Home > Productivity > The Long Run is Now

The Long Run is Now

The 2008 Pre-Budget Report was a response to a combined demand-side and supply-side shock.  The major discretionary changes were a temporary deficit-funded VAT cut (demand-side or supply-side stimulus, take your pick), bringing forward some planned capital spending (ditto), “efficiency saving”-type cuts planned for 2010 onwards, plus:

1. introducing a new 45% marginal tax band for high earners,

2. introducing two new 60% marginal tax bands for high earners (“for no obvious economic rationale” – Robert Chote),

3. raising employee and employer-side national insurance rates from 2011,

4. raising alcohol, tobacco and fuel duty.

Pop quiz.  Would you expect those policy changes to (a) increase or (b) reduce potential aggregate supply?  If you don’t like the framing of this obvious right-wing trap, let’s ask another question.  In that PBR document the Treasury described the situation as follows (p161):

[…] the global credit shock has significantly increased the uncertainties surrounding trend productivity and it is therefore difficult to assess to what extent lower rates of productivity growth over the course of 2007 and 2008 are likely to reflect cyclical or structural developments. Challenges in decomposing recent developments into cyclical and structural elements are likely to persist for some time.

From the perspective of 2014, the last sentence in that quote is certainly astute; the challenge of decomposing cyclical and structural issues has arguably only got harder since 2008.  My (slightly) less loaded question, then: would the aforementioned tax hikes reduce or increase your uncertainty around the future path of productivity?

I had a depressing conversation with a friend recently, a high-skilled high-ish-earner with two growing-up children and a partner looking to return to part-time work after a few years providing full-time childcare.  The family had calculated that due to the insane schedule of child benefit withdrawal, they could raise their net household income by having the high-skilled parent take a day off per week, and have the lower-skilled parent take a part-time job working that day.  (This happens because the increasingly generous personal allowance applies a 0% marginal rate to the lower hourly wage and the benefit withdrawal schedule imposes a 60+% reduction on the higher gross hourly wage.)

That’s only a dumb anecdote, and I hate policy-by-anecdote debates, but it seemed like a good reflection of what has happened to the UK labour market.  Since 2007 the government has introduced policy after policy aimed at reducing labour supply from high-skilled workers, just a sample here:

  1. The top tax band, now back at 45%, remains higher than in 2007.
  2. Marginal tax rates due to various withdrawals have risen at 60% and above for some.
  3. “Fiscal drag” means an increasing proportion of the workforce is hit by higher marginal rates; the IEA claim that in 2013, one in six income tax payers face a 40% tax rate, up from one in sixteen in 1990.
  4. Immigration reform aimed at reducing the number of (future) high-skilled workers entering the country.

For many of the policies above, I would think we would see the “long run” effects pretty quickly.  At the same time, we have benefit reform and a large increase in the personal allowance aimed at increasing labour supply from low-skilled workers.  If you discourage labour supply from high-skilled workers at the same time as encouraging supply from low-skilled workers, what’s the expected effect on average productivity?   I don’t want to overstate the case, but surely at least some of the reduction in productivity which we’ve seen is just not that hard to explain.  (Post title stolen shamelessly from Sumner/Lucas.)

PS.  Since I know some progressives believe raising tax rates causes people to work harder, I asked the Guardian’s personal finance writers for their advice to those facing higher marginal tax rates:

Taking an extra week’s unpaid holiday,

The first six words were enough.

Categories: Productivity
  1. December 18, 2014 at 11:57

    I think currency movements are an under-appreciated part of this story. Productivity is ultimately about RGDP/capital. If we look at russia we see that the falling oil price naturally leads to falling productivity in russia, but it, quite separately puts pressure on the currency, and the economy attempts to move back to equilibrium through domestic inflation and a natural tendency to move ULC back to those determined by the “Law of One Price”. In russia, its easy to see the causality. Oil Price -> falling value of exports -> weak currency -> domestic inflation. So the pro-cyclical currency movement gives you a double whammy to measured productivity, as the price inflation stats move much faster than wages.

    On the other hand, nothing is really changing, so if the oil price returned to $120 Russias productivity would rise and its currency would strengthen, putting downward pressure on domestic prices.

    But didnt the same thing happen to the UK? Except our services were Finance and Legal and Consulting. As international demand for those services rises, then we will get this played out in reverse, as not only will it raise the productivity stats directly, it will also reduce the CA deficit and put upwards pressure on the pound and downwards pressure on other prices.

    • December 18, 2014 at 12:11

      I like that kind of trade story to some degree. The City as a “golden goose” which is just sleeping, rather than dead; when foreign demand for City output explodes it is effectively a massive favourable terms-of-trade shock, and we get to exchange a large volume of imports for a small expenditure of domestic labour (exports). Is that roughly what you are saying?

      On the other hand I don’t like it: it’s really a “labour hoarding” story on acid. Are finance/legal/City workers currently idle? There has been a massive surge in employment in London since 2008, which seems inconsistent with the idea that there is a large pool of idle-ish labour in finance able to ramp up productivity easily.

      • December 19, 2014 at 00:23

        “On the other hand I don’t like it: it’s really a “labour hoarding” story on acid. ”

        So this is is the bit I question. Its not that their idle, its just that they are best in class, so when demand goes up they get to up their price. I would guess, though I don;t know, that investment bank fees are cyclical to some extend. Not only because the biggest deals are hard to finance except in booms, but also because there is more work.

        If you can stay fully employed but put up your prices, then you are more productive by definition right?

      • December 19, 2014 at 07:19

        “If you can stay fully employed but put up your prices, then you are more productive by definition right”

        I don’t see why, that sounds like “inflation” to me. It’s possible that’s true in terms of how the ONS measure M&A output.

        I remember from looking at this before that many of the output measures in finance are quite surprising, things like volume of stock traded, AUM deflated by the the stock price index for a fund manager, etc. Many of those will be highly cyclical, but it’s hard to see why they would not have recovered by now.

  2. SK
    December 18, 2014 at 13:38

    The marginal rates of tax when someone reaches the 40% tax rate and the child benefit withdrawal threshold (50K) are ridiculous.
    There are families out there which suffer under the pressure of high rents and nursery fees and the government does not make their life any easy at all.
    If you add the transport costs, then things are really bad.

  3. james in london
    December 18, 2014 at 16:26

    Britmouse: Your productivity has certainly shot up. Four posts in two days!

    Martin Weale is a continuing disgrace, and seems to have learned nothing from his mistake back in 2011 voting for rate rises. And Ian Mccaskill seems to be doing an Andrew Sentance, vote for rate rises until you are blue in the face, ie until your tenure runs out (next August).

    The duo’s most grievous error is continuing to believe that monetary policy only operates with a lag. As you demonstrate well, parsing the tealeafs to assess the true underlying producitivity situation is fiendishly difficult.

    If we did get strong wage growth and with low RGDP how would the BoE and react? Tighten monetary policy or improve supply side incentives for higher skilled work?

    • December 18, 2014 at 23:40

      James, since blogging is a leisure activity, I’ll blame high taxes and too much leisure for increasing my consumption/output. Also, I think you have confused a BBC weather forecaster with world renowned expert on monetary theory, Ian McCafferty. I agree on lags of course.

      Strong wage growth and slowing RGDP would almost certainly be a case where we have rising inflation & NGDP, so the MPC would tighten I suppose?

      David Miles’ term just got extended to August 2015 I read today, which will allow HMT to replace him & McCafferty at the same time. Stack the deck with doves!

      • james in london
        December 19, 2014 at 12:58

        The two Ians looked the same when I checked on wiki for the spelling, and Mccaskill was standing by a chart of some sort. Perhaps I need to check my glasses.

        Any confusion between economic and weather forecasts is purely accidental.

      • james in london
        December 22, 2014 at 08:58

        Reasonable piece by David Miles in The Sunday Telegraph. The worst part is the overall managerial tone that just reinforces the need to replace the boobies discretion with (good) rules, like NGDP Forecast Targeting.

  1. April 22, 2015 at 11:45

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