A UK Supply-Side Counterfactual
I started wondering about Switzerland.
Consider what would happen if Swiss productivity falls 50% tomorrow. What would happen to the level of Swiss output? Well, we know that Switzerland is at the ZLB, and so Swiss real GDP is determined by Swiss fiscal policy… right? Therefore, absent any change in Swiss fiscal policy, Swiss real GDP would stay the same, and the 50% fall in productivity implies that Swiss workers would immediately double their number of hours worked, so they could retain the same level of real income (output). That logic is unassailable. There is no other possible way that the Swiss could keep real GDP the same except by a doubling in employment, defined in terms of hours worked.
Obviously that argument is totally bonkers. Who really believes that the level of Swiss output is unrelated to the level of Swiss productivity? Now read the argument repeated endlessly by the likes of Martin Wolf (H/T Mr. Portes), writing today on the Autumn Statement:
Unfortunately, this heartwarming performance on employment is a mirror image of the dismal performance on productivity. Ultimately, real wages have fallen because output per hour has fallen. That has softened job losses. The OBR assumes the past productivity losses, relative to the trend, will not be recouped. Yet it hopes growth of output per hour will recover to close to 2 per cent by 2015.
“output per hour has fallen. That has softened job losses.”
Falling productivity is the mirror image of rising employment… because we know that UK output is demand-determined – is determined by George Osborne’s fiscal austerity.
I don’t see why that argument is any less bonkers. Does Martin Wolf really believe that the level of UK output is unrelated to the level of productivity? That is exactly what he argues.
The OBR’s March 2011 forecast appears to be the first time they published a forecast for total hours worked. I’ve graphed below the change in the level of UK real GDP since 2011 Q1 in three different ways:
1) The OBR forecast,
2) What the current ONS data say actually happened,
3) A supply-side counterfactual derived from:
a) The expected path of UK productivity (output/hour) from the OBR forecast, and
b) The actual observed path of UK total hours worked from the current ONS data.
This simple 5-minute counterfactual implies that the productivity collapse more than explains the entire shortfall of output (vs expected) since 2011. By 2013 Q3, hours worked is 3% higher than expected, and productivity is 7% lower.
Now consider the “fiscalist” claims that the weakness of UK real GDP since 2010 is evidence that the “fiscal multiplier” is real and large. That works perfectly, but not as a demand-side argument; as a supply-side argument it fits the data extremely well.