The economy’s British summer

The spring equinox was at 4.30 this morning, heralding lighter evenings and, we hope, much warmer days. Last week’s economic forecast by the Office for Budget Responsibility felt distinctly autumnal though.

This, the important story from the budget, barely made it onto the front pages. Most of the headlines were about the sugar tax. Only the Guardian mentioned the forecast £56 billion deterioration in the public finances. It is the cause of that black hole that was the real story  on Wednesday.

Some spotted it early. In this great video, recorded just after the chancellor had finished speaking, the FT’s Chris Giles said that the OBR had forecast lower growth, like, forevuuuh!

OK, he didn’t actually mean forever but for the period over which it is possible to make any reasonable judgement, the OBR has effectively told us that growth will bump along at just over 2 percent. We described a period of similar growth as a mini-downturn in 2002, a sign of how far our expectations have shifted. In other words, then, the OBR has decided we’ve had all the post recession bounce we are going to get.

CdrDhprWAAA7u5q.jpg-large

Chart by Resolution Foundation

The chancellor got his excuses in early a couple of months ago, blaming global economic headwinds and a cocktail of risks from the rest of the world. The OBR was having none of it though:

Real economy indicators around the world have not been as weak as financial markets, so we have made only relatively small downward revisions to our forecasts for world GDP and world trade growth, with knock-on implications for the UK’s export markets.

No, what really blew a hole in the public finances was a home-grown problem. Low productivity:

The most significant change we have made to our domestic forecast since November has been to revise down our estimate of potential productivity growth, which in turn reduces the sustainable level of GDP and our forecast for GDP growth over the next five years.

[P]roductivity growth in mid-2015 seemed consistent with our long-held assumption that the post-crisis drag on productivity growth would ease as the financial system returned to full health and that it would be back at its pre-crisis historic average rate of 2.2 per cent by the end of the forecast period. That pick-up appears to have been another false dawn.

The productivity plummet at the end of last year killed all that optimism stone dead.

CdrqqANXIAEnR7d.jpg-large

Chart by Office for Budget Responsibility

The upshot of this is that the OBR’s productivity forecasts have been revised down every year, as this chart from the Resolution Foundation’s excellent budget briefing shows.

Screen Shot 2016-03-18 at 18.14.07

Chart by Resolution Foundation

The report comments:

This change reflects the OBR’s assumption that more of the weak productivity growth post-crisis represents a permanent shift in the UK’s potential to grow, with the pick-up in productivity growth in mid-2015 now being described as a ‘false dawn’.[1] This goes further than the concern that has dominated the productivity discussion to date – namely the scale of the productivity hit endured after the crisis. Instead, it implies that trend productivity growth has fallen.

Productivity is already around 17 per cent below where it might have been in the absence of the post-crisis stagnation. If the trend rate of productivity growth has fallen, then this gap will widen – rising to 24 per cent by the end of the forecast horizon.

In other words, the OBR has given up on productivity growth returning to normal, at least for the rest of this decade.

Screen Shot 2016-03-18 at 18.20.46

Chart by Resolution Foundation

This, says the Resolution Foundation, will have an impact on pay growth. Based on these forecasts, it doesn’t expect real-terms median employee pay to get back to its pre recession level until sometime after the next election.

Screen Shot 2016-03-18 at 18.24.05

Chart by Resolution Foundation

The result of this is much lower tax revenue than the chancellor was hoping for. Some of this shortfall is due to the raising of tax allowances but most of it is simply due to weaker pay growth.

Screen Shot 2016-03-18 at 18.30.27

Chart by Resolution Foundation

So there you have it. Stubbornly low productivity eventually feeds through to a £56 billion black hole in the public finances.

Most people, including me, thought that, as the economy improved, the labour market would start getting back to normal. We assumed that some of the features of the recession, like low investment, low productivity, wage stagnation and high self-employment, would start to unwind. They did, for a while, then over the past few months things seemed to go into reverse again.

This wasn’t what was supposed to happen. Past recessions have always been followed by booms which have made up for lost growth. This time we have had a much more severe downturn but the post recession recovery never really got going.

GDP growth March 2016

Source: ONS, OBR

 

It reminds me of one of those classic British summers. After a long cold winter, everybody is waiting for the warm and sunny days to arrive but they never quite do. We get the odd hot spell but none of them seem to last very long. The abiding image of the summer is pouring rain at Wimbledon and overcast days at Headingley. Before you know it, there is that first whiff of autumn in the air and everyone is asking where the summer went.

Like the weather forecaster in late August, telling us that we have probably seen the last of the hot days, the OBR told us last week that the best of the recovery is behind us. The economic nights are drawing in and we are now into a period of low growth for the rest of the decade.

Of course, the OBR could be wrong. As Chris Giles says, “this one of the most sudden and nastiest changes of view it has offered to date.” Some people think it is being way too downbeat and its chairman Robert Chote said productivity forecasts are some of the “least certain judgements that any medium term forecaster has to make”.

It could be that the  last few months was the blip, not the previous year. We may still see another spurt of growth. Perhaps the recovery is not quite over yet. Perhaps, but then again, you know what those British summers can be like….

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3 Responses to The economy’s British summer

  1. sdbast says:

    Reblogged this on sdbast.

  2. Keith says:

    Back in the sixties Harold Wilson spent years inventing schemes to boost productivity. Entire little empires of neddys and little neddies. No one seems to bother today with plans for solving this problem. May be some one should come up with a plan?

  3. Patricia Leighton says:

    It’s in part about waste, especially of time. Compared to other workplaces I am familiar with, outside the UK we have high sickness absence levels, meetings that go on forever with no discipline, managers who waste time on trifling matters and no real time discipline. If we paid for the 50% of overtime that is unpaid, we might get a sense of just how inefficient we are.We jeer at the French for their supposed long lunches but when they are scheduled to be working, they are-no long football discussions round the coffee/water machine!

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