Home > Data, Fiscal Policy, Inflation > Productivity, Growth and The Deficit

Productivity, Growth and The Deficit

Keynesians love to say that the deficit will come down with growth.  This is 50% wrong, because when Keynesians talk about “growth” we know they mean real GDP growth 100% of the time.  But it is nominal GDP growth which determines the course of the public finances; tax revenue follows nominal GDP and NGDP is the denominator in debt/GDP.  (When we talk about “debt/GDP” it is the only time that “nominal” is implicit!)

Japan had positive real GDP growth for some of its “lost decade”; but it never had any nominal GDP growth.  That is why Japan’s public sector debt/GDP went off the charts; not merely because Japan had insufficient real growth (though that is probably also true).

Keynesians are also 50% right, because under inflation targeting real GDP growth “determines” nominal GDP growth.  This assumption is embedded in many macro models; we read that improving productivity will improve the public finances, which is true because higher productivity ⇒ higher real GDP growth ⇒ higher nominal GDP growth – if inflation is always held constant.

Maybe I’m beating a dead horse here, but Keynesians should be more open about the insane implications of macro models which embed the assumption of price stability.  For example, such models tell us that it is roughly true that the collapse in productivity since 2007 has caused the collapse in the public finances.

Deviation from 1993-2007 Trend of Price Level, Tax receipts and Productivity

Deviation from 1993-2007 Trend of Price Level, Tax receipts and Productivity. Source: ONS CGBV, ANBV, ABMI/YBUS

Categories: Data, Fiscal Policy, Inflation
  1. James in London
    December 13, 2013 at 20:41

    Really clear. I do fear you may need an “irony alert” for American Keynesians, and maybe humourless British ones too.

    • December 18, 2013 at 22:10

      Hey, I was being serious in this post!

      • jamesxinxlondon
        December 19, 2013 at 08:17

        Oh dear. I must be too dim, then. Tight money causes the fall in NGDP causing the fall in productivity that causes the fall in tax revenues. Mmm.

  2. ChrisA
    December 14, 2013 at 08:19

    As your chart shows, UK productivity has basically been flat since 2005, which is the end of a consistent trend of many decades. Facebook started around this same time, I wonder if this is a coincidence?

    More seriously, its pretty amazing and unprecedented that we see this trend come to an end that survived all the recessions and booms, exchange rate crises, various mismanagement of the economy in the 1960’s and 70’s by government picking winners and the various nationalisation and privitisation trend. The UK would be up to 25% more productive if the productivity trend had persisted just an enormous amount. Krugman once said that productivity is not everything, but in the long run it is just about everything. What an under-reported issue.

  3. James in London
    December 14, 2013 at 12:46

    Who cares about productivity if we are all happier? On Facebook, on the iPhone, in touch with our friends. Are Americans happier with their two weeks holiday per person per year? It’s not ALL about work.

    And anyway, in service sector-dominated economies like the UK’s, especially the South East, with law, accountancy, consulting, IT, insurance, finance, civil engineering, etc, productivity is impossible to measure.

    I also suspect our productivity would show higher if the marginal rate of top tax hadn’t been 52% for a few years. Drop the top rate back to 40% and we’d see a lot more “production”.

    • ChrisA
      December 14, 2013 at 23:23

      James, agree with your points, its just striking to me that a trend that has been rock solid for many many decades despite all the changes in the UK economy has now significantly deviated from that trend. I agree with you that measurement could be part of the problem, but I would have thought that would be a gradual change rather than the sharp drop we have seen. One thought of mine is that it is related to oil and gas production in the UK sector, which (combined) peaked at around 2003/4, with a very significant decline in oil afterwards.

      • James in London
        December 15, 2013 at 08:47

        There is good research on this. Oil production has suffered a dramatic and those workers were very productive because of the huge fixed assets they use relative to staff numbers.


        Financial professionals, too. Huge balance sheets controlled by very few people. Those balance sheets have shrunk considerably but staff far, far, less so.

        Remember, the Global Financial Crisis was, well, “financial”, ie it hit financiers and related professionals, too. And they are very well paid, especially the few at the top. They are well paid employees because they can relatively easily flit between employment and self-employment/partnerships/etc. The “going rate” is thus fairly easy to establish.

        Taxing the rich: Is it worth it?

        I think these three factors, oil production, the GFC, and punitive UK tax rates, are unique events, enough to throw long run trends off course.

      • James in London
        December 15, 2013 at 09:00

        You also have to wonder about the impact on productivity of the rise in public spending from 35% to 45% of GDP between 2000 and 2012. And, yes, I know half of this was partly cyclical. But it still counts when you think about productivity.

  4. W. Peden
    December 15, 2013 at 11:49

    James in London,

    Especially when public sector productivity (as measured- obviously the whole idea is suspect) has been falling.

  5. December 18, 2013 at 22:30

    Thanks for all the comments. Public sector productivity has actually been rising since 2010, albeit slowly.

    I find the “North Sea decline” excuse the least convincing. As Chris says this is not at all a new problem, the decline in oil extraction was a *huge* drag on RGDP at various points in the early and mid-2000s. Ex-oil RGVA averaged 3.4% 1998-2008 vs headline GDP at 3.1%.
    It’s true that there was a sharp decline in North Sea output in 2011/12 but this was from a much, much smaller base *relative to ex-oil GDP*. To me all that implies we should raise not lower expectations for trend growth.

    I will try to do some more posts on this, the IFS paper on hours and output/hour is some of the most interesting but it only goes to mid-2012.

  6. December 19, 2013 at 08:44

    jamesxinxlondon :

    Oh dear. I must be too dim, then. Tight money causes the fall in NGDP causing the fall in productivity that causes the fall in tax revenues. Mmm.

    Ah, my fault. I was not trying to be ironic there… I am trying to present the “serious” alternative, supply-side view. If we treat the fall in productivity as the “real” shock, as the pessimists want, then we get “falling productivity ⇒ collapse in NGDP [necessary to keep inflation stable] ⇒ collapse in tax revenue”.

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