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.

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Why the Psychoactive Substances Act is much better than anyone will admit

Under the Psychoactive Substances Act it will not be a criminal offence for someone to possess for their own consumption recreational drugs too dangerous to be legally sold to the public.

From Thursday, it may be illegal for churches to use incense. They should be safe from prosecution though, because, as the policing minister was forced to clarify, the mind-altering effects of holy smells aren’t the intended target of the Psychoactive Substances Act, which comes into force this week.

Incense-wafters aren’t the only ones wondering whether they will be criminalised by the Act. Its loose definition of psychoactive substances has been ridiculed for apparently banning, among other things, flowers, perfume and vaping.

Anyone writing about drugs can save time by creating a shortcut to insert the words “the government has ignored its advisors” and this Act was no exception. The advisory council repeatedly warned the government that its definition would both ban things that it didn’t mean to prohibit and could, at the same time, be unenforcable. You can guess how much difference these interventions made.

But, bad though the definition is – not a small problem when the entire law rests on it – the Act is actually much better than is usually admitted.

Under the law, it will not be a criminal offence for someone to possess, for their own consumption, recreational drugs that are considered too dangerous to be legally sold to the public.

That sounds like a mess, and it is. But it’s a mess that many reformers have long advocated for other drugs. Portugal decriminalised drug possession in 2001 while keeping supply illegal, and its approach is well-regarded by reformers, including the Liberal Democrats, who pledged to adopt this model in their last manifesto.

This fudge is the best option out of what was politically possible for dealing with what, until this week, were called legal highs.

Before the Act, high-street shops were free to display new drugs in their windows. With 335 head shops in the UK, the drugs were visible in everyday places – giving the impression that they couldn’t be that dangerous. As far as the data can be trusted, it’s likely that dozens of people are now dying each year after taking the drugs.

Since legal highs were being openly sold and people were thought to be dying from them, it was obvious that the government would have to act. Until it did, every death would be blamed on its inaction, even if the death rate for users of some newly banned drugs may be lower than it is for those who take part in still-legal activities like football. The only question was what the government would do.

The most exciting option would have been for it to incentivise manufacturers to come up with mind-altering drugs that are safe to take. New Zealand is allowing drug makers to run trials of psychoactive drugs, which could eventually – if proved safe enough – be sold legally. One day, this might change the world of drug-taking, but this kind of excitement was never going to appeal to Theresa May’s Home Office.

What was far more plausible was that the government would decide to treat new drugs like old ones. Just as anyone caught with cocaine or ecstasy faces a criminal record, so users of new drugs could have been hit with the same. This was how legal highs have been treated up until now when one was considered serious enough to require a ban.

But instead, the government has recognised that its aim – getting new drugs out of high-street shop windows so they don’t seem so normal – didn’t depend on criminalising users. A similar law in Ireland achieved precisely this. To its credit, the government realised it would be disproportionate to make it a criminal offence to possess the now-illegal highs.

The reality of the law will look chaotic. Users will still be able to buy new drugs online – which could open them to prosecution for import – and the law will do nothing to make drugs any safer. Some users might now be exposed to dealers who also want to sell them more dangerous other drugs. There will be few prosecutions and some head shop owners might try to pick holes in the law: the government seems to have recognised that it needed a better definition to have any chance of making the law stick.

But, most importantly for those of us who think the UK’s drug laws should be better at reducing the damage drugs cause, the government, for the first time, has decided that a class of recreational drugs are too dangerous to be sold but that it shouldn’t be a crime to possess them. The pressure on the government to act on legal highs has been relieved, without ordinary users being criminalised. For all the problems with the new law, it’s a step in the right direction.

Leo Barasi is a former Head of Communications at the UK Drug Policy Commission. He writes in a personal capacity