Bad for Osborne, worse for Balls

Yesterday, the Bank for International Settlements released its 84^thAnnual Report on the health of the global economy. The Bank, an international organisation that advises national Central Banks, examined in detail the progress made across the world in managing the post-2008 recovery. The picture is highly complex, pointing out that nations suffered economic reversals of substantially different types. But its analysis of the UK’s economy is startling and contains within it some hard lessons for British politicians, as they begin setting out their economic policy positions in preparation for next year’s General Election.

In the wake of the crisis, the report finds, the United Kingdom suffered an initial fall in output of 7.5 per cent. After six years, output is still 0.5 per cent below its pre-2008 peak. The report also suggests that current levels of economic output, in Britain as well as elsewhere, are substantially below where they would have been had pre-crisis growth continued on its former trajectory. If pre-crisis growth had continued in the United States at its pre-2008 rate, output today would be 12.5 per cent higher than its present level. The equivalent number for the UK is 18.5 per cent and for Spain, 29 per cent. The report makes clear that it is possible that pre-crisis growth expectations were artificially elevated, having been boosted by the asset price boom of the 2000s. For this reason, the report allows that that these figures may be overstated. However, even if revised substantially downwards, they remain a stark expression of the economic damage that was wrought by the 2008 market failure.



The report also addresses perhaps the most troubling legacy for Britain of the financial crisis—weak productivity growth. Other nations are suffering from this unpleasant economic residue, but the report shows clearly that Britain’s productivity problem is more acute than that of all other comparable economies.

As can be seen from the above right chart, output per employee in Britain is lower, relative to pre-crisis trend, than the US, Japan, or any of the major European economies. Since 2010, in the US and Germany, productivity growth has been about 1 per cent, whereas pre-crash, it stood at 2.3 per cent and 1.8 per cent respectively. But in Britain, which before the crisis had productivity growth of around 2.5 per cent, the number is now zero.

Part of Britain’s problem was in the nature of the crash that it experienced. Unlike Germany, the UK underwent a balance sheet recession, meaning that both banks and non-financial companies experienced sudden shocks. The rest of Europe had very different experiences. “Part of the weakness of productivity growth since the start of the recovery,” says the report, “reflects… the slow recovery typical of a balance sheet recession.” The report also points out that the downward trend in UK productivity growth began well before the crisis. In Britain productivity growth rose somewhat between the 1980s and 2000, but has declined ever since, a phenomenon that was obscured during the boom years of the 2000s.

The report's assessment is that technological innovation has contributed to this slowdown in productivity, a view shared by Ed Balls, whose speech at the London Business School on Monday contained a similar diagnosis. However, the comment that “high levels of public debt may also weight negatively,” on productivity growth is a diagnosis that Balls would find less welcome.

Intriguingly, the report also suggests a link between monetary policy and productivity. “Evidence suggests that in crisis-hit countries low interest rates and forbearance might be locking up resources in inefficient companies,” it says, drawing on an argument originally set out in a Bank of England working paper. “For example, firm-level data indicate that in the United Kingdom around one third of the productivity slowdown since 2007 is due to slower reallocation of resources between firms, in terms of both labour movements between firms and firms' market exit and entry.” It is a comment that might give George Osborne—and also Mark Carney, Governor of the Bank of England—cause for alarm. Low interest rates have caused house prices to rise substantially. As such, the government's economic credentials have benefitted from a growing sense of prosperity among property-owners, and the positive effects on GDP that a buoyant housing market can bring.

But if at the same time those same low rates have allowed inefficient businesses to limp along with no incentive to improve their output and practices, then the Bank of England’s zero lower bound policy can be seen as grossly counter-productive. If low rates are holding down productivity growth, then the policy can be considered a dangerous failure. As the report states: “Unless productivity growth picks up, the prospects for output growth are dim.”

The concluding remarks on productivity are that it can only be tackled by deep structural changes. Only this will lead to long-term growth. “Debt-financed stimulus may be less effective than hoped,” says the report, which succeeds in delivering an economic analysis that should trouble both sides of Britain’s political divide.