GDP growth of 0.7 per cent in the final quarter of 2013 has finally confirmed that the recovery is taking hold. Growth for 2013 as a whole has come in at just under 2 per cent. Whilst welcome, this figure shows just how much our expectations have altered in recent years. It is becoming increasingly clear that the economy is unlikely to revert to the heady growth rates that existed before the financial crisis
However, what is particularly disappointing about these figures is that employment has grown at about the same rate, which means that GDP per person employed has hardly grown at all – if anything, these figures confirm that we are in the midst of a productivity crisis. The fourth quarter figures for employment have not come out as yet but simply extrapolating the 3rd quarter figures at the same rate of growth provides a decent estimate. GDP per person employed in 2013 is only a fraction higher than in 2012 (0.4 per cent). GDP per hours worked tells the same story (with 4th quarter hours extrapolated there would appear to be a small fall in GDP per hour worked of 0.4 per cent). Output per worker to the third quarter of 2013 was only 0.3 per cent higher than in the first 9 months of 2012.
So from where is the growth coming? Essentially, growth is coming from household spending which is increasing at roughly the same rate as hours worked and employment. People are working more, producing more and spending more. However, unlike in recent decades, people are not increasing the amount they produce per hour worked. As such, even if living standards rise, given current trends, they will only be rising because we are working harder.
This shows how fragile the recovery is. There is a limit to the extent to which employment can rise. Until we see business investment picking up and the building of capacity, growth in the medium term will be anaemic, probably at around 2 per cent for the foreseeable future. The ‘catch-up growth’ from the Great Recession will not happen. This contrasts markedly with the record after the Great Depression or, indeed, after post-war recessions. Business investment in Q3 2013 (five years after its peak) is 24 per cent down from that in Q1 2008. In contrast private sector investment in the Great Depression was 3.5 per cent up from its 1929 peak five years later.
What can boost growth and get the economy back on to a reasonable growth path? The answer lies in raising private investment to grow and improve productivity as well as improving the productivity of that investment. The first point to note is that this is a problem for the real economy which cannot be solved by monetary policy. The second thing to realise is that private investment is unlikely to grow with so much political uncertainty around. The state sector is still at historically high levels crowding out private enterprise and the budget deficit and government debt are still not showing clear signs of control – again quite contrary to the situation from 1933 after the Great Depression. The election in 2015 and the implications for future taxation are unclear – and they were made still less clear over the weekend.
As well as reducing the size of the state in terms of government spending, we also need to reduce it in terms of its regulatory role. For example, there are clear signs of an increased demand for housing in the UK, but little capacity for a sustained increase in supply (in contrast to the recovery in the 1930s). This not only prevents the highly productive activity of house construction, but it also prevents labour and businesses from moving from low to high productivity areas. In the field of energy, government regulation and subsidies are promoting energy production through very-low-productivity mechanisms and in financial services government policy is strangling bank lending through capital regulation.
The good news is that there is plenty of unrealised potential for higher growth if any government genuinely wishes to preside over a growing economy with rising living standards. The bad news is that we have had a decade or more of poor or indifferent policy choices and radical change does not look like coming soon. Although the government does seem to wish to make some incremental improvements in some areas, much more could be done to raise productivity, growth and living standards.