Labour-hoarding, capital mismatch or simply the wrong data on GDP. Whatever you blame for unimproving productivity during the economic downturn, its existence is worrying
Something weird seems to be happening to the economy and, despite having important implications, only a few geeky economists appear to have noticed. Productivity – the average amount produced by each employee in an hour – has apparently fallen just when you would expect it to rise.
For those who do not spend several hours a day thinking about economics a sports analogy should help explain why this is so odd. Imagine a troubled cricket team that decides to get rid of some of its weakest players. The batting and bowling averages for the team would be expected to improve simply as a result of removing the laggards.
This effect is of course simply mathematical. Just getting rid of weak players does not in itself create a stronger team. But it does make the team figures look better.
A similar process would be expected to happen in a recession. Say that the weakest firms are shut down in a time of economic difficulties. Under those circumstances the productivity figures would be expected to improve even if nothing else changed in the economy.
Of course the hope would be that the stronger firms would reorganise themselves and invest in new technology. That would then create the basis for an economic recovery.
Only the UK’s productivity levels seem to be roughly where they were when the recession first hit in 2008. Output is still about 4 per cent down from its peak while many new jobs – a lot of them part-time – have been created.
Indeed David Cameron did what you would expect any politician to do with such statistics during his recent speech at the Conservative party conference. He pointed out that over 1m jobs have been created in the private sector since his government took office in 2010. Naturally he failed to draw out what this means for productivity.
It was Joe Grice, the chief economist of the Office for National Statistics, who brought what he called the “productivity conundrum” to the public’s attention in a paper* published in the summer. Ben Broadbent, an external member of the Bank of England’s monetary policy committee, has subsequently raised in it a speech** in August. Economist journalists such as Martin Wolf of the Financial Times and Stephanie Flanders of the BBC have discussed it too.
The most obvious explanation for the puzzle is that the data is simply wrong. Some have suggested, for instance, that the official figures underestimate the real level of GDP.
However, Grice argues this is unlikely. He says the GDP figures are based on a broad range of data and the results are confirmed by a lot of survey data. He also points to a similar trend in Germany and Italy.
Assuming the figures are right there are several possible explanations. One is that labour hoarding is going on. In other words firms are holding on to a lot of unproductive workers, rather than making them redundant, in the hope that there will be an upturn soon. That way they hope to avoid the cost of recruiting and training new staff.
The fact that corporate cash flow has remained strong during the recession has made it easier for firms to hold on to workers. Companies are under less immediate financial pressure to get rid of existing workers.
Another explanation of the productivity puzzle is that employers are replacing machines with workers. Since the cost of capital is high at present it is often cheaper to get individual employees to do tasks that machines would previously have done.
A final possibility raised by Broadbent is that of a capital mismatch. Capital has struggled to move from sectors of the economy hit badly by the economy to relatively stronger areas. In contrast, labour has proved relatively mobile.
Of course these different factors are not mutually exclusive. It could be that the productivity puzzle is the result of a combination of factors along with some statistical mis-measurement.
However, it seems to me likely that something more fundamental is going on. The economy is simply not being restructured on a significant scale.
From this perspective a recession should be like a healing process: although it is painful for many it creates the basis for a new round of growth. This is a process Joseph Schumpeter, one of the leading economists of the early twentieth century, called “creative destruction” (“Economic debate is missing a beat” Fund Strategy, 14 November 2011).
To go back to the cricket analogy the recovery process is roughly akin to a team improving its existing players and bringing on board new ones. That way it can become genuinely stronger rather than simply having higher statistical averages.
The fact that productivity does not appear to be improving, even during such a protracted economic downturn, is a deeply worrying sign.
* Joe Grice “The productivity conundrum, interpreting the recent behaviour of the economy”. Office for National Statistics. 24 August 2012.
** Ben Broadbent “Productivity and the allocation of resources”. Speech at Durham Business School. 12 September 12, 2012.