1. The Problem
That the UK is
trapped in a doom loop while the income of the US races away from that of the
UK is a widely perceived perception of the two countries. The left and the
right are both clear on the nature of the problem and have their radically
different solutions. The left sees the problem as one where the current labour government
continues what are usually described as neoliberal policies. These can be
summarised as a belief in markets and the importance of fiscal responsibility
as illustrated by the chancellor’s stress on meeting the fiscal rules she set
out. The right, in contrast, sees that the increases in government expenditure
on welfare make meeting the fiscal rules possible only by increasing taxes.
Such increases in taxes reduce growth. Further the right sees the labour
government as passing laws which will damage the housing rental market and the
labour market, further limiting growth.
From
their very different policy perspectives both are agreed that Britain is
trapped in a doom loop. On the left the fiscal rules prevent expenditure
necessary for growth and poverty reduction. On the right the doom loop is of
higher taxes, lower growth and lower living standards. The perception
among the public that both of the main political parties have failed, in quick
succession, to provide higher incomes and better public services has fuelled
the rise of parties to both their right and left.
The success of the
US relative to the UK is seen as evidence, by the right, that a low tax, low
regulated economy can grow much faster than the higher taxed, highly regulated
economy of the UK. But is this view, of the relative success of the US economy,
correct? In this blog I want to discuss a paper which offers a very different
perspective to those of the right and the left outlined above:
‘The UK Productivity “Puzzle” in an
international comparative perspective’. John Fernal and Robert Inklaar,
Oxford Bulletin of Economics and Statistics, 2025.
I am going to
present similar data to that used in their paper. Their conclusion is that what
explains the performance of the UK economy compared with that of the US is, in
large part, their very different rates of Total Factor Productivity (TFP)
growth after the financial crisis. In the final part of the blog I will argue
that political debate about the problems of the UK economy not only does not
address the real problems, but focuses on policies that will make the problems
worse.
I begin by explaining
Total Factor Productivity (TFP) and why it is of central importance for
understanding the causes of growth in an economy.
2. The size of an economy, sources of
growth and TFP
In seeking to
understand why economies are of very different economic size we need to focus
on two factors. The first is how large is the population and its labour force.
The second is the amount of capital in the economy, that is the amount of
buildings, infrastructure, machinery, indeed any capital equipment that produces
output. We need to include in our measure of capital the skills of the
workforce as those skills too increase output.
However, we are
not simply interested in the size of the economy. We are interested in how well
off are the people in any country. Simplifying rather, how rich people are in
an economy depends on two factors. The first is the amount of capital relative
to labour – which we term the capital labour ratio – the second is how efficiently
this capital and labour is used. What the data shows is that countries with the
same amounts of capital and labour can have very different levels of output.
That is what we mean when we talk about the efficiency with which labour and
capital are used. The name we give to this measure is Total Factor Productivity
(TFP). It is a measure of how much more output we get for any given level of
labour and capital.
In summary, the
economic size of an economy depends on the levels of labour and capital and
TFP. How much income per person is available to an economy depends of the
amounts of capital relative to labour and the level of TFP. Finally, how fast
income per person grows depends of how fast the capital to labour ratio rises
and how fast TFP grows. In the sections that follows we show data for all these
aspects of both the US and the UK economies.
3. What explains the
performance of the UK economy relative to the US?
We begin at the
end of our story, namely how the growth rates of the UK and US economies have compared
since 1950. In the left-hand part of Figure 1 we show the annual growth rate of
the two countries since 1950 in the periods I used in my book The Poor and
the Plutocrats where the data ended in 2007.
Two key facts
emerge from Figure 1. The first is that the trend growth rate of both economies
in the period from 1950 to 2007 was identical at 2.2 per cent per annum. The
second is that in the period after the financial crisis of 2007 the growth rate
of both the US and the UK economies dropped markedly. What has been the focus
of public concern is that in the UK the trend growth rate declined from 2.2% per
annum to 0.7% per annum.
In Figure 2 we
look at what these growth rates imply about the levels of GDP in 2007, that is
the start of the financial crisis, and 2023, the most recent year for which we
have data. As we know the UK is a much smaller economy than that of the US due
in part to the much higher population of the US. The relative sizes are shown
in the left-hand part of Figure 2. What is striking is that the difference in
size grew markedly. In 2007 the US economy was six times that of the UK. By
2023 it was seven times bigger.
The right-hand
part of Figures 2 shows the incomes per capita. Here too the gap between the
economies grew. In 2007 the US income per capita was 5 per cent higher than
that of the UK, by 2007 its was 22 per cent higher. Thus, in terms of both
income and income per capita the US economy has outperformed that of the UK
since the financial crisis. How and why? The how part of that question is
answered in Figures 3 and 4.
Figure 3 shows the
growth of labour and capital services. Figure 4 in its left-hand chart shows
the effects of this growth in labour and capital services, that is changes in
the capital labour ratio. We outlined in section 2 above the size of the
capital labour ratio plays in determining how productive are workers in an
economy. Before turning to that in Figure 4 note in Figure 3 how different are
the US and the UK in the growth of labour services. In the period prior to 2007
the growth of labour services in the US was far higher than in the UK, in large
part due to immigration. It is this higher rate of growth in labour services
that explains the higher growth in the size of the US economy relative to the
UK.
While Figure 3 is
relevant for understanding the growth in the size of the economy it is Figure 4
which is crucial for understanding how incomes per capita have grown and why
growth in the UK economy has been so much lower than that in the US. The figure
also shows that the factor that matters most for these differences in growth
rates is TFP. While in the period before 2007 the trend growths rates in the two
economies were the same at 1.2%pa after 2007 the growth rate of TFP in the UK
collapsed relative to that of the US. While, as Figure 4 shows, the trend
growth rate in the capital labour ratio was lower in the UK than the US the
differences were much smaller than those shown for TFP.
4. A doom loop for the UK
The answer to the
question - Is the US a more successful economy than the UK? - is, in general, no. It is true that
since the financial crisis its GDP growth rate has been higher but in the
period from 1950 to the financial crisis the trend growth rates were identical.
The implication of
these conclusions is that the policy perceptions on both the left and the right
in the UK, that Britain is trapped in a doom loop, is simply wrong. More
government expenditure, the recipe of the left, or lower taxes, the recipe of
the right, are only relevant if they can be shown to impact either TFP or the
capital labour ratio. It is though possible the UK is trapped in a doom loop,
one where the populist calls for lower immigration and policies undermining
investment in skills, particularly the universities, do lead to a continuing
failure to address what actually matters for increasing the growth rate of incomes
in the economy, namely TFP and the capital labour ratio.
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