2 The macroeconomy
Recovery
2. There has been an improvement in the near-term
outlook for the economy since the OBR's last forecast in March
2013. As Table 1 shows, the OBR now forecasts stronger GDP growth
in 2013 and 2014. This forecast improvement in the near-term outlook
followed improved forecasts for UK growth by the IMF in October
2013 and the OECD in November 2013.[1]
Unemployment has fallen from 7.8 per cent in Jan-Mar 2013 to 7.2
per cent in Oct-Dec 2013.[2]
In the minutes of its December 2013 meeting,
the Monetary Policy Committee of the Bank of England also provided
evidence of a recovery:
The news on the month had continued to suggest
a burgeoning recovery in the United Kingdom. The second estimate
of GDP growth in the third quarter had been unrevised at 0.8 per
cent. Business surveys pointed to growth rates of around 1¼
per cent in each of the next two quarters, and although Bank staff
took a more cautious view they nevertheless expected growth of
0.9 per cent in the fourth quarter of 2013. The recent data suggested
that the recovery was being driven by consumption and stockbuilding,
with both investment and net trade weaker than expected, although
the Committee treated first estimates of the GDP expenditure breakdown
with considerable caution.[3]
Table 1: OBR GDP growth forecast (in
per cent)
At:
| | Outturn
| Forecasts
|
|
| 2012
| 2013
| 2014
| 2015
| 2016
| 2017
| 2018
|
March 2013
| 0.2* | 0.6
| 1.8 | 2.3
| 2.7 | 2.8
| |
December 2013
| 0.1 | 1.4
| 2.4 | 2.2
| 2.6 | 2.7
| 2.7 |
Change
| | -0.1
| 0.8 | 0.6
| -0.1 | -0.1
| -0.1 | |
Source: Office for Budget Responsibility, Economic
and Fiscal Outlook, Cm8748, December 2013, p10, Table 1.1; Office
for Budget Responsibility, Economic and Fiscal Outlook, March
2013, Cm8573, p9 , Table 1.1
*Forecast
Revisions by ONS in December 2013 also showed that
GDP in 2013 had been stronger than originally estimated. The ONS
reported that "GDP in volume terms increased by 1.9 per cent
when comparing Q3 2013 with Q3 2012, revised up 0.4 percentage
points from the previously estimated 1.5 per cent increase."
[4] It also noted
that "In Q3 2013 GDP in volume terms was estimated to be
2.0 per cent below the peak in Q1 2008, as compared with 2.5 per
cent below this peak as previously estimated."[5]
The latest ONS GDP estimate for 2013 Q4 stated that "GDP
remains 1.4% below the pre downturn peak".[6]
3. Recent survey data has also been positive. As
the Office for Budget Responsibility noted in its Economic and
Fiscal Outlook:
Most survey evidence suggests a strong pick-up
in underlying activity in recent months. In October, the composite
CIPS Purchasing Managers' Index (PMI) rose to its highest level
since May 1997, 7.1 points above the series average of 54.0. The
PMIs for manufacturing, construction and services are all well
above the average of recent years, although the manufacturing
index fell back slightly in October. The construction PMI has
been lifted by the housing sector; the sub-index has risen 8.6
points since its recent trough in June 2013.
The Bank of England Agents' Summary reports a
sustained increase in investment intentions and exports of goods
as well as stronger demand for consumer goods and services since
the time of our March forecast. The GfK Consumer Confidence measure
suggests that consumer sentiment has risen since March and returned
close to its long-run average after nearly 6 years running below
it. Within this measure, there has been a significant improvement
in the climate for major purchases and in expectations for the
general economy. The Confederation of British Industry's (CBI)
quarterly Industrial Trends Survey reported that growth in manufacturing
output and new orders for the second and third quarter of 2013
were both stronger than their long-run averages. The CBI's Service
Sector Survey reported business volumes in the three months to
November increasing at their strongest pace since 2007.
[7]
In January 2014, the BDO Optimism index rose to the
highest level since the index began in 1992.[8]
4. Robert Chote, Chairman of the Office for Budget
Responsibility, provided the following outline of the drivers
of this near-term recovery:
If you look at the surprise we have had in the
data since the Budget then the main contributors to the fact that
the growth has been stronger than we anticipated are consumer
spending, private consumption and the housing market. Net trade
and business investment continue to disappoint. On the consumer
spending side, it does seem to be that it is people dipping into
savings or taking more debt rather than an increase in income.
As we know, real incomes remain very weak. Looking at that element,
you can see that that is what appears to be driving the most recent
news.[9]
However, in its Economic and Fiscal Forecast, the
OBR provided the following warning:
We are conscious that forecast revisions tend
to lag economic developments at turning points, leading to repeated
overestimates of economic activity in downturns and repeated underestimates
when activity finally picks up. But the experience of 2010 provides
a recent example of what appeared to be a turning point in the
cycle ebbing as the factors needed to generate self-sustaining
recovery failed to take hold. And with productivity, real income
growth and UK export markets remaining weak, and problems in the
euro area far from fully resolved, our central forecastlike
that of the Bank of Englanddoes not assume that the growth
rates seen in the last couple of quarters are maintained through
next year and beyond. We assume that growth slows to rates of
around 0.5 per cent a quarter through 2014, with risks to both
the upside and downside.[10]
The Monetary Policy Committee also provided a similar
warning in the minutes of its December 2013 meeting, noting that
for a recovery to be sustained, it would have to be seen in more
sectors of the economy:
A sustained recovery was likely to require a
pickup in investment growth as well as consumption, and some rebalancing
from domestic to external demand. The prospects for continued
robust consumption growth would depend on productivity gradually
increasing and supporting a strengthening in real incomes. There
had been some signs of softness in recent consumer spending data
and confidence surveys. However, there were increasing signs from
business surveys and the Bank's Agents that investment might be
rising as expectations of a continued recovery in demand became
entrenched. The net trade data had been weak over the past couple
of years, reflecting in part demand conditions in the rest of
the world. In the euro area, only a very weak recovery was in
prospect and inflation remained materially below 2 per cent, but
a moderate expansion appeared to be underway in the United States
and there were signs that growth in the emerging economies had
bottomed out. It would be difficult to achieve a better balance
of domestic and external demand as long as activity in the UK's
main trading partners remained subdued.[11]
5. Melanie Baker, Vice President, UK Economics, Morgan
Stanley, when asked whether the OBR's forecast growth rate was
sustainable, told us that:
I am confident it is sustainable, partly because
I think it makes sense for the UK economy to be doing better now.
Fiscal austerity is dragging a bit less this year. The external
environment has improved, so the Eurozone is a bit more stable.
That is important for business confidence and for the banks as
well, of course. We have also seen a dramatic improvement in credit
conditions. All these things mean it makes sense for the UK to
be recovering. I would expect those things to persist as a central
case.[12]
Alan Clarke, Director, Fixed Income Strategy, Global
Banking and Markets, London, Scotiabank, also explained that:
The angle I come from is it is normal to grow
unless you have a countervailing influence holding you back, which
we have had over the last year with tight credit conditions and
headwinds from the Eurozone. It is normal to mean revert and what
is the normal growth rate now? My view would be around 2 per cent
or maybe slightly above that, but we have many years to go of
fiscal austerity applying a brake domestically. Externally we
have the brake on growth in the Eurozone from our biggest trading
partner. We should move back towards trend growth, but there are
a couple of headwinds getting in the way of that. The flipside
is that we do have this boost coming from the housing market.[13]
Dr Carney, Governor of the Bank of England, emphasised
to us that:
When thinking about the sustainability of the
recovery, we need to think about the life cycle of the recovery.
Recoveries are very seldom, in this country or other countries,
led by business investment. There needs to be a source of demand
that then generates the need for that business investment and
the confidence for that business investment. If you look at the
situation the UK is in right now, that demand is not going to
come from outside our shores. The eurozone has improved somewhat,
but it is still very weak and growing roughly at 1 per cent a
yeareffectively a stagnationand that is our largest
export market, as you know. The question is the extent to which
domestic demand can provide the initial lift that will bring that
rebalancing towards business investment. That is what we are seeing
now.
What is important is that all of the elements
are in place for business investment to pick up, and that means
reducing unnecessary uncertainty. Our contribution to that is
forward guidance, providing stimulus, again, the stance of monetary
policy, but making sure that the transmission of that stimulus
is as effective as possible to businesses, and that means ensuring
that we finish the job on fixing the core of the financial system
here, fixing the banks and major building societies, and a lot
of progress has been made there. It is those elements that help
put in place the conditionsdemand and stimulus. They put
in place the conditions for that recovery in business investment,
but we still need to see it.[14]
Household consumption and household
debt
6. The crucial question in current circumstances
is the sustainability of a recovery based on an increase in household
consumption. This is especially true against a backdrop of lower
household saving and rising household debt: The IFS Green Budget
2014 notes that "there is little scope for households to
reduce their savings any further",[15]
and the Bank of England said in its November 2013 Financial Stability
Report "the UK household debt to income ratio, of 140%, remains
higher than comparable ratios in the euro area and the United
States"[16] We discuss
these points in turn.
HOUSEHOLD CONSUMPTION
7. The OBR's Economic and Fiscal outlook said that
"With consumer spending growth forecast to outpace disposable
income growth, we forecast that the saving ratio will decline
gradually from just above 5½ per cent in 2013 to just under
4½ per cent in 2018."[17]
Mr Chote explained that this forecast fall in the savings ratio
was because:
Basically, you have a relatively weak process
of incomes recovering. Once again, we are coming back in part
to the productivity puzzle. We are still waiting for productivity
growth to pick up and the expectation would be that that would
lead to earnings growth. If you look in terms of real earnings,
for example, we do not get the 2 per cent a year real growth in
wages and salaries that people would be used to on past historical
experience for a couple of years still. We have consumption rising
faster than that; therefore, leading to a relatively modest fall
in the saving ratio. It should be borne in mind there are other
things going on within the saving ratio that means it is not quite
as straightforward a picture as that, but that is broadly it.[18]
However, Mr Chote also explained that:
People may be making their decisions on the basis
of their expectations of future incomes. If there is greater optimism
around about that, that could be having an impact there. The other
question is whether those data remain looking as they do into
the future. You will have noticed from successive ones of these
that not only do the forecasts for the saving ratio move around
quite a lot, but so do the estimates of its path in the past.[19]
8. The forecasts for household consumption and saving
are linked to the forecast for real wages, a point emphasised
by the MPC minutes for their January 2014 meeting:
The recovery in growth over the year to 2013
Q3 had largely been driven by household spending. Following the
data revisions, quarterly consumption growth over this period
was estimated to have averaged 0.7 per cent, in line with its
long-term average. With little growth in household income over
this period, the growth in household spending had been associated
with a fall in the saving ratio from almost 8 per cent to just
over 5 per cent of household income. The decline in the saving
ratio was likely to have reflected a number of factors including:
increased optimism about future incomes; higher asset prices;
reduced uncertainty and an associated reduction in precautionary
saving; and increased credit availability and lower loan and deposit
interest rates. While it was difficult to estimate precisely the
relative contributions of these various factors, it seemed unlikely
that any would drive a similar fall in the saving ratio over the
coming year. Consequently, maintaining the recent rates of consumption
growth would require a sustained pickup in real income growth,
preferably underpinned by stronger productivity growth.[20]
The OBR provided the following commentary on its
forecast for real wage growth:
We expect the weakness of real wage growth to
persist into 2014 before picking up gradually to match productivity
growth. We do not expect real take-home consumption wages to reach
their pre-crisis peak until late 2015, mainly reflecting the slow
recovery of productivity growth toward its historical average.
With wage growth remaining weak over the near term, real disposable
income is expected to pick up relatively gradually, before strengthening
over the medium term as earnings growth gathers pace and inflation
falls back.[21]
Given that households may be undertaking consumption
now, in the expectation of rises in future income, we asked others
about for their views on the future path of wages. Melanie Baker,
of Morgan Stanley, explained where wage growth may come from:
We do expect a rise in productivity. We do expect
business investment to pick up. I am saying there was a bit of
a pick-up last quarter, so these things should start working better,
and with stronger productivity, that gives a justification for
higher wage growth. You may also see pay growth for other reasons
as well. The RPI rate of inflation is still relatively high. Wage
demands may pick up because fears of unemployment have fallen
and there are skill shortages in certain sectors as well, but
average earnings growth we are expecting to pick up, but we do
need to see that for a more sustainable recovery.[22]
Alan Clarke of Scotiabank noted, however, that:
I am slightly nervous about wages. I agree the
trend is favourable and it is upwards. However, what has come
out in the recent labour reports is that the claimant count unemployment
is going down fast, about 120,000 per quarter. There is a corresponding
increase in employment, 155,000 to 200,000. Those two offset one
another, but the wider definition of unemployment is going down
much more slowly, even though it includes claimant count, and
that is because in activity, new supply is coming into the labour
pool. At the moment, that is a drop in long-term sick and discouraged
workers. Further down the road, we will have Bulgarian and Romanian
workers coming in, so there is obviously an increase in demand
for workers, employment is going up fast, but there is a corresponding
increase in supply as well and that should slow the upward trajectory
in wage inflation. I agree it should be up, but it could be perhaps
a little bit slower than the OBR forecast.[23]
Commenting on both the weakness in real wage growth
and how to ensure real wage growth in the future, the Chancellor
argued that:
I just think it is inconceivable that you can
lose 7 per cent of your GDP and that does not have an impact on
the living standards of the people of this country, but the best
answer to that is to work through the problems, deal with the
public finances, get the economy into a position where it can
grow in a sustainable way.[24]
HOUSEHOLD DEBT
9. The Economic and Fiscal Outlook forecast the household
gross debt to income ratio to rise above 160
percent by 2019.[25]
When asked what a high level of household debt might mean for
the recovery, Spencer Dale, Chief Economist of the Bank of England,
noted that:
I think it reflects an increased vulnerability
to economic shocks. The balance sheet of the household sector
as a whole is relatively healthy, but within there are distributions
where some people have very high levels of debt and others very
high levels of savings. The vulnerability is with the people who
have the high level of debt. To a very large extent those increases
in debt are a counterpart to the increase in house prices we saw
prior to the financial crisis, where what we saw were young households
having to take out mortgages to pay for their houses. The recipients
of that were old households who then saved that money, which is
why the balance sheet as a whole was relatively strong but where
we do have these pockets of vulnerability associated with high
levels of debt.[26]
When we questioned whether households, given the
level of household debt, may be vulnerable to rising interest
rates, given the level of household debt, Professor Nickell, a
member of the Budget Responsibility Committee, argued that:
The rise in interest rates will stress households.
The fact that a household takes on a mortgage and the mortgage
and the mortgage has to be bigger than the households who were
taking on mortgages 20 years ago, in some sense you could think
of new mortgages replacing old mortgages and the new mortgages
are going to be bigger. That is the driving force behind the rise
in debt. The fundamental issue is how cautious everyone is being.
Historically, people and the lenders in the UK have been reasonably
cautious, which may surprise some people but is, nevertheless,
true. As a consequence, the level of repossessions, as we know,
has been exceptionally low relative to the depth of the recession
compared with, say, the early 1990s and the level of losses that
lenders have made in the UK mortgage market have been absolutely
tiny.
You could say, "Well, yes, but there is
more forbearance and interest rates are low and so on and when
interest rates shoot up there will be a problem". I think
it is perfectly true to say that there will be some households
who will be stretched when interest rates rise, but I think we
have been through this argument before. All the evidence suggests
that what gets households into trouble and what leads to repossessions
and so on is change in the financial circumstances of the household,
either because of unemployment or because of sickness and so on,
not basically because of rises in interest rates.[27]
Professor Nickell also disagreed that rising debt
was the only way households would be able to sustain the economy.
He argued:
If we have productivity growth growing at its
historical rate, we can easily have growth without a booming housing
market. It just so happens, however, that when everyone's incomes
are growing, given the desire for people to own houses and given
our inability to build any houses, the inevitable consequence
of that is the price of houses keeps going on up relative to incomes.
If we sustain the level of owner occupation and mortgages that
we have had in the last 10 or 15 years, when that happens you
will find debt going up as well, but the rise in debt is not a
necessarily condition once you have productivity growth and real
wages growing. That alone will be quite enough to drive growth
in the economy.[28]
10. On overall household debt, the Chancellor believed
that:
The best thing the authorities can do, and this
is a decision that the MPC and the new Bank Governor have taken,
is to at least provide people with good communication about the
future expected path of interest rates. That enables families
to anticipate what future changes there might be. I think the
Bank of England has done a good job and indeed a better job than
some central banks at giving a better forward guidance on the
likely path of interest rates or the thresholds that would lead
to them thinking about interest rate decisions. I think communication
is an issue.
I would just make this point, though. There has
been a deleveraging. I completely agree with you that we had an
unsustainable debt boom in the last decade that led to the biggest
recession and financial crisis of modern history in this country,
or contributed to it, but at the moment debt servicing costs are
down for families. We also have this new architecture that will
keep an eye on this and I have confidence in the system that Parliament
and the Government have established to monitor this going forward.[29]
Trade and the balance of payments
11. The balance of payments is defined by the Office
for National Statistics as follows:
The balance of payments summarises the economic
transactions of the UK with the rest of the world. These transactions
can be broken down into three main accounts; the current account,
the capital account and the financial account.
The current account comprises of the trade in
goods and services account, the income account and current transfers.
A difference in the monetary value of these accounts is known
as the current account balance. A current account balance is in
surplus if overall credits exceed debits and in deficit if debits
exceed credits.
A deficit or surplus on the current account is
offset with an equal and opposite surplus or deficit on the capital
and financial account. As the capital account is relatively small
in comparison, the current account and financial account can be
said to be counterparts.
The current account balance plus the capital
account balance measures the extent to which the UK is a net lender
(that is, in surplus) or net borrower (that is, in deficit). The
UK has run a combined current and capital account deficit in every
year since 1983 and every quarter since Quarter 1 2008. [30]
The persistent deficit noted above on the UK's current
and capital accounts must have been offset by surpluses in the
UK's financial account, which would include direct investment
in the UK.
12. Net trade, defined by the OBR as "the extent
to which the domestic sector consumes less or more than it produces",
is one of the components used to measure expenditure GDP, and
is a potential contributor to GDP growth.[31]
Yet the December 2013 Economic and Fiscal outlook reduced the
contribution to forecast GDP growth expected from net trade when
compared with the March 2013 forecast.[32]
On the OBR's forecast for net trade, Mr Chote told us that:
If you look at it overall in terms of the net
trade contribution, which is not just emerging economies, basically
we have very little addition to GDP growth from net trade over
the course of the five years of the recovery.[33]
He explained that:
There is a short-term and a medium-term story
there. We have had weaker data on exports recently and that has
led us to be more cautious in the near term about that. There
has been some rewriting of history again in terms of the statistics.
I think last time we were here we would probably have been talking
about the fact that one of the puzzles was that UK market share
had deteriorated by more than one would have anticipated given
what had been going on with sterling and laying quite a lot of
that at the door of financial services exports, which seemed to
have been considerably weaker. The data has now been rewritten
on that. The financial services export data has been revised up.
That does not appear to be so much of a story. The market share
figures do not look at puzzling as they did. Looking further out
into the medium term, it is the lowering of global growth and
global trade forecasts generally that has led us to take a more
cautious view of the contributions that net exports can be making
in the future. If you look at our aggregate GDP forecasts, we
have nudged down 2015, 2016 and 2017 by 0.1 points each again.
Not a large number obviously, but it is basically that judgment
on the weakness of UK exports markets over that horizon that has
led us to do that.[34]
Dr Carney, Governor of the Bank of England, provided
the following view of the external environment, and when it would
provide support to UK GDP:
It is a sorry history. For the last five years,
whether it is the OECD, the IMF, the Bank of England or indeed
the Bank of Canada, where I was previously, about this time every
year we were capitulating on our forecasts of global growth and
having forecasts where there would be a modest improvement in
global growth the following year. This year is no exception, global
growth coming in around 3 per cent. The Bank's expectation is
global growth will pick up to about 3.5 per cent in 2014; the
IMF would be slightly stronger, about 3.75 per cent; the OECD,
I think, somewhere around there.
The question is, why would it be different this
time, and will we see that actual benefit? Importantly, the reduction
of some of the tail risks in Europe help reduce some of the downside
risk to that global forecast. The very large swing in the fiscal
impulse in the United States from very large drag to less of a
drag in the US helps us, as does the improvement in balance sheets
in the financial system in the US. The UK helps. As an example,
if you improve your financial system, you get much more traction
in terms of stimulus. Consumer balance sheets have improved. We
have seen the dynamic here.
The downside risks to that improved forecast
relate still somewhat to the eurozone, where there is tough execution
around a series of structural reforms, and secondly, across a
range of emerging markets, where they are going through an adjustment
at present to rebalance growth. On that last point, if I may,
we have taken that into account and we have substantially marked
down the prospects for emerging markets into 2014 such that, in
effect, about 70 per cent of the improvement in global growth
is being driven by the improvement in the core of the advanced
economies, which is different than any other time in the recent
past.[35]
Business investment
13. Given the forecast lack of a contribution to
GDP growth from net trade, business investment is another potential
source of GDP growth. Yet growth in business investment has been
far weaker than forecast by the OBR even as recently as March
2013. Its forecast for business investment growth in 2013 fell
from 1.9 percent in March to -5.5 percent in December.[36]
Mr Chote provided the following explanation:
In terms of thinking why it is that business
investment has been weaker than we anticipated you would probably
want to point to, first of all, uncertainty about future demand.
The second possibility is that the weakness of
profitability means that there is a lack of internal finance for
those firms that are reliant on internal finance and also weak
productivity implies and the weakness of profits implies weak
expected profitability and, therefore, firms thinking, "Is
it worth me undertaking an investment programme on that basis?"
If we were to look at the three reasons why you have had, over
the period since the June 2010, weaker outturns than we anticipated,
those are probably the ones that you would point at.
More recently, if you look at page 71[of the
Economic and Fiscal Outlook] what is striking is that, since the
budget, the ONS has changed the methodology for estimating business
investment and we now have a picture that is much more volatile
with a steeper fall and a lower average rate of business investment
since the recession. We have a business investment deflator, the
measure of inflation in that sector, which is now very volatile
by historic standards and by the standards of other statistical
series for that in other countries.[37]
Brian Hillard, Chief UK Economist, Société
Générale was, however, optimistic about a growth
of business investment:
I am reasonably confident it will recover within
the next year or two. I think it is surprising that we have such
a disconnect between fairly positive business surveys and the
weak official data and the Governor of the Bank of England has
highlighted that. It is not just a UK issue. It is something that
is general to the industrialised economies. We have had a cash-rich
corporate sector that I think has been restrained by lack of visibility
and demand and I think the conditions are falling in place for
that to improve. Domestically certainly we are getting this increase
in consumption from whatever source, but internationally we are
getting some reduction in the uncertainty in the Eurozone, which
I think is a very important backdrop for an improvement. One can't
be precise on the timing, but I think the conditions are in place
for investment to pick up. I would not suddenly say they are going
to leap up within the next six or nine months, but they should
be recovering.[38]
When asked what he would do to deliver business investment,
the Chancellor told us that:
I would say above all we can provide a backdrop
of economic stability and certainty and solidity to our economic
programme. That is what we are doing by having a plan, working
through that plan and providing people with the confidence that
Britain has a grip on its problems in the public finances and
that we are providing a competitive environment in which we can
do business with the rest of the world.[39]
14. In February 2014, following the conclusion of
our hearings, the ONS released revisions to business investment
data since Q1 2013. These revisions, in conjunction with the latest
estimate of business investment growth of 2.4% in Q4 2013, show
that business investment is estimated to have grown for the last
four quarters, from Q1 2013 to Q4 2013.[40]
Productivity
15. Employment has remained stronger than expected
given the fall in output since 2008, reflecting a more flexible
labour market than many continental EU countries. As noted in
NIESR's Economic Review, "from the viewpoint of the
undesirable nature of unemployment, the increases in employment
and consequent decreases in the numbers unemployed are to be welcomed".[41]
However, it also means that productivity has declined. This is
important, as the NIESR Economic Review emphasises that
"productivity growth is the key to the evolution of the standard
of living of a population in the long run. Low or zero productivity
growth limits the growth of real per capita incomes".[42]
The OBR noted that:
Ultimately, productivity-driven growth in real
earnings is necessary to sustain the recovery and raise living
standards. We therefore expect quarterly GDP growth to slow into
2014, gradually strengthening thereafter as productivity picks
up and real earnings growth provides the foundation for a stronger
and more sustained upswing. This recovery in productivity growth
is perhaps the most important judgement in our economy forecast.[43]
This point was also emphasised to us by the Chancellor,
who argued that:
I think it [the productivity puzzle] remains
absolutely an issue of concern. Indeed, I flagged it up in my
Autumn Statement speech. Productivity is too low. It is a clear
cause for concern in that sense, but the better news is that the
OBR forecast that productivity will pick up. They make the observation
that, ultimately, a sustainable recovery and a sustainable increase
in people's living standards depends on that happening.[44]
16. Charlie Bean, Deputy Governor for Monetary Policy
at the Bank of England, told us that one main area of uncertainty
was why productivity had been so weak in recent years:
Certainly, the key issue that faces the economy
is how much spare capacity there is. Spare capacity comes in various
guises. There is spare capacity in the labour market, which we
have been talking about, unemployment, workers who may be part-time
rather than full-time, as they would prefer. There may also be
spare capacity within companies that they could run at a high
level of utilisation. The big unknown that we are faced with,
and this ties into the design of the policy guidance, is why productivity
growth has been as weak as it has been over the past five years.
If you just compare the level of productivity now with the naive
extrapolation of the pre-crisis trend, it is about 15 per cent
below that. I am not going to suggest we can get back to that
15 per cent trend, but we can probably get some of the way back
there.[45]
He provided the following potential explanations
of why productivity may have been weak so far:
There are lots of different hypotheses for why
productivity has been weak. Some of these imply that as demand
picks up, so you will see productivity analogously responding.
There are others that suggest that that productivity may have
been permanently lost or pretty persistently lost. That would
be particularly the case to the extent that it is associated with
weak past investment in the past, workers not having the opportunity
to learn by doing because the activity was weak, and to the extent
that capital has been misallocated as a result of the problems
in the banking system.
We, and many other people, have been trying to
get to the bottom of the relative importance of the various causes,
but the honest answer is that we do not really know how much productivity
will come back as growth proceeds.[46]
The Chancellor provided the following explanation
as to why productivity was weak:
I think we are clear that it is a combination
of the impairment of the banking system. That is the primary reason
and I think there is an interesting argument, which we would give
some credence to, about the allocation of resources within an
impaired banking system.[47]
The Office for Budget Responsibility's 2012 Forecast
Evaluation Report also noted other potential explanations for
the productivity puzzle, including undermeasurement of real GDP
or capital mismatch, where resources are not reallocated from
so-called 'zombie firms' to firms with potentially higher rates
of return.[48]
17. Looking forward, the Governor of the Bank of
England gave us the following reasons for a potential increase
in productivity in the future:
The first element is just that you have businesses
that have slack, and we can think of it in two simple metrics.
They are economies of scale and production. They are not producing
at optimal scale. The more demand there is, the more they can
produce at optimal scale. That is the first element.
The second element is learning by doing. It is
a very fundamental point, but the more you produce, the better
you get at things, and you end up [
] having people move
from firms within industries that bring knowledge from best performers
to less-good performers, and that improves overall productivity.
It is that dynamic first. That is one.
The second dynamic [
] is the improvement
in the capital labour ratio, the reigniting of business investment.
All surveys and other indications suggest that we are close to
that point, and in fact, in our forecast, when you go into 2014,
consistent with that forecast is really a handover towards business
investment and a pickup in business investment.
The third point is a point that Mr Bean emphasised,
which was related to the recycling of capital in the economy,
so it is poor-performing firms exiting, but very importantly new
firms starting up at the same time, so the birth and death of
firms. We will look to those types of figures as well to get a
sense of whether productivity is coming back.[49]
The Chancellor provided the following argument on
the future of productivity growth:
I do not accept the argument that is made in
the United States primarily, but you see spilling over here, that
there is some great secular stagnation taking place in the west,
that we cannot be more productive or that we cannot provide better
living standards for our populations [
].[50]
18. Recent data revisions suggest that GDP has
been growing by more than previously thought, and business surveys
also suggest that the recovery is taking root. That the recovery
is, at the moment, consumer-led, is not surprising. As the Governor
of the Bank of England has noted, "recoveries are very seldom,
in this country or other countries, led by business investment".
However, a broad based improvement in the long run performance
of the economy will be required if the recovery is to lead to
a long period of trend growth. As we have previously recommended,
a greater focus on supply side reform will be required.
1 IMF, World Economic Outlook: Transitions and tensions,
October 2013, Table 1.1, p2; OECD, Economic Outlook, Volume 2013/2,
November 2013, p120 Back
2
ONS, Labour Market Statistics, February 2014, published 19 February
2014, Table 1 Back
3
Bank of England, Minutes of the Monetary Policy Committee meeting held on 4 and 5 December 2013,
published 18 December 2013, para 21 Back
4
ONS, Quarterly National Accounts, Q3 2013, 20 December 2013 Back
5
ONS, Quarterly National Accounts, Q3 2013, 20 December 2013 Back
6
ONS, Second Estimate of GDP, Q4 2013, 26 February 2014 , p3 Back
7
Office for Budget Responsibility, Economic and Fiscal Outlook,
Cm 8748, December 2013, p21, para 2.8 Back
8
BDO, BDO Business Trends, 13 February 2014 Back
9
Q6 Back
10
Office for Budget Responsibility, Economic and Fiscal Outlook,
Cm 8748, December 2013, p9, para 1.20 Back
11
Bank of England, Minutes of the Monetary Policy Committee meeting held on 4 and 5 December 2013,
published 18 December2013, para 22 Back
12
Q76 Back
13
Q84 Back
14
Oral evidence to the Treasury Committee, Bank of England November
2013 Inflation Report, HC 825, Tuesday 26 November 2013, Q61 Back
15
IFS, Green Budget 2014, Summary, p3 Back
16
Bank of England, Financial Stability Report, November 2013, p17 Back
17
Office for Budget Responsibility, Economic and Fiscal Outlook,
Cm 8748, December 2013, p68, para 3.102 Back
18
Q11 Back
19
Q13 Back
20
Bank of England, Minutes of the Monetary Policy Committee meeting held on 8 and 9 January 2014,
published 22 January 2014, para 16 Back
21
Office for Budget Responsibility, Economic and Fiscal Outlook,
Cm 8748, December 2013, p68, para 3.101 Back
22
Q51 Back
23
Q51 Back
24
Q216 Back
25
Office for Budget Responsibility, Economic and Fiscal Outlook,
Cm 8748, December 2013, p70, Chart 3.24 Back
26
Oral evidence to the Treasury Committee, Bank of England November
2013 Inflation Report, HC 825, Tuesday 26 November 2013, Q86 Back
27
Q20 Back
28
Q21 Back
29
Q156 Back
30
Office for National Statistics, Balance of Payments, Q3 2013,
20 December 2013, pp1-2 Back
31
Office for Budget Responsibility, Forecasting the economy, Briefing paper No. 3,
October 2011 p32, para 3.86 Back
32
Office for Budget Responsibility, Economic and Fiscal Outlook,
March 2013, Cm 8573, p53, Table 3.3; Office for Budget Responsibility, Economic and Fiscal Outlook,
Cm 8748, December 2013, p55, Table 3.3 Back
33
Q40 Back
34
Q40 Back
35
Oral evidence to the Treasury Committee, Bank of England November
2013 Inflation Report, HC 825, Tuesday 26 November 2013, Q62 Back
36
Office for Budget Responsibility, Economic and Fiscal Outlook,
March 2013, Cm 8573, March 2013, p9, Table 1.1; Office for Budget
Responsibility, Economic and Fiscal Outlook, Cm 8748, December
2013, p10, Table 1.1 Back
37
Q29 Back
38
Q17 Back
39
Q197 Back
40
ONS, Business Investment, Q4 2013 Provisional Results, Released:
26 February 2014, Table G2 Back
41
National Institute of Economic and Social Research, National Institute Economic Review No. 227,
February 2014, pF44 Back
42
National Institute of Economic and Social Research, National Institute Economic Review No. 227,
February 2014, pF44 Back
43
Office for Budget Responsibility, Economic and Fiscal Outlook,
Cm8748, December 2013, p9, para 1.19 Back
44
Q175 Back
45
Oral evidence to the Treasury Committee, Bank of England November
2013 Inflation Report, HC 825, Tuesday 26 November 2013, Q42 Back
46
Oral evidence to the Treasury Committee, Bank of England November
2013 Inflation Report, HC 825, Tuesday 26 November 2013, Q42 Back
47
Q176 Back
48
Office for Budget Responsibility, Forecast Evaluation Report,
October 2012 ,pp39-40 Back
49
Oral evidence to the Treasury Committee, Bank of England November
2013 Inflation Report, HC 825, Tuesday 26 November 2013, Q60 Back
50
Q176 Back
|