1.5% growth is the economy’s speed limit

There was a good discussion on the Bank of England’s interest rate rise on the World at One yesterday. (It’s here at around 34 minutes in.)

Duncan Weldon explained that the interest rate rise was driven by pessimism, not optimism. The Bank has taken its foot off the pedal not because the economy is speeding ahead but because, even at the slow speed it is chugging along at, it is already starting to shake. Jajit Chadha also used a car analogy, explaining that the Bank can only use the brake and the accelerator but can’t do much about the problems with the engine.

The Bank of England was already on board with the motoring explainer, declaring that the economy’s speed limit is now GDP growth of 1.5 percent per year, way below its pre-crisis trend. The Bank believes that there is very little spare capacity in the economy.


The clapped out engine, of course, is the economy’s chronic productivity problem. This, says the Bank, is due to low investment and the inefficient use of labour and capital.

The contrast with the pre recession period is sharp. At the moment, all that is increasing is employment. The UK’s output is only rising because more of us are working and so the number of hours worked has gone up. What we manage to produce per hour hasn’t changed. As a country, we are working harder but not smarter. In previous decades, output increased because we became more efficient. Nowadays, like Rick’s Sandwich Bar, we are growing the business simply by throwing more and more low-paid people into the fray.

The Bank’s outlook is gloomy:

Taken together, these factors are consistent with productivity growth remaining subdued in coming years. Alongside modest labour supply growth, that will weigh on growth in the
United Kingdom’s overall potential supply capacity, which in turn will limit the speed at which output can grow before it leads to domestic inflationary pressure.

As Duncan says, this is actually more important news than the rate rise.

The Bank of England has drawn similar conclusions to the Office for Budget Responsibility; the UK economy’s problems are deep-rooted. The productivity stagnation and low growth isn’t simply a hangover from the recession, it is something that looks to be set in, at least for the next few years.

If growth of around 1.5 percent per year really is as good as it’s going to get for the rest of the decade, it will mark a significant shift from what most of us have been used to for most of our working lives. The economy used to trundle on at around two-and-a-half percent and most of us took it for granted. When there were recessions we made up the ground afterwards. Not any more. We have now had ten years of stagnating wages and what little growth there has been has simply been the result of putting more hours in. The Bank of England and the OBR have, effectively, written off growth prospects for the rest of the 2010s. Those people who warned of a lost decade when the financial crisis hit may turn out to have been optimistic.

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27 Responses to 1.5% growth is the economy’s speed limit

  1. Miles Parker says:

    Do you think there is any link to Robert Gordon’s forecast of slowing growth in the US economy linked to a slow down in innovation (not investment related)?

  2. Dipper says:

    “This, says the Bank, is due to low investment and the inefficient use of labour and capital”

    A decade of low interest rates and FOM providing as many people as you want at low rates has lead to an inefficient use of labour and capital. Quelle surprise! If you make something free, people won’t use it efficiently. If a resource is scarce or costly, they will use it more efficiently. Answer: raise rates (2% now) and reduce immigration to specific business cases. Done.

    • Dipper, to borrow a phrase beloved of the Governor of the Bank of England, you need to “look through” the choice of words here. The “inefficient use of labour and capital” is a critique of the quality of UK management, i.e. the ability to maximise factors of production, not a suggestion that cheap migrant labour is a problem. In fact, imported labour will have disproportionately benefited productivity (either they’ve produced the same output as natives but at lower cost, as you suggest, or they have filled skill gaps that natives couldn’t), so the one thing it isn’t is “inefficient”.

      The poor quality of UK management is intimately tied up with low investment, not only in the sense that human capital investment tends to track physical capital investment, but in the sense that the ruling ideology of UK business (short-termism, undervaluing shopfloor knowledge, focus on shareholder value etc) tends to inhibit development of the sort of culture and corporate infrastructure needed to promote steady productivity gains.

      Carney’s words should be seen in the context of a long tradition in which the City denigrates native industry, reflecting its history as an outward-facing financial centre. The critique is not without foundation, but it is also a self-fulfilling prophecy that has been used to justify the diversion of British capital to foreign speculation.

      • Dipper says:

        It isn’t sufficient to point out that this is a critique of UK management and a result of low investment and short-termism. If we take your second paragraph this statement could have been made practically any time in the last 40 years for most of which productivity was increasing and growth chugging along at 3%. Productivity started to flatline just before the GFC so we have to find something that occurred around that time. I would contend that Freedom of Movement and the use of that on a large scale to commoditise and push down the cost of skills kicked in at that time.

        • Dipper, UK productivity growth has been lagging our chief comparators for decades, not just since the mid-2000s. When we were chugging along at 3% p.a., this was less than the rate achieved in other developed economies with broadly similar endowments. Today, a worker in France can produce in 4 days what a UK worker takes 5 days to do.

          There are a number of factors at work here, but the dominant one is political choice. France has opted to maintain a regulated labour market which has produced relatively high wages, high productivity and high unemployment. In the UK, we’ve opted for low wages, low productivity and low unemployment. It is deregulation, not migrant labour, that has been the main enabler of low wages.

          It is also worth remembering that headline UK productivity rates were flattered first by the decimation of UK industry in the 80s, which shrank the denominator (i.e. jobs), and then by the contribution of high-profit/low-headcount financial services in the 90s, which swelled the numerator (i.e. GDP was boosted by increased global financial flows). Our problem now is that we no longer have the option of Thatcherite “creative destruction”, nor can we expect the City to gild the lily (not least because of Brexit).

          The aftermath of 2008 has revealed that the UK’s productivity problem is systemic and longstanding, and has probably been worse than we’ve hitherto been prepared to admit. There seems little likelihood of this changing unless we address the related issues of under-investment and poor quality management. Blaming migrant labour is just a distraction.

          • Blissex says:

            «In the UK, we’ve opted for low wages, low productivity and low unemployment.»

            Please replace “low unemployment” with “reporting low unemployment”, as employment levels have not been good, but the “methodologies” have been very “improved”.

            «the contribution of high-profit/low-headcount financial services in the 90s, which swelled the numerator (i.e. GDP was boosted by increased global financial flows).»

            It turned out that a lot of the GDP contribution of financial services, those high profits, were due to “creative”, “deep and special”, accounting of risk, that is asset stripping. Perhaps the 1.2% points difference between 2.7% and 1.5% is due entirely to fake “book” profits in the financial sector no longer being available.

            Like other blog commenters looking at the graphs here there is something striking about the source of financial sector profit, and not “global financial flows”, but pretty local mortgage accumulation:


            especially these two:

    • I can only speak authoratively of my own industry (engineering manufacturing) and company but the problem described would be exacerbated not alleviated if EU migrant labour were removed/reduced.

      Skills shortages are a key factor, we import skills because we don’t have them. It’s as simple as that. The question we should ask ourselves is, in a first world developed economy why don’t we have the people with the skills we need?

      • Dipper says:

        Gulliver I disagree and think your answer illustrates my point. If you had more problems recruiting skilled people, you would think more about how you use the people you have got to get more out of them (i.e. increase productivity), and would think more about how to get the right set of skills in the workforce (and so increasing the earning potential of UK employees).

        • When I say “my company” I mean the company I work for however I was, for a period, responsible for some of its recruitment. This coincided with a period when I also taught an engineering discipline part time at a local tertiary college (it was pre GFC). What I can say is, in that period I was able to recruit locally and indeed had the opportunity to recruit from said tertiary college. Those recruited were occasionally the same individuals I taught.

          Then a funny (some might say stupid) thing happened, Adult education funding was slashed, I was no longer able to continue lecturing as, quite simply, I had no one to teach and courses were discontinued (there is a threshold below which a course becomes unviable, depending on the funding subsidy available – the lower the subsidy, the greater the number of paying students required to run the course). Coincidentally recruitment became harder shortly after.

          You can blame EU immigration, or immigration in general, and you may say that that the UK skills shortage is because UK employers are recruiting abroad rather than training local workers but I would say that if the base line skills are not present in the UK in sufficient numbers, and if it’s becoming harder and harder for UK employees to improve their skills inside or outside of work than this points to an underlying problem that did not originate with immigration. From my own perspective and experience the influx of skilled immigrants was to fill a vacuum that was already there.

          And the key problem with all this is that come Brexit, and IF immigration is curbed, it is those remaining, skilled, in-work UK employees who could find themselves at a disadvantage. Many companies may decide that it is easier to move their capital elsewhere, to where the skills are more readily available. The effect of students unable to further their own skill advancement because courses are not viable to run could be mirrored if skilled UK workers are unable to work because the global company that employs them has decided their UK operation is no longer viable due to the lack of available skills.

          • gunnerbear says:

            “From my own perspective and experience the influx of skilled immigrants was to fill a vacuum that was already there.”

            But we’re not talking of a few skilled immigrants, were talking huge numbers of dross, unskilled immigrants who’ll live 15 to a house, accept dangerous and dodgy working conditions and very low pay because it is still better than the f**king s**t-tip they’ve come from….

            ….those low skilled migrants will never, ever be net taxpayers so long as they’ve got a hole in their a**e….and their very presence smashes down wages for UK citizens.

        • Mick McNeill says:

          Dipper, you consistently deny reality and try to turn it on it’s head, you’ve been told time and time again from a myriad of sources which are backed up with facts, that the problem is not due to migrants but the lack of skillsets within the UK, particularly wished for by this Tory government – low wages, low unemployment, low productivity, now all together now – I will see common sense one day! As a poster says above – without migrant labour with their own skillsets, hoping that little englanders with a chip on their shoulder will work with the same ethics and principles is wishful thinking.

    • dazwright says:

      Freedom of movement applies to all EU countries yet it isn’t having an impact on the productivity of other member states. Germany has similarly low interest rates and higher rates of immigration.

  3. srjc3 says:

    “This, says the Bank, is due to low investment and the inefficient use of labour and capital”

    We also make very inefficient use of the third factor of production: land.

    Maybe the supply constraints on housing and commercial property in our most productive locations are becoming more binding over time.

  4. Melvin says:

    I read your sandwich bar example. One thought that struck me which I do not think was pointed out is that if we are all working to full capacity in low paid jobs with a devalued currency then we have no leasure time to buy and enjoy services and manufactured products. We become slaves to work. Once this becomes the custom we spiral down to even lower productivity as we are all consumed with outstanding work and no time to innovate. Technological advances pass us by while we toil away and transport ourselves into total slavery

    • Blissex says:

      «if we are all working to full capacity in low paid jobs with a devalued currency then we have no leasure time»

      A farm is not run for the benefit of the livestock, it is run for the benefit of the farm owner.

      You can be sure that every pound of lower wages and benefits and every pound of higher house rents and prices is not wasted, but contributes to better living standards, longer leisure, and a greater ability “buy and enjoy services and manufactured products” for business and property owners.

  5. Pingback: Blah Blah Land – Connecting the Sex Pistols to the Productivity Puzzle | monaghanpj

  6. Blissex says:

    «The UK’s output is only rising because more of us are working and so the number of hours worked has gone up. What we manage to produce per hour hasn’t changed.»

    Our blogger amazingly is channelling the very lucid analysis of 35 years of thatcherism made by David Davis in ConservativeHome.com of all places, just last year:


    «Economic growth in the UK has been founded on a number of unhealthy characteristics in the last decade or so. It has depended above all on large population increases based on uncontrolled mass migration. This has made the economy bigger, but not necessarily better for individual citizens, as shown by GDP per capita growth rates of two per cent or less – significantly weaker than in most decades since the Second World War. It has depended on moving a large number of people moving out of unemployment, which is good, but because the new jobs tend to be low paid it created a low productivity economy. And it all depends far too much on domestic demand, which even after 2008 is excessively funded by consumer credit. This is unsustainable in the long run.»

  7. Patricia Leighton says:

    I can only echo the various comments made about the impact of poor management-I work in other countries and can see the differences clearly. One of the areas that might be explored and then changed are the business schools that for huge fees churn out graduates schooled in marketing, strategic business, finance and little on people, their development etc. We have copied some bad habits from across the Atlantic-a lot of rhetoric, wild plans etc and a lack of practical application with feet on the ground.

  8. srjc3 says:

    Many people are commenting about bad management – but I imagine this is a secular problem.

    The question is: why aren’t badly managed firms going out of business and the freed-up resources flowing to the well-managed firms?

    Perhaps the post-recession environment has meant the gears of competition have not ground as effectively.

    • Despite the aggressive SME foreclosure policy pursued by RBS (which seems to have been partly driven by political pressure), most banks tended to “extend and pretend” on larger underperforming business loans in the years immediately after 2009, essentially to help their balance sheets meet tougher capital requirements (a situation that was facilitated by continuing low interest rates). That’s been gradually changing, but it allowed many weak businesses to limp along.

      The higher value resources in an economy tend to be monopolised by larger, longer-established firms. Creative destruction requires these, rather than risky startups, to go bust (as they did in the 80s), but the recession has been marked by strategies that have allowed these larger firms to preserve themselves. Employee churn is down and upward pressure on wages weak; QE boosted share prices and (together with low interest rates) made operational financing easier; and low-levels of capital investment since the 90s have boosted company cash buffers.

      This has been exacerbated by the gradual change in the startup ecosystem from the creation of small firms that wanted to grow big and challenge incumbents to a combination of lifestyle businesses and R&D ventures aiming for an acquisition (sometimes by the company that the founders left) rather than an IPO. In other words, the ecosystem has become less competitive and more complementary, which has allowed the 800lb gorilla firms to entrench their position by reducing internal R&D risk and flexing their skill base through contracting.

      Basically, it’s been a benign environment for corporates since 2009 despite the recession. Paradoxically, an improvement in the economy would usher in a harsher climate, essentially because a growing market would allow the better-managed incumbents and new entrants to secure an expanding share. What is uncertain for the UK is how Brexit will complicate this. A major negative shock in 2019 could lead to a shakeout comparable with the early-80s, or continuing confusion and a last-minute lash-up to preserve as much of the SM and CU as possible could extend the stagnation.

  9. Passingby says:

    There’s a lot in the low level of capital intensity, which is longstanding. A big part of this — and the poor mixing of capital and labour that goes with it — is that planning laws make investment in major service industries relatively constrained (it’s actually quite difficult to plonk a new hotel or restaurant down where it might have a good competitive position).

    But that aside, the sustained growth in volume but not productivity could reflect where the constraint lies: historically, innovation and investment was needed to tackle scarce labour supply, especially in labour-intensive industries; but over the past 20 years, this hasn’t been a constraint and so businesses in those industries can just expand by hiring fresh immigrant labour. If an economy optimises around its key binding constraint, we’ve moved from one optimised around workers (consequently, growth up labour productivity and so wages) to one optimised around houses (growth drives up house prices).

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