In an earlier blog I showed that after the financial crisis of 2007-08 real wages fell, while the amount of output produced by each hour worked in the economy rose at a far lower pace than earlier. Figure 1 below reproduces the data from that earlier blog.
Figure
1 The collapse of productivity growth in
the UK economy post the financial crisis
Source ONS data: GDP per hour is obtained from the volume measure of GDP divided by the measure for total weekly hours worked annualised. Real hourly earnings are from data for average weekly earnings divided by weekly hours worked and deflated by the consumer price index.
In this blog I want to answer the
question as to why that output per hour worked grew so much slower than before
the financial crisis. Why was this crisis so very different from earlier
recessions?
Teresa May, during the 2017 general
election campaign, said there was ‘no magic money tree’ when asked by a nurse
why her pay had been frozen. Well, was
that true? A ‘magic money tree’ is an informal way of describing what has been
happening to now rich countries for the last 200 years in that the amount of
output each produces grows faster than does the labour to produce that output. Her
more accurate answer, as the above figure shows, should have been that under
previous governments there had been a ‘magic money tree’ but that the
conservative dominated governments after 2010 had succeeded in killing it
off. This blog is about the mechanisms
by which death was affected.
If you work hard and do your job,
what if each year you produced more with no additional effort on your part. It
sounds a bit unlikely but that is exactly what the UK economy did up to the
financial crash. Economists call it total factor productivity (TFP). It is,
quite literally, a measure of how much more output you get without more inputs
into production (or at least any that are measurable).
Figure 2 More output but not more inputs
Source ONS data: Release
of Productivity Overview, UK: October to December 2021. The figure for TFP in
the chart is for the Total Market Sector.
Figure
3 How much more capital did workers have?
Figure 4 Changes in capital and labour inputs
Source ONS data: Release of Productivity Overview, UK: October to December 2021. Capital services and labour hours are for the Total Market Sector.
While we can see from Figure 3 that
the amount of capital each worker has to work with fell soon after the
Financial Crisis, we need to know how this changed occurred and that we show in
Figure 4.
Two changes occurred after the
financial crisis which were quite different from earlier recessions. The first
was that capital services grew much more slowly than before. The second was
that, in dramatic contrast to earlier recessions, labour supply started to grow.
The result was the decline in the capital to labour ratio.
We can now answer the question we
posed in the title to this blog as to why labour productivity growth collapsed
after the Financial Crisis. Labour productivity growth depends on two factors.
The first is TFP (Total Factor Productivity) which is the magical factor producing
more output with no more inputs. While this fell marked immediately following
the crisis it then started to rise again. The second factor is the capital to
labour ratio which we showed in Figure 3 fell significantly after the financial
crisis. It is this fall which is the most important factor explaining the
failure of labour productivity to rise by more than very modest amounts.
Labour productivity is not the focus
of political debate. Indeed, outside the columns of relatively specialised
newspapers it is not mentioned at all. That is regrettable as it is the
collapse of that growth in labour productivity that underlies all the UK’s
present economic woes. It explains the low wages many workers face, it explains
the inability of the government to fund adequately the NHS and social care, it
explains why at the end of a decade of ‘austerity’ there was still no budget
surplus and the advent of the pandemic ensured that to address it the result
has been a public sector deficit far larger than when ‘austerity’ began. It
drives real earnings. It is how all of the painful political choices can be
avoided. As real incomes rise taxes will rise even if tax rates do not change,
there will be more income for workers and more funds for public services.
Put simply more people in the UK
have been working so output has been rising but the amount of output each
produce has not been increasing – the end of the magic money tree. This shows
up in Figure 5 below where, following the financial crisis, after a short term
fall, output continued to grow while output per person did not. As Figure 5
also shows this had not happened after any earlier recessions.
Figure
5 How output grew and productivity did not after the financial Crisis
Sources: As for Figure 1.
While the above analysis shows how the decline in productivity has been affected, the results clearly poses two more fundamental questions. Why did labour supply start rising and investment start falling after the recession caused by the Financial Crisis, while neither had happened in earlier recessions? To that I will return in a future post.
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