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.
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.