Medium and long run prospects for UK growth in the aftermath of the financial crisis Nicholas Oulton Centre for Economic Performance London School of Economics Email: n.oulton@lse.ac.uk Centre for International Macroeconomics and Finance Conference “The Causes and Consequences of the Long UK Expansion: 1992 to 2007” 19th ‐ 20th September, Clare College Cambridge
The issue Up till the end of the boom in 2008Q1, the UK’s productivity growth rate was excellent. But then during the Great Recession productivity (GDP per hour) fell by 4.5%. In 2013Q1 it was 5.1% lower than at the peak in 2008Q1. So how has the Great Recession affected our long ‐ run prospects? Will the growth rate be permanently lowered? Or will we eventually get back to something like the growth rate of 1990 ‐ 2007? 2
Hypothetical paths for GDP per hour during recession and recovery Very pessimistic Pessimistic GDP per hour (log scale) GDP per hour (log scale) time time GDP per hour trend GDP per hour trend Optimistic GDP per hour (log scale) time GDP per hour trend 3
OUTLINE • UK growth in the run ‐ up to the crisis 1. UK performance 1970 ‐ 2007 2. Projected growth of productivity using only pre ‐ crisis data • What has happened since 2007? 1. The UK productivity puzzle 2. Explanations • Will UK growth in the aftermath of the crisis be faster or slower? 1. Long run effects of a financial crisis: theory 2. Long run effects of a financial crisis: empirics 4
OUTLINE • UK growth in the run ‐ up to the crisis 1. Performance 1970 ‐ 2007 2. Projected growth of productivity using only pre ‐ crisis data [This section draws heavily on N. Oulton (2012). “Long term implications of the ICT revolution: applying the lessons of growth accounting and growth theory”. Economic Modelling , vol. 29, 1722 ‐ 1736, 2012.] • What has happened since 2007? • Will UK growth in the aftermath of the crisis be faster or slower? 5
UK productivity growth was poor 1970 ‐ 1990 … Source: EU KLEMS, November 2009 release (www.euklems.net) 6
… but improved greatly over 1990 ‐ 2007 Source: EU KLEMS, November 2009 release (www.euklems.net) 7
A growth ‐ model ‐ based approach to projecting UK productivity growth • One ‐ sector model (textbook neoclassical) • Two ‐ sector model: necessary since we need to take account of the ICT revolution 8
ICT (computers, software & comms.): a unique product group 9
One ‐ sector model 1 Y BK [ hH ] , 0 1 Long run growth rate: ˆ , y g h 1 ˆ y Y / H , B (TFPgrowth), g :growth of skill ( ), 1- : labour share h h 10
PARADOX If a country does not produce ICT goods and services, then it gains nothing from the ICT revolution! Or does it? 11
Two ‐ sector model • Two sectors 1. Non ‐ ICT: produces consumption goods and non ‐ ICT capital goods 2. ICT: produces ICT capital goods Productions functions are identical in the two • sectors, except for TFP which grows faster in ICT This implies: • Rate of decline of relative price of ICT goods = TFP growth in ICT minus TFP growth in non ‐ ICT 12
Long run growth in a two ‐ sector model (no ICT output) Growth of GDP per hour Growth of TFP in non-ICT sector plus Growth of skill Labour share ICT income share Rate of decline of ICT relative price plus Labour share ↗ ICT use effect 13
Long run growth, with some ICT output Growth of GDP per hour Growth of (non-ICT) TFP plus Growth of skill Labour share ICT share Rate of decline of ICT relative price income plus Labour share plus ICT output share Rate of decline of ICT relative price ↗ ICT output effect 14
Difference between TFP growth rates in ICT and non ‐ ICT sectors 15
Projected growth rates of GDP per hour for the UK market sector derived from one ‐ sector and two ‐ sector models (parameters values calibrated on pre ‐ crisis data from EU KLEMS) Description Parameter Method Value TFP growth rate Mean, 1990 ‐ 2007 0.0114 ln B (whole economy) TFP growth rate Mean, 1990 ‐ 2007 0.0087 ln B C (consumption sector) v K ICT ICT income share HP trend 0.0641 w ICT ICT output share HP trend 0.0183 v L Labour share Mean, 1990 ‐ 2007 0.7301 Rate of decline of ICT HP trend ‐ 0.0590 ln p relative price g h Growth rate of skill Mean, 1990 ‐ 2007 0.0057 Projected growth rates of GDP per hour ln y One ‐ sector model 0.0213 ln y Two ‐ sector model 0.0261 16
Bottom line Actual growth of GDP per hour in the market sector 1990 ‐ 2007: 2.87% p.a. Projected growth rates after 2007: One ‐ sector model: 2.13% p.a. Two ‐ sector model: 2.61% p.a. 17
OUTLINE • UK growth in the run ‐ up to the crisis 1. UK performance 1970 ‐ 2007 2. Projected growth of productivity using only pre ‐ crisis data • What has happened since 2007? 1. The UK productivity puzzle 2. Explanations • Will UK growth in the aftermath of the crisis be faster or slower? 1. Long run effects of a financial crisis: theory 2. Long run effects of a financial crisis: empirics 18
Hypothetical paths for GDP per hour during recession and recovery Very pessimistic Pessimistic GDP per hour (log scale) GDP per hour (log scale) time time GDP per hour trend GDP per hour trend Optimistic GDP per hour (log scale) time GDP per hour trend 19
GDP has yet to regain its previous peak in 2008Q1 20
GDP per hour has fallen since the recession began and is still below its previous peak 21
But hours worked have surpassed their previous peak … 22
… and the same is true of jobs 23
Explanations 1. Distortion due to hard ‐ to ‐ measure or otherwise problematic sectors 2. Reallocation of labour to sectors where productivity is lower 3. Mis ‐ measurement of GDP due to mis ‐ measurement of banking output 4. Overheating in the boom 5. Lower physical capital input 6. Lower human capital (skill) 7. The impact of austerity 8. Crippled banks and zombie firms 9. Labour hoarding 24
Productivity growth in the market economy (exc. Government services) 25
Productivity growth looks similar if we also exclude “problematic” sectors 26
2. Reallocation of labour to sectors where productivity is lower? Calculate GDP per hour assuming labour shares were the same as in 2007. Result: virtually no difference. 27
The productivity puzzle is widespread … 28
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3. Mis ‐ measurement of banking output during the boom? “Bankers sold toxic rubbish during the boom. So banking output was overstated during the boom. Therefore UK performance was not as good as we thought. And this helps to explain the productivity puzzle since GDP has not fallen as much as the official figures say.” WRONG: The growth of real GDP is measured from the expenditure side [GDP(E)]. And most of the “toxic” part of banking is not part of final expenditure. So banking output may have been mis ‐ measured but this does not imply that GDP was mis ‐ measured (Oulton, NIER, 2013) 32
5. Lower physical capital per hour worked? Business investment fell substantially during the Great Recession and has not recovered. But this does not necessarily imply lower capital intensity (capital per hour worked). A Perpetual Inventory Model using business investment shows that capital per hour worked is now higher than at the peak (4 ‐ 7% higher in 2012Q4 than in 2007Q4). 33
7. Austerity? “Savage cuts to government spending have crippled the UK economy, just when a Keynesian fiscal stimulus was needed”. BUT: Interest rates have been very low (0.5% since March 2009). The banks were bailed out. The exchange rate was 23% lower in 2013Q1 than at its peak in 2007Q1. QE has resulted in the BoE owning 29% of the stock of gilts. 34
Austerity in practice Government expenditure on goods and services and GDP 2008Q1=100 105 100 95 90 1 3 1 3 1 3 1 3 1 3 1 3 1 Q Q Q Q Q Q Q Q Q Q Q Q Q 7 7 8 8 9 9 0 0 1 1 2 2 3 0 0 0 0 0 0 1 1 1 1 1 1 1 0 0 0 0 0 0 0 0 0 0 0 0 0 2 2 2 2 2 2 2 2 2 2 2 2 2 GDP Source: ONS, Quarterly National Accounts, June 2013 and own calculations. Note: Seasonally adjusted. Grey bar marks Great Recession (2008Q2-2009Q3). 35
Austerity in practice Government expenditure on goods and services and GDP 2008Q1=100 105 100 95 90 1 3 1 3 1 3 1 3 1 3 1 3 1 Q Q Q Q Q Q Q Q Q Q Q Q Q 7 7 8 8 9 9 0 0 1 1 2 2 3 0 0 0 0 0 0 1 1 1 1 1 1 1 0 0 0 0 0 0 0 0 0 0 0 0 0 2 2 2 2 2 2 2 2 2 2 2 2 2 Gov. exp. (official) GDP Source: ONS, Quarterly National Accounts, June 2013 and own calculations. Note: Seasonally adjusted. Grey bar marks Great Recession (2008Q2-2009Q3). 36
Austerity in practice Government expenditure on goods and services and GDP 2008Q1=100 110 105 100 95 90 2007Q1 2007Q3 2008Q1 2008Q3 2009Q1 2009Q3 2010Q1 2010Q3 2011Q1 2011Q3 2012Q1 2012Q3 2013Q1 Gov. exp. (official) Gov. exp. (K1) Gov. exp. (K2) GDP Source: ONS, Quarterly National Accounts, June 2013 and own calculations. Note: Seasonally adjusted. Grey bar marks Great Recession (2008Q2-2009Q3). K1: deflated by GDP deflator; K2: deflated by AWE 37
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