Theresa May’s government is creating enough of its own bad news without any help from the Office for Budget Responsibility (OBR), created in 2010 to provide independent and authoritative analysis of the UK’s public finances. Yet in today’s “Forecast Evaluation Report,” the OBR has pretty much holed the Treasury and the government below the water line at a crucial time in the Brexit negotiations, and just weeks before the Budget.
For the last seven years, the OBR has continuously assumed that the UK’s disappointing productivity (output per hour worked) performance would revert to a pre-financial crisis trend of 2 per cent per annum over the medium-term. Ever hopeful, it anticipated that a rise of 1.5 per cent in 2016 heralded just such an outcome, but this proved to be a false dawn, and now the OBR has thrown in the towel. In its report, it says
“...it seems less plausible to assume that the factors holding back productivity growth will fade substantially over the forecast period. In light of this, we expect to revise down our assumption for average potential productivity growth significantly in our November forecast.”
We don’t know how much “significantly” will be, but this is not an area in which we wanted to hear bad news, for UK productivity has long been disappointing. According to data previously published by the ONS, it has hardly grown since 2014, and is barely higher than in 2010. In 2016, productivity levels were higher than in Japan and Canada, but over 15 per cent lower than in other G7 countries. Comparing the pre- and post-financial crisis trends, UK productivity was almost 16 per cent lower than it would otherwise have been, about twice as bad as for other G7 countries.
The latest news is bound to have a strong negative effect on the Chancellor’s best laid fiscal plans over the next few years—just when Brexit demands that the country’s finances are robust and in good order.
Until now, the OBR had estimated that the direct costs of Brexit would amount to about £15 billion. That’s almost certainly an under-estimate. Its forecasts also allowed Philip Hammond to build in to future Budgetary arithmetic a £26 billion pot to smooth these costs. Up to 60-70 per cent of this cushion could have evaporated if the OBR lowers its new productivity growth forecast to recent trends.
With the latest political twists suggesting a somewhat higher probability of a ruinous, no-deal Brexit, Hammond and the Treasury are under the cosh now, especially with rising demands for new money for public sector pay and housing. Their softer targets for public borrowing are proving as mirage-like as George Osborne’s budget surplus projections.
"Comparing the pre- and post-financial crisis trends, UK productivity is almost 16 per cent lower than it would otherwise have been"The only caveat to this glum picture is that with more people than ever at work, tax revenues are higher and public spending is lower than they would otherwise have been. This compensates to an extent but in a fairly aged expansion with low unemployment and lower immigration, the potential in future is not that great.
There’s no question that we are in bad shape. Why is the UK having such a bad time? And does the ghost of Brexit loom here too?
A pot-pourri of reasons has been put forward to explain what’s going on in the UK. They range from mis-measurement, to the unintended effects of QE in keeping zombie firms and credit lines in place instead of a more productive allocation of capital and credit, to a tighter regulatory environment in, for example, finance, transportation and energy. Each of these could be contributing to weaker productivity, but not so much as to make such a difference.
The weakness of investment in this expansion is unquestionably one important reason, as the OBR points out today. Further, some people have said that innovation nowadays is simply not as productive as it used to be. If this were true though, why the fuss about the implications of AI, robotics, digital technology, Big Data, and the human genome? I think this is way off base. If anything, the benefits of these technologies are under-stated and we are not encouraging them quickly enough to spread through the economy. The Bank of England’s Chief Economist, Andy Haldane referred to this in a speech earlier this year, suggesting that what ails us is not so much “secular stagnation” as the slow diffusion of technology. He said, for example, that 1 per cent of UK firms were experiencing 6 per cent productivity growth, while a third had shown no change since 2000.
This could be pointing to a sharp post-crisis deterioration in competitiveness, or rise in firm concentration, as a serious productivity blockage. In other words, fewer and fewer firms account for the bulk of production, turnover, profits and so on. The idea that industry concentration is impeding productivity growth is supported by government statistics, especially as they relate to some of our previously leading sectors in productivity, such as banking and finance, information services, key consumer markets, telecommunications, but also to energy and utilities. It chimes with labour market data that suggest that the good news of high levels of employment is countered by the bad news that most people finding work in recent years have flocked into firms and sectors that account for the bulk of hours worked and the lowest levels of productivity.
The government’s challenge, then, should be not only to try and create a favourable macro-economic environment for investment and the adoption of new technologies. It should also pay much more attention to more micro-economic issues, especially those policies (including on corporate governance) that focus on creating more competition, and more job opportunities in higher productivity industries.
While these issues pre-date the EU referendum, Brexit is making a bad situation worse, and distracting the government from mitigation measures designed to shore up the economy ahead of the instability to which the government is driving it. The OBR’s message is that far from taking control of the economy, the government is losing its grip with alarming speed.
