Home > Data, Productivity, UK GDP > UK Supply-Side Counterfactual, updated

UK Supply-Side Counterfactual, updated

Back in 2013 I described a (crude) supply-side counterfactual for UK real GDP using the OBR’s 2011 Forecast as the baseline.  Here is an update which uses the data from the OBR’s June 2010 Budget forecast and extends to 2014.  (I am not sure why I did not find the forecast for hours worked in the 2010 forecast before.)

The exercise is again simple (or if you want, much too simple): I take the OBR’s June 2010 forecast of output per hour, the observed data for total hours worked, and calculate a supply-side counterfactual path for real GDP.  That path is compared against both the OBR’s June 2010 forecast of real GDP, and the actual data we have for for real GDP – I’ve rebased this time to highlight the difference since the pre-recession peak.

UK Real GDP, Forecast and Counterfactual: 2008 Q1 = 100

UK Real GDP, Forecast and Counterfactual: 2008 Q1 = 100. Source: ONS, OBR, Own Calculations

It remains true that a purely demand-side view of the UK recovery seems to prove too much.  At least, it is hard to see that the weakness of RGDP relative to expectations circa June 2010 can be explained by a demand-side view; the shortfall in output is simply not a reflection of a shortfall in employment.

IFS chief Paul Johnson laments the absence of political debate about productivity:

What happens next to productivity will define our economic performance over the next five years. In the end growing productivity is the key to our economic wellbeing. As the Nobel Laureate Paul Krugman once put it, productivity isn’t everything, but in the long run it is almost everything. Strong productivity growth will lead to higher earnings, higher living standards, and an easier job reducing the deficit. If productivity growth is weak, then we are in for some more tough years.

So why don’t we hear more about this from the politicians? Whatever they may say, they really can’t just legislate for higher earnings and lower prices. Those will come only as a result of a more productive and efficient economy.

It’s funny really.  Some will attribute the stagnation of living standards since 2010 (or 2008) to mostly demand-side causes (e.g. Coalition austerity), and get extremely cross that politicians don’t take the AD policy seriously… and others get extremely cross that politicians don’t take supply-side policy seriously enough.  The spectrum of views between the two extremes is also available.

I get more frustrated that we lack a common methodology or understanding of how to interpret the macro data.  How do we decide the extent to which each view is true?  Without that, I’m not sure why we should expect politicians and policymakers do much better than pick some position.  (To be fair, many fail even that test.)  Crazy models like the “paradox of toil” – which are taken seriously by some academics – make a mockery of the idea we can or even should separate the supply-side from the demand-side.

Unemployment towards the end of 2014 was 0.3% higher than in early 2007.  Is it unreasonable based on figures like that, to say sure, the stagnation in UK living standards has been “clearly” supply-side?  I could pick other data: low inflation or wage growth maybe, low (forecast) nominal GDP growth, and say, yes, demand-side problems remain.

But it’s complicated.  If productivity growth has fallen to around 0% (god forbid) then nominal wage growth at around 2% is consistent with something like “full employment”.  The argument goes back and forth… it only appears satisfying if you have strongly held prior beliefs and find a data point to confirm them.

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Categories: Data, Productivity, UK GDP
  1. james in london
    January 29, 2015 at 16:22

    As Benjamin Cole would say: “Just shoot for 5% nominal wage growth and see what happens. it can’t do any harm. And might do good.”

    Don’t get too depressed. Service sector output is impossible to measure, as is service sector productivity. We are in the dark. 5% of bust!

  2. January 29, 2015 at 19:03

    Too gloomy, I know – blame the weather.

    Anybody want to bet we see average wage growth of 5% this side of 2030?

    • ChrisA
      January 30, 2015 at 03:59

      I wonder how much the German Chancellor-for-life, Angela Merkel, and the series of weak French presidents since the late 1990’s have had to do with weak demand in the EU? So imagine a world where in 2017 Angela Merkel fall victim to some sort of scandal and German politics falls into disarray. And at the same time the new French president is elected on a mandate to reduce unemployment to more Rosbif like levels. Could the French then create a strong enough alliance with the Med countries, while Germany is weak, to strong arm the ECB into a “Southern Med” reflation strategy? And the resulting boom in Northern European countries drags up demand and then emigration from the UK. “Auf Wiedersehen, Pet” was not so long ago and stranger things have happened. But I am still not taking the bet.

  3. W. Peden
    January 30, 2015 at 11:44

    One possibility is that the headline unemployment figure doesn’t accurately represent the output gap, due to things like cut hours or a fall in the natural rate of unemployment. The latter shouldn’t be too surprising, both due to Coalition policy in that direction and due to the gradual unwinding of the deindustrialisation shocks of the 1960s-1990s. The 2007-2013 rise in unemployment increasingly looks like a deviation from a secular downward trend-

    https://timetric.com/index/unemployment-all-16-over-lfs/

    (Note that there are serious problems with the data in terms of taking into account changes in the participation rate, especially in the 1980s. From corrected figures I’ve seen, the main difference is that the rise in unemployment was worse than the official figures suggest in the early 1980s and the fall in unemployment started in the mid-1980s, not the late 1980s, contrary to the hysteresis hypothesis.)

    There may also be a problem in some (most?) models of the output gap if they assume that that the NAIRU will tend to rise after a recession due to skills erosion and/or inside-outsider dynamics. If, in fact, the stylized facts that were used to justify the hysteresis hypothesis were the products of (a) deindustralisation and (b) changes in the participation rate, then we might be fundamentally misunderstanding the cyclical dynamics of unemployment. I’m not denying that there is hysteresis effect; I’m simply questioning whether it has an important effect size.

    • January 30, 2015 at 12:25

      W. Peden, nice comment.

      I think my position is this: if we can trivially show that there has been a significant loss of labour supply 2008-14 then that is a good reason to reject out of hand the assumption that the stagnation of living standards 2008-14 is purely demand-side.

      There are a number of data points which mean that is not trivial: I would pick the headline unemployment rate (or employment rate) and per capita hours worked. Most recent Inflation Reports contain a good survey of these labour supply slack measures.

      I agree it is probably also true there has been a positive labour supply shock lowering the natural rate, and you CAN get to an explanation of stagnant living standards using a argument on the composition of the workforce. i.e. something like Germany post-Hartz, that when you STOP excluding lower skilled workers you drag down average productivity.

      Buuuut (here we swing the argument back again). Most UK studies are saying they fail to find any such compositional change in the UK workforce. There is even one today from the IFS! http://www.ifs.org.uk/uploads/gb/gb2015/ch2_gb2015.pdf

      Probably just my bias, but I find it more convincing that the relevant composition effect is due to the “chase all evil bankers from the country with pitchforks” policy, which is not obviously demand-side.

    • January 30, 2015 at 14:11

      “From corrected figures I’ve seen” – do you have a reference for that, W. Peden? It sounds interesting.

  4. W. Peden
    January 30, 2015 at 19:28

    Sure: Pissarides (2003) “Unemployment in Britain: A European Success Story” is the best I’ve come across. It’s a very good article overall, but the bit where he (apparently) debunks the stylized “fact” of the 1983-1986 jobless recovery is the best. David Webster goes deeper from a very old-school Keynesian perspective-

    http://papers.ssrn.com/sol3/papers.cfm?abstract_id=904707

    On the basis of such research, I suspect that the path of the UK NAIRU is best explained by the natural rate hypothesis, and in particular long-term structural factors (like regional mismatch) rather than hysteresis. Webster argues persuasively that the participation rates patterns across regions can’t be adequately explained by a hysteresis explanation. I stress again that this is a question of the effect size of hysteresis, not its existence.

  5. jamesxinxlondon
    February 2, 2015 at 22:30

    Britmouse
    I thought the third chart from a commenter’s link at Money Illusion would cheer you up. Top level productivity growth is not always something to be envied.
    http://fatasmihov.blogspot.com.br/2015/02/which-country-managed-great-recession.html

    • February 2, 2015 at 23:32

      Looks like more mess of supply-side and demand-side.

      Spain… “I see dead people”, I mean I see composition effects. Employment in Spain is down from 20m to 17m. Staggering, shocking numbers. The 17m have 12% higher average productivity than the 20m did. What else do we know? What happened to the missing 3m? They’re not all in London. I expect they are on the streets marching for Podemos – I probably would. Three million on the streets marching for socialism, it’s that secret neo-liberal masterplan in action.

  6. james in london
    February 3, 2015 at 12:43

    Pre-crash Spaniards weren’t working hard enough, we all knew that, now those in work are :-)

    Of course you are right, shifts in demand curves vs shifts in supply curves, (and) vs moves along demand curves vs moves along supply curves. Not easy to untangle.

    That IFS study W Peden refers to doesn’t look at employment or productivity by industry. Too tricky.

  7. james in london
    February 6, 2015 at 10:33

    I wonder how the lines on the chart Rob send Scott, that was added to the comment, correlate with productivity?
    http://www.themoneyillusion.com/?p=28567

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