard to have one without the other.