Autumn Statement 2013 - Treasury Contents

2  The macroeconomy


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 1.82.3 2.72.8
December 2013 0.11.4 2.42.2 2.62.7 2.7
Change -0.1 0.80.6 -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


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 forecast—like that of the Bank of England—does 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 year—effectively a stagnation—and 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 conditions—demand 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.


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]


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]


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

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