The OBR needs to get it right on productivity

If our forecasts carry on being made on faulty assumptions the government will never learn.

The Office for Budget Responsibility is making a critical mistake in being excessively gloomy about a lack of productive potential in the UK since the 2007 crisis.

One of the characteristics of the recession has been how quickly employment levels have returned to pre-recession levels. The OBR interprets this as being a result of severe damage to the productive capacity of the economy. Any demand expansion through fiscal policy to stimulate growth would, in its opinion, quickly run into production bottlenecks and hence price increases rather than an increase in output. OBR estimates put spare capacity, the potential to meet any new demand, at below 3 per cent. The issue is, where's the firm evidence for this view?

Historically, the UK economy has always returned quickly to its underlying long-run trend in productivity growth following a recession, and there's nothing to suggest this pattern has changed. The OBR is simply being far too pessimistic. Based on the evidence from past trends, the current level of spare capacity is likely to be nearer to 12 per cent than 3 per cent, mostly in the form of underemployed labour. Employers have decided to hold onto workers rather than risk running down their workforce.

The OBR has powerful allies in its position on capacity from the Treasury and the Bank of England. So who's right? What can look like an academic detail around the nature of 'spare capacity' has a direct impact on the livelihoods of huge numbers of workers and their families. It's important that such powerful institutions take a closer look at why there is so much disagreement between experts.

The first step is to understand how the current recession differs from those in the past and the implications. The drop in output has been more severe and persisted far longer than all previous recessions in the past forty years. Output has still not reached its pre-recession level after five years and there is little chance of it doing so before 2015. At the same time, employment growth has confounded the forecasters. Employment fell by 600 thousand following the 2008 downturn but recovered to exceed its pre-recession level by 2012. Despite stagnant output growth, employment increased by 700 thousand (2 percentage points) between 2010 and 2012.

The overall increase in employment between 2010 and 2012 is not all that it seems at first sight. Firstly, more than half of the additional jobs have been for part-time, not full-time, workers. For women, nearly three-quarters of the extra jobs have been for part-time workers. Secondly, workers are not working as many hours as they would like. According to the Office for National Statistics, one in ten workers wanted to work more hours than they were offered during 2012; and between 2008 and 2012, the number of workers who wanted to work more hours increased by one million. Thirdly, there were half a million fewer full-time jobs in 2012 than at the start of the recession.

Employers are temporarily "hoarding" labour so that output can be increased more rapidly when demand recovers. They don't want to lose skilled and experienced workers; keeping workers on during periods of slack demand can help build morale and good relations; and laying workers off can be difficult and expensive. There is also, for example, no evidence of large-scale scrapping of plant and machinery as happened in the manufacturing sector during the recession of the early 1980s.

The likelihood that low productivity in the UK is a consequence of labour hoarding is supported by international trends. Employers in the USA are less reluctant to shed labour during recessions than UK employers. The drop in labour productivity following the financial crisis was consequently much smaller in the USA than in the UK despite a very similar drop in output. The German experience has been similar to the UK. Jobs were protected in the early part of the recession through government sponsored short-time working schemes. This resulted in a sharp drop in labour productivity and a rise in labour hoarding.

The OBR is surely wrong to assume there has been no growth in productive potential since 2007. This not only assumes that technological progress has come to a stop because of the recession, which seems most unlikely, but also denies the likelihood that productivity has been held down because of substantial labour hoarding. The existence of large amounts of spare capacity in the UK economy implies that a demand expansion could be achieved without any serious inflationary consequences. Even if the growth in productive capacity has not kept pace with its historical trend, a growth rate of only half the historical trend would still leave enough spare capacity to justify a demand injection in order to bring a quicker end to the recession.

It is surely the right time to get the economy moving forward again by financing much needed infrastructure projects and new housing developments. To do otherwise would be seriously wasteful and ongoing pessimism could lead to a withering of productive capacity over the longer term. It is high time the Treasury took some positive action instead of burying its head in the sand.

A trader sleeps at her desk. Photograph: Getty Images

Jim Taylor is an Emeritus Professor at Lancaster University Management School.

Photo: Getty
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Here's what Theresa May could say to save the Brexit talks

The best option would be to invent a time machine, but unfortunately that's not on the table. 

One of my favourite types of joke is the logical impossibility: a statement that seems plausible but, on closer examination, is simply impossible and contradictory. “If you break both legs, don’t come running to me” is one. The most famous concerns a hapless tourist popping into a pub to ask for directions to London, or Manchester, or Belfast or wherever. “Well,” the barman replies, “I wouldn’t have started from here.”

That’s the trouble, too, with assessing what the government should do next in its approach to the Brexit talks: I wouldn’t have started from here.

I wouldn’t have started from a transient Leave campaign that offered a series of promises that can’t be reconciled with one another, but that’s the nature of a referendum in which the government isn’t supporting the change proposition. It’s always in the interest of the change proposition to be at best flexible and at worst outright disregarding of the truth.

Britain would be better off if it were leaving the European Union after a vote in which a pro-Brexit government had already had to prepare a white paper and an exit strategy before seeking popular consent. Now the government is tasked with negotiating the terms of Britain’s exit from the European Union with a mandate that is contradictory and unclear. (Take immigration. It’s clear that a majority of people who voted to leave want control over Britain’s borders. But it’s also clear that a minority did not and if you take that minority away, there’s no majority for a Leave vote.

Does that then mean that the “democratic” option is a Brexit that prioritises minimising economic harm at the cost of continuing free movement of people? That option might command more support than the 52 per cent that Leave got but it also runs roughshod over the concerns that really drove Britain’s Leave vote.

You wouldn’t, having had a referendum in inauspicious circumstances, have a government that neglected to make a big and genuinely generous offer on the rights of the three million citizens of the European Union currently living in the United Kingdom.

In fact the government would have immediately done all it could to show that it wanted to approach exit in a constructive and co-operative manner. Why? Because the more difficult it looks like the departing nation is going to be, the greater the incentive the remaining nations of the European Union have to insist that you leave via Article 50. Why? Because the Article 50 process is designed to reduce the leverage of the departing state through its strict timetable. Its architect, British diplomat John Kerr, envisaged it being used after an increasingly authoritarian state on the bloc’s eastern periphery found its voting rights suspended and quit “in high dudgeon”.

The strict timeframe also hurts the European Union, as it increases the chances of an unsatisfactory or incomplete deal. The only incentive to use it is if the departing nation is going to behave in a unconstructive way.

Then if you were going to have to exit via the Article 50 process, you’d wait until the elections in France and Germany were over, and restructure Whitehall and the rest of the British state so it was fit to face the challenges of Brexit. And you wouldn’t behave so shabbily towards the heads of the devolved administrations that Nicola Sturgeon of the SNP and Carwyn Jones of the Welsh Labour Party have not become political allies.

So having neglected to do all of that, it’s hard to say: here’s what Theresa May should say in Florence, short of inventing time travel and starting the whole process again from scratch.

What she could do, though, is show flexibility on the question of British contributions to the European budget after we leave, and present a serious solution to the problem of how you ensure that the rights of three million EU citizens living in Britain have a legal backdrop that can’t simply be unpicked by 325 MPs in the House of Commons, and show some engagement in the question of what happens to the Irish border after Brexit.

There are solutions to all of these problems – but the trouble is that all of them are unacceptable to at least part of the Conservative Party. A reminder that, as far as the trouble with Brexit goes, Theresa May is the name of the monster – not the doctor. 

Stephen Bush is special correspondent at the New Statesman. His daily briefing, Morning Call, provides a quick and essential guide to domestic and global politics.