Home > Data, Fiscal Policy > A UK Supply-Side Counterfactual

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.

UK Real GDP: Expected, Actual, and Supply-Side Counterfactual

UK Real GDP: Expected, Actual, and Supply-Side Counterfactual. Source: ONS, OBR, Author’s Calculations

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.

Categories: Data, Fiscal Policy
  1. December 7, 2013 at 00:43

    I’m inclined to view the UK’s GDP weakness since 2010 as primarily a supply-side problem. I know this is controversial, but…..double-digit inflation in energy & fuel prices across all sectors is a pretty hefty supply shock.

    • December 8, 2013 at 21:01

      Frances – yes, it is one interpretation of the data. But I am not completely convinced. The nominal GDP numbers are very very weak, which screams a demand problem. I would quite like comments saying I am making some basic error with posts like this about the supply-side!

  2. February 9, 2015 at 11:25

    I missed this post. I always come back to the same conclusion. GDP, employment, and productivity between them measure only two real things. There is a hard constraint: GDP = employment*productivity, loosely speaking.

    If GDP falls, (at least) one of employment and productivity must fall. Perhaps the split between them is nothing other than a cultural fit. Americans seem much happier firing large numbers of people than the British. Perhaps its labour laws.

    I think world if just referring to this hard constraint. For a given GDP performance, the UK had better employment and worse productivity, and the US had worse employment and better productivity, and in aggregate that means….nothing?

    I can switch round your question – is it really believable that UK workers are suddenly much less productive than US ones? Why?

    Anyway, its dangerous to given any one of these series primacy, none of them is “more real” than any other.

    • February 9, 2015 at 11:25

      *Wolf*, not world. Sorry

    • February 9, 2015 at 13:18

      Maybe I explain it badly, but I find it hard to read the Wolf (et al) “explanation” of UK employment as anything other than a claim that “falling productivity has CAUSED higher employment”. Of course the arithmetic must work, X=Y*Z, but you can’t reason from an accounting identity. What’s the MECHANISM? Were the Luddites right, and did George Osborne rampage around the country smashing up “the machines”?

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