A couple of months ago, Tim Worstall asked:
OK, put together a few simple things.
1) Per capita GDP growth pretty much comes from productivity growth.
2) We know from Baumol that increasing prductivity in services is much more difficult than in manufacturing (or agriculture).
3) Services have been growing as a portion of the economy, manufacturing falling.
4) Trend growth rates are now lower than they were 30-50 years ago.
It seems pretty obvious to me that 4) is in part caused by 1-3.
So, has anyone actually tried to measure this? Luis? Chris?
Both Luis and Chris replied with this study by the University of Toronto, which found that:
[S]ectoral labor productivity differences and the structural transformation they produce account for more than 50 percent of the fast catch-up in aggregate productivity observed in less developed economies and all of the stagnation and decline observed in more developed economies in recent decades.
In other words, much of the reason for the relatively high growth in productivity in emerging economies and the relatively low growth in mature economies is because the former have large manufacturing sectors and the latter have large service sectors. In service dominated economies productivity increase is slower simply because, for reasons I explained here, it is harder to improve productivity in service organisations.
It would therefore be unreasonable to expect the more service-based mature economies to grow at the same rate as the manufacturing economies of the postwar period. Yet many of us seem to assume that they will.
After the Second World War, our economy grew at 3 percent per year until the early seventies. Subsequently, although punctuated by more frequent recessions, the growth rate during the boom years was similar.
We have based a lot of our assumptions about the post-crisis economy on the previous half-century. Once the present troubles are over, we tell ourselves, years of 3 percent growth will once again power us out of recession and debt. Just like they did before.
But what if that doesn’t happen? What if the developed economies are no longer capable of generating that sort of growth?
Chris Dillow has gone back over the productivity data for the last 150 years and reckons that the postwar period might be something of a blip:
If we split annual peacetime productivity growth into distinct periods we get:
1856-1913 = 1.3%
1920-1939 = 1.7%
1947-1973 = 3.1%
1973-2011 = 1.9%
What stands out here is the fast productivity growth during post-war period. The last 40 years of weaker growth look normal compared to the pre-war period.
As I’ve said before, the reason that we were able to simultaneously increase public service provision and shrink our debt-to-GDP ratio was because our economy grew so rapidly after the war. As long as the economy was growing faster than the debt and the cost of public services, we were laughing.
Now, though, it is the other way round. Our debt is increasing and the cost of our public services will rise rapidly as our population ages. If the great boom was simply due to a manufacturing-led postwar productivity catch up, then it was a one-off. Could it be, then that the slow growth predicted for the next few years is as good as it’s going to get for the next decade or so?
American economist Robert Gordon reckons that economic growth in the USA might be pretty much over:
There was virtually no growth before 1750, and thus there is no guarantee that growth will continue indefinitely. Rather, the paper suggests that the rapid progress made over the past 250 years could well turn out to be a unique episode in human history.
His central theme is that “innovation does not have the same potential to create growth in the future as in the past”. While there is still some innovation, it is not the sort that will drive productivity:
Invention since 2000 has centered on entertainment and communication devices that are smaller, smarter, and more capable, but do not fundamentally change labor productivity or the standard of living in the way that electric light, motor cars, or indoor plumbing changed it.
What little productivity growth there is, argues Gordon, will be constrained by six ‘economic headwinds’ – demography, education, inequality, globalization, energy/environment, and the overhang of consumer and government debt. This could, he says, reduce US economic growth to less than 1 percent per year for decades!
A report on the Eurozone published by Ernst & Young last week uses the same ‘headwinds’ terminology and predicts an average growth rate below 1 percent for the next five years. Uncertainty, says E & Y will probably reduce investment and stifle innovation, leading to a lost decade for the Eurozone.
If growth in the USA and Eurozone is to be sluggish over the next decade, that of the UK will be too. According to McKinsey, to maintain the sort of growth rates we have been used to, northern European countries would have to increase their productivity 33 percent faster than they have managed for the past two decades. Unless somebody discovers some miraculous new productivity-boosting technology, that is very unlikely.
PwC’s John Hawksworth remarked:
It seems likely that we have entered a ‘new normal’ period where growth will be relatively subdued by historic standards for some years to come.
Some of this would probably have happened anyway. As western economies became more service-based, they were bound to struggle to achieve postwar levels of productivity growth. Ageing populations were always going to put more pressure on public finances. It was unlikely that innovation would drive enough productivity growth to compensate.
The trouble is, on top of all this we’ve had the worst financial crisis in living memory which has knocked the stuffing out of the world economy, slashed tax revenues and pushed up government debts.
For the most of the period since the foundation of the welfare state, economic growth was increasing and debt-to-GDP levels were reducing. That’s why we were able to expand the role and scope of the state without having to worry about it too much. Now, the trend seems to be moving in the other direction. If the state continues to provide current level of services, the cost will increase faster than the economy is able to grow. This means that the state will take up an ever larger proportion of national income, estimated in some scenarios to reach 52 percent of GDP by the end of the next decade.
The left may attack Ed Miliband for saying he would not reverse public spending cuts, Ed Balls for promising a line-by-line review of all public spending and Stella Creasy for demanding a re-design of the state but these politicians are just being realistic. When the economy was growing we could give public services higher than inflation budget increases. Now, with rising costs, rising debt and negligible growth for the forseeable future, there is very little room for governments of whatever political colour to manoeuvre. Unless the public sector is radically reformed (or the British suddenly discover an appetite for paying much higher taxes) many of its services will just stop functioning over the next decade.
Some of the low growth (or no growth) predictions may be over-pessimistic but if they are even half-right, things will be very different over the next few decades. Without some dramatic new productivity-boosting innovation, it is unlikely that we will see the sort of economic growth rates we enjoyed during the last half of the Twentieth Century.
We will probably be in a low growth world for some years to come. We have built our world on the assumption that continued economic growth is a given. A sustained period of low growth has implications for politics, for work, for the postwar social contract and, especially, for public services. Combine low growth with rising public service costs and the nature of the state will inevitably change – either by design or default. Like everything else, the post-growth state will look very different from the one we’ve been used to.