Economic performance under labour.
Liadze, Iana ; Weale, Martin
This article compares the performance of the UK economy since 1997
with that between 1979 and 1997 and with the performance of the other G7
economies in both periods. It concludes that Britain has done relatively
well in terms of productivity growth, economic growth and national
income per head but not very well in terms of labour market performance.
Savings rates were too low to deliver sustainable economic growth over
the period 1979-97 and there has been very little improvement since
then. The performance of the economy during the recession and its
immediate aftermath has been disappointing relative to the other G7
economies.
Keywords: Economic growth; national income; labour market;
sustainability; recession JEL Classifications: E20; E32
Introduction
A General Election is an obvious time to assess a government's
economic record and in this commentary we present a summary of the
performance of key aspects of the British economy since Labour came to
power in 1997. We make comparisons both with Britain's performance
under the earlier Conservative Government from 1979-97 and also with
that of other countries. This survey provides the background for four
articles describing aspects of that performance in more detail. Alan
Budd provides an account of fiscal policy, identifying the factors which
lay behind the deficit which has opened up in the past two years.
Timothy Besley and Kevin Sheedy look at monetary policy. Paul Gregg and
Jonathan Wadsworth look at the performance of labour market policy in
the recent recession and Lorna Unwin at training policy. Thus these four
articles provide an account of key aspects of both demand management and
of supply-side policy.
Any assessment is overshadowed by the recession. The monthly
profile of GDP points to a picture slightly worse than that of the early
1980s, although the calendar year of 2009 showed the largest contraction
since 1921 and indeed the worst GDP performance of any year since 1870
with the exception of the three years after the end of the First World
War. Nevertheless, the recession was an international phenomenon and,
despite being more severe than that of the 1980s, the interval since the
previous recession was longer. Although we obviously address the
recession and its consequences, we aim to provide a perspective broader
than that which would be obtained by looking at the recession alone.
The policy framework and Labour's performance
A key feature of the Labour Government and one of which it was
proud for most of its tenure was the system of macroeconomic management.
Labour formalised the arrangement which had gradually developed since
Britain had left the ERM in 1992 that the interest rate should be set to
deliver an inflation target and devolved the responsibility to the
monetary policy of the Bank of England (Besley and Sheedy, 2010). Fiscal
policy was given the twin goals of keeping the government current
account in balance or in surplus over the economic cycle and keeping
government net debt at no more than 40 per cent of GDP (Budd, 2010).
These policies were set out in the belief, which proved to be quite
mistaken, that they would make the economy more stable than it had been
in the past.
The flaws to the policy are, by now, all too apparent. Since in
purely arithmetic terms, the Government assumed, despite a past history
of forecasting errors, that there was no possibility of a recession, it
set its budget on the assumption that there was no risk of large
recession-related deficits, (1) This meant that, when the true nature of
the business cycle emerged, it was impossible to deliver the target of
balancing the government current account over the cycle, with the
consequence that the national debt is set to rise sharply. There is now
some doubt whether it is politically possible to reduce the national
debt sharply enough in time for the next recession or whether a
permanently higher level of debt means that the economic cost of the
recent recession and crisis is to be spread across all future
generations.
A second failure has been that, although inflation has been kept
close to target, and in that sense monetary policy has been a success,
the fiscal/monetary combination has allowed imbalances to build up in
the private sector which at the very least have left households in a
position which makes it difficult for them to manage the effects of the
recession and which may have the effect of slowing the recovery as they
seek to reduce their indebtedness.
The generic flaw of the policy was the underlying pre-Keynesian
assumption that the Government did not need to concern itself with
developments elsewhere in the economy. It maintained this position
despite evidence that overall saving levels were very low and household
debt was rising in a way which was unsustainable. Had the Government
shown any interest in any of (i) private debt levels, (ii) private
sector saving or (iii) overall national saving, the recession would not
have been avoided but the private sector would have been in a better
position to cope with it; it is possible that it would have been less
acute and the prospects for recovery would be better.
A further and related failing of at least as much importance was
that the Government did not recognise any macroeconomic role for
financial regulation. This meant that when interest rates were set,
while the Monetary Policy Committee might have felt unhappy about
developments in credit and asset markets, neither it nor anyone else had
any means of addressing these except as they were thought to affect the
risk of inflation. As we now know, this meant that instability built tip
in the banking system with consequences which we now recognise. This
shortcoming has been generally recognised ex post. However the
regulatory framework needed is still to be developed and the role of
macro prudential regulation is under discussion (Bank of England, 2009).
It is often snggested that the economy needs to move to a structure
which is export-led rather than consumption-led and that saving matters.
It is also understood that an additional policy instrument, over and
above fiscal and monetary policy, is needed. At present the preferred
approach seems to be one of regulating financial institutions. This,
while important in its own right, rather loses sight of the possibility
that the problems arising from low saving and high debt may be a
consequence of poor decision-making by households and non-financial
businesses or a rational response to fiscal and legal incentives to
borrow (such as tax relief on debt interest and the incentives created
by limited liability). Insofar as one is concerned about debt because of
the burden it imposes on future generations, it is important to remember
that government debt is only one mechanism for transferring resources
from the future to the present and that policy-makers concerned about
this issue also need to look at the transfers associated with (i) the
system of state transfers and benefits and (ii) the effects of movements
of land prices (Barren and Weale, 2010).
Monetary and fiscal policy were only two arms of the policy
framework. The third was supply-side policy. This in turn has two key
aims. The first is to promote a high level of labour supply, in terms of
both numbers of people working and hours worked, and the second is to
ensure that when people are working, their labour is as productive as
possible. Thus an exploration of Labour's record has to examine
these issues as well.
A basis for comparison
We focus our assessment on the major macroeconomic
indicators--growth rates of GDP and national income, the performance of
labour productivity, labour market indicators, inflation, unemployment
and the sustainability indicators of saving and the fiscal position.
Any comparison of the economic performance of two different
countries, or of the same country in two different periods, can be
distorted by the fact that many of the economic indicators of interest
follow the economic cycle. A comparison of one country or time period
enjoying a boom with another experiencing a recession will inevitably
flatter the former; the explanation of the better performance of the
first is simply the cyclical nature of the economy.
An international assessment of the United Kingdom's
performance obviously also depends on the countries with which it is
compared. We have made our comparison with the other countries of the
G7, with the data for Germany relating to West Germany before
unification.
Dealing with cycles poses obvious problems with the sort of
comparisons that we want to carry out, and no resolution of them is
completely satisfactory. HM Treasury has identified a cyclical peak in
1997 (although Besley and Sheedy--2010, figures 2 and 9--suggest it lay
between two peaks). The period of the Conservative Government, from 1979
to 1997, then covers two complete economic cycles with a separate
cyclical peak in 1990. The recent recession started in early 2008, but
on annual data output was slightly higher in 2008 than in 2007 and it is
reasonable to put the recent peak in 2007, with 2008 being, by any
measure except annual GDP growth, a recessionary year.
Our main aim is to present the records of the two Governments, and
we therefore focus on the period 1979-97 and 1997 or 1998 to 2009,
depending on the variable in question. However, where relevant, we also
h)ok at 1997 or 1998 to 2007 so as to give some indication of the
performance of the economy over a complete, if weak, economic cycle. Of
course these comparisons are still subject to the problem that, while
1997 was a weak cyclical peak in the UK, it was not so in all the other
countries of the G7.
[FIGURE 1 OMITTED]
GDP and national income
Figure 1 summarises the growth rate of the UK economy since the
Conservatives came to power in 1979. As table 1 sbows, the growth rate
improved sharply from 2.2 per cent per annum to 2.9 per cent per annum
during the 1997-2007 cycle as compared to growth tinder the
Conservatives. However, if we look at the picture tip to 2009 the record
is, not surprisingly, worse, with average growth of 2.0 per cent. Of
equal interest is the fact that, despite the performance of the economy
during the recession, the UK improved its ranking among the G7 countries
slightly under Labour as compared to that under the previous Government.
However, GDP growth on its own does not deliver improvements to
welfare. GDP per capita is much more important since this reflects the
implications of population change. We see from this, in table 2, that
adjustment for population growth improves the United Kingdom's
relative position, putting it top of the G7 for the period 1997-2007 and
second for the longer period 1997-2009.
Growth in GDP offers a robust measure of the expansion of the
economy. Nevertheless comparisons of GDP between countries can be
misleading. GDP is gross of depreciation, which merely makes tip for
resources used up in the production process. And it does not take any
account of net property income from abroad. Net national income is
computed after these adjustments. When computed at current prices and
compared between countries at current purchasing power parities it
offers a better snapshot view than does GDP compared on the same basis,
but with the drawback that it does not allow a helpful interpretation of
growth rates.
We therefore show, in table 3, per capita net national income of
the G7 countries measured relative to the United States. This indicator
of the position, at points in time rather than the growth rate over
intervals, shows the effects of the country's good growth
performance with a rise up the scale under both Conservatives and
Labour. The gap relative to the United States remains, nevertheless,
substantial.
Productivity
The broad measures discussed above serve to indicate the
performance of the economy from the perspective of residents, but they
do not indicate effectively its performance as a productive unit. The
latter depends on the proportion of residents of working age, the
proportion of those of working age who do actually work (and also the
proportion of those older than the conventional retirement age who
work), the average number of hours of work by people who work and the
productivity of the economy--the amount of output generated per hour
worked. The age structure of the population is obviously exogenous to an
analysis of economic performance, but the other variables are all
relevant to an analysis of performance. We discuss in the section on
labour market performance the movement in employment and hours worked
and focus here on output per hour worked or labour productivity.
This, shown in table 4, grew at 1.7 per cent per annum between 1997
and 2009. Over the period 1979 to 1997 on a comparable basis
productivity per person hour grew at 2.2 per cent per annum. However,
from 1997 to 2007 the growth rate of labour productivity was the same as
it had been under the Conservative Government. Since, internationally,
there was a general deterioration of productivity growth, this resulted
in the UK being the top performer during the period 1997-2007. Looking
at the period 1997-2009, performance was worse only than the United
States.
The drivers of labour productivity are growth in the capital stock
per person employed and a residual, known as growth of total factor
(capital deepening) productivity. The evidence is that the UK's
performance is explained by both capital deepening and faster growth in
total factor productivity. This is shown in table 5.
An important factor behind Britain's above average performance
in total factor productivity growth has probably been the continuing
expansion of tertiary education. The proportion of 25-64 year olds with
tertiary education has risen from 23 per cent in 1997 to 32 per cent by
2007. This improvement was faster than in the other European G7
countries and the United States, but slower than in Canada and Japan. Of
course it reflects not only the policies that the Labour Government has
followed m encourage participation in tertiary education but also those
of its Conservative predecessor. It is not possible to regard this as a
solely Labour achievement. As Unwin (2010) points out, this good record
with tertiary education is not matched at lower educational and skill
levels.
As with GDP per capita an alternative measure of performance is
delivered by comparing the level of productivity in the United Kingdom
with that of the other G7 countries. This is done in table 6. These data
are computed at 2005 purchasing power parities. The good record in
productivity growth results in an improved ranking of the UK's
relative level of productivity but, as the table shows, the level of
productivity remains substantially lower than that of France and Germany
as well as that of the United States.
Inflation
While economists have only limited explanations of how inflation
affects people's welfare, there is no doubt that low inflation is
regarded as an important policy target. Indeed the Government has made a
great deal of the success that it claims has flowed from making the Bank
of England independent a few days after coming to power in 1997.
Inflation is very obviously lower than it was under the Conservative
Government; the average rate from 1979 to 1997 was 5.8 per cent per
annum measured by the consumer expenditure deflator, while from 1997 to
2009 it has been 2.0 per cent per annum. The reduction in inflation has,
of course, been fairly general. A comparison of the G7 country ranking
of average inflation for 1979-97 and 1997-2009 is shown in table 7.
Although inflation was lower after 1997 than before, the reduction in
the inflation rate between the late 1970s and 1997 was extremely
substantial. It is an open question whether this was a greater or lesser
achievement than delivering low inflation from 1997 onwards.
Labour market performance
Another important feature of the British economy has been its
improved unemployment performance. The unemployment rate reached a peak
of l1.8 per cent in [984 and, despite the severity of the recent
recession, has stayed well below this, reaching 8 per cent in early
2010. Gregg and Wadsworth (2010) discuss, later in this Review, some of
the factors behind this good performance. Average unemployment rates in
the period since 1997 have been 5.6 per cent, whereas between 1979 and
1997 they were 9.2 per cent. Nevertheless, if we look at an
international comparison of unemployment rates in the years 1979, 1997
and 2009, we see no movement in the country's position.
We now turn to broader indicators of supply conditions in the
labour market, having noted that aggregate GDP depends, in part, on how
many people work and how many hours they put in. In table 9 we show the
activity rate. This measures total employment (including
self-employment) as a proportion of the population aged 15-64. Since
employed people of all ages, including those aged 65 and over, appear in
the numerator, this indicator reflects the outcome of policies which
extend working lives beyond conventional retirement as well as those
which encourage economic activity by people of working age. We note,
however, that policies which promote post-compulsory full-time education
depress the ratio.
The table shows that the UK's activity rate has improved since
1997, with an important factor behind the improvement being increased
labour force participation by people older than 50. It is also
noteworthy that this improvement has taken place despite 2009 being a
year of deep depression. Nevertheless the improvement is less than in
other countries; we note, in particular, that Germany's position
reflects the part-time working schemes it has had in place during the
recession.
Table 10 shows average annual hours worked per worker. These data
show a general downward drift, as people have made use of rising living
standards to reduce their work effort. It is also worth pointing out
that these data are in some sense a counterpart of those in table 9.
Italy shows a low activity rate and high hours per worker because people
who do not work in Italy might be working part-time if they lived in say
Germany. Perhaps a greater surprise is that the data for the United
Kingdom do not provide any evidence of a long hours culture. A possible
reason for this is that they average over full-time and part-time
working; full-time workers in the United Kingdom could be working long
hours with the total nevertheless depressed more here than in some other
countries by part-time working. It should also be noted that this
finding is not a consequence of the recession; the rankings are little
different if one looks at 2007 rather than 2009.
The general conclusion of this picture of the labour market is
that, although, seen in terms of activity rates, things have improved
since 1997, and in terms of unemployment they are not much worse despite
the recession, nevertheless in international terms Britain's
performance has not been very impressive and there must surely be scope
for a new government to develop measures to raise Britain's labour
supply further.
Sustainability
An underlying concern about the British economy is that the balance
between consumption and saving is inappropriate. Low saving means that,
even if GDP performs adequately, consumption and living standards are
likely to disappoint. If saving levels are low, then the capital stock
has to be financed by borrowing from abroad, or by foreign businesses
investing in Britain. A consequence of this is that an increasing
proportion of profits is paid abroad as a return on that foreign
investment. As a result the nation's income falls below the
national product; the high levels of consumption made possible by low
levels of saving are not sustainable, or at least do not grow in a way
which is likely to match people's aspirations.
An initial summary indicator of whether the economy has been
managed in a sustainable way is provided by the ratio of produced
capital to GDP. Produced capital is capital accumulated by saving; it
includes produced physical assets, but not land, intangible assets such
as computer programmes, stocks and work in progress and also net foreign
assets. Seen from this perspective, the position has improved under
Labour. In 1997 the ratio of produced capital to annual GDP was 2.5. At
the end of 2008, the last year for which data are available, it had
risen to 2.7.
However, the increase is entirely attributable to capital gains
made on Britain's net foreign asset position as a result of the
decline in sterling and the financial crisis. At the end of 2006
Britain's net foreign liabilities amounted to 352bn [pounds
sterling]. By the end of 2008, the 2009 Blue Book shows this had been
transformed into assets of 92bn [pounds sterling] despite the fact that
the country had run a balance of payments deficit throughout the period.
The improvement is equal to just over 30 per cent of one year's GDE
It is not easy to produce similar data for other countries, because
national capital stock data are not as well developed as national
accounts. However, an alternative perspective is offered by national
saving. Table 11 shows net national saving (the sum of private sector
and government net saving) for the G7 economies, with 2009 data not yet
available. Looking at the United Kingdom on this basis, we can see that
it and the United States compete for the bottom position.
The UK savings rate was higher tinder Labour than it had been under
the Conservatives. However, if the economy maintains a growth rate of 2
1/4 per cent per annum with this savings rate, the ratio of produced
wealth to annual GDP will eventually settle at 1.9. Thus, Labour was not
running the economy in a way which could sustain the ratio of produced
wealth to income that it inherited from the Conservatives.
A low level of saving and a reduced ratio of wealth to GDP might be
justified if there were reasons for thinking that initial levels of
wealth were too high. However there are two related reasons for doubting
that this is the case. First of all there is widespread concern about
the adequacy of pension arrangements; since pensions are financed by
saving, this suggests that saving is thought to be too low. Secondly,
the peak of the baby boom was reached in 1965. One might therefore
expect that, if baby boomers were saving properly for their old age, the
saving rate would be large enough to be associated with rising rather
than falling wealth. Khoman and Weale (2008) present a full analysis
which suggests that ahead of the recession in 2005, the country's
consumption level was up to 9 per cent higher than is sustainable,
depending on how much and when working lives increase. This analysis
assumed that people, when old, want living standards which rise in line
with those of younger people and that people do not rely on their
children to provide financial support.
National saving and produced national wealth are much the most
important indicators of sustainability. However, greater public
attention focuses on the fiscal position, and we therefore also explore
Britain's fiscal performance tinder this Government and its
predecessor. The Government's fiscal targets are defined in terms
of net government debt (which is nevertheless gross of some financial
holdings such as those in banks). However an international comparison
can be made only on the basis of gross debt and we therefore present
data for gross debt and gross borrowing as a proportion of GDP (tables
12-13).
These data suggest a better than average international performance
and certainly provide no rational background for the suggestion that the
United Kingdom, which has never defaulted on its domestic debt, (2)
might now consider such a move. Only if the 2009-10 current deficit
continued unchecked would a situation arise where it could become very
difficult for the Government to collect the taxes needed for debt
service. On the other hand, given the effects of the recession on the
fiscal position, which we discuss subsequently, and the fiscal
prospects, no one could suggest either that fiscal policy has been a
success or that it has been managed better than in the previous period.
Economic performance in the recession
Normally a discussion of economic performance over a number of
years provides a better indication of the underlying position than does
a focus on the short term. But, given that the past two years have seen
the worst recession since the early 1930s, an assessment of
Britain's economic performance has to take into account the
country's experience of the recession.
Table 14 shows the profile of the recession itself, indicating the
change in output relative to the first quarter of 2008. Canada, France
and the United States have performed markedly better than the other G7
countries, and the United Kingdom's relative position has slipped
during the early recovery phase.
Two other important indicators also suggest that the United Kingdom
has performed relatively poorly during the recession. Table 15 shows
that it has the second-largest increase in unemployment of the G7
countries, with only the United States showing a larger increase. Thus,
although, as Gregg and Wadsworth (2010) indicate, unemployment has risen
less during the current recession than might have been expected from
past experience, an international comparison nevertheless points to a
relatively poor performance. The figures of course reflect the special
measures that the different countries have taken to limit the rise in
unemployment during the depression and are not necessarily indicative of
the labour market more broadly.
Table 16 shows the deterioration in the budgetary position between
2007 and 2009 with the United Kingdom as the worst performing of the G7
economics. With both unemployment and the budgetary position past
experience of recessions would suggest that 2010 may be worse than was
2009, even though output is now generally rising. Moving to the current
recession, there is, however, increasing evidence that unemployment has
now stopped rising in some countries; this is less likely to be true of
the budget deficits.
In the early phase of the recession to Q1 2009, country differences
in output change could be explained by the size of the external
deficit/surplus and the growth of government consumption (Weale, 2009).
In the later phase the pattern seems to have changed, and the UK has
performed poorly. While it is too early to be able to give a clear
account of the factors which account for this, there are a number of
possible influences. First of all the good GDP performance of Canada and
the United States is probably explained by different facts. Canada kept
its banking system well regulated and did not experience a banking
crisis. It was affected only by the spillover from the crisis elsewhere.
The United States has been helped for two reasons. First the fiscal
stimulus was larger than m the United Kingdom and secondly a policy of
credit easing was pursued. Unlike the Bank of England's
interventions in money markets, those in the United States included as
an important component the purchase of corporate loan stock and other
forms of direct lending to businesses. For all its shortcomings, and the
problems which can arise with such interventions, this has provided some
relief from credit shortages which has been absent in the United
Kingdom. Henriot (2010) suggests that France's relatively good
performance is attributable to its industrial structure and its large
public sector.
New Labour's legacy: the cost of the crisis
The analysis above, which suggests some relative improvement in
Britain's economic performance, fails to indicate the magnitude of
the problems that the new government will inherit. Our monthly estimates
of GDP suggest that the recession which began in March of 2008 ended in
September of 2009. Nevertheless, two years after the start of the
recession, output is 5.4 per cent below its level of March 2008. Given
that the underlying rate of growth of productive potential is probably
around 2 1/2 per cent per annum, the cumulated output shortfall is now
around 10 per cent. As Haldane (2010) points out, the long-term cost of
the crisis depends much more on the permanent output loss than on the
short-term movements. If one assumes that the permanent output loss is
one quarter of the current shortfall, and that future output is
discounted at 5 per cent per annum, then the total loss of output is
equal to one year's GDP or a bout 1400bn [pounds sterling].
The magnitude of the shortfall depends, however, on two factors:
(i) how far output was above long-run productive potential before the
crisis and (ii) how far and how fast the current shortfall will be made
good. Estimation of the permanent component of the output loss cannot be
made with any degree of precision. The importance of this depends upon
the context in which we see it. If we are considering the longer-term
prospects for the public finances, then the change in perception of
potential output between 2007 and 2009 must be fully taken account of in
our plans. However, some of the perception of what was potential output
in 2007 may have been mistaken and its loss does not therefore count as
a cost of the crisis. We have, in the past, argued that there are three
components.
1. The cost of capital is likely to be higher in the future than it
was in the period before the crisis, depressing capital accumulation. It
is not immediately clear how far the change between the period before
and after the crisis is a consequence of the user cost of capital being
abnormally low before the crisis rather than abnormally high afterwards.
If risk were underpriced before the crisis, output was too high to be
sustainable in the long run, even if we did not realise that in making
our plans. If risk has been repriced because nobody had assumed such an
event as we have seen could ever happen, but they now realise it can,
then the user cost will be higher than previously in a different way,
and there will be a permanent loss of potential output. We have
previously argued that the rise in risk premia we are likely to see
between the pre- and post-crisis period might reduce long-run
sustainable output by around 3 per cent (see Barrell, 2009), as compared
to pre-2007 projections.
2. The relative scale of the crisis in the UK as compared to
migrant source countries is likely to reduce net inward migration to the
UK. The UK has been a major destination for New Member States migrants
in the past five years, mainly because it did not put up barriers whilst
some other EU countries did. Although the factors driving migrants to
move are hard to assess, they clearly include relative income levels,
and many recent source countries, such as Poland, have fared much better
in this crisis than the UK and may not suffer a permanent loss of
output--indeed they may be seen as relatively less risky places to
invest. In addition, more traditional large-scale source countries such
as India and Australia have also suffered less than the UK and hence net
inward migration is likely to fall. Barrell et al. (2009) suggested that
these changes in the population could take up to 1 per cent off
potential output (but not output per person) in the long run.
3. The financial services sector had expanded rapidly in the period
2000-2007, from 5.2 per cent to 8.3 per cent of GDP. Value added per
person employed in the sector is roughly twice what it is in the rest of
the economy and the volume of output of the sector is computed, in large
part, by means of business income deflated by wage rates. The aftermath
of the crisis is likely to lead to the sector shrinking again and one
might suppose that it will shrink towards its relative size in 2000. If
wage rates fall in line with shrinking income but employment remains
constant, then there will be no impact on the volume of GDP. By
contrast, if a shrinking income results in fewer people being employed
in the sector and those being released finding jobs elsewhere at the
average value added per person in the rest of the economy there will be
a fall in reported GDP approximately equal to the shrinkage in the size
of the sector. However, it is possible that the people associated with
high value added are more able than the rest of the population. Hence if
labour is reallocated, and to the extent that the skills and talents are
transferable, those who move will continue to be associated with high
value added elsewhere. It is difficult to balance these factors, but it
might be reasonable to assume that output will be 1 per cent lower
permanently if this sector shrinks towards its relative size in 2000.
The OECD (2009) have argued that there is a third influence to be
taken into account--that the rise in unemployment and non-employment
during the recession is likely to be associated with a semi-permanent
rise in long-run unemployment. We are less concerned about this than
these authors, because a number of successful programmes have been
developed to prevent this happening. Their estimate of the permanent
loss of output from the crisis is lower than ours, at about 31/2 per
cent, with I per cent of this coming from labour market effects. Indeed
one should be cautious about estimates of the cost of the crisis.
Cecchetti, Kohler and Upper (2009) suggest that only about one in four
systemic crises have permanent significant negative effects, whilst
about one m eight might have positive effects. Barrell et al. (2010)
also suggest that only one in four crises have a permanent effect.
However, it would be surprising if the most recent crisis were not one
of these one in four.
Just like any individual, the country can adjust to reduced
circumstances. As we argued in the section on sustainability, it in fact
needs to do more than that. As part of this adjustment one might expect
the public sector to reduce its expenditure on a broad front, an obvious
reference point would be a uniform squeeze on public spending.
But the public sector faces a more difficult adjustment process for
three reasons. First of all, public sector plans have been made on the
assumption that the pre-2007 trajectory would continue. As we noted, the
change relative to this is almost certainly larger than the change
relative to underlying pre-2007 output. Secondly, the crisis has exposed
weaknesses in the tax base. Reliance on revenue from the financial
sector and housing transactions has meant that revenues have fallen more
than in proportion to GDP. And thirdly politicians have announced that
substantial parts of current expenditure will be ring-fenced at a level
based on pre-2007 estimates of GDP and the tax base. This means that
some combination of large cuts to other areas and tax increases is
needed to restore budget balance. The treatment of the health service
provides a good example of the folly of this approach. Most studies
suggest that spending on health rises more than in proportion to income
(e.g. Beth et al., 2010), and this is probably a reasonable estimate of
underlying social preferences. It follows that if GDP falls
semi-permanently, health spending should be reduced at least in
proportion, and not ring-fenced.
Resolution of the fiscal legacy will be one of the major problems
to be resolved by the Government elected on 6 May. It is important to
realise that achieving Labour's target of halving the deficit by
2013-14 does not mean the problem is solved. The budget needs to be in
balance or in surplus so as to ensure (i) that the costs of the current
crisis are not spread on to future generations and (ii) future crises
and recessions can be managed with ever-rising debt.
Conclusions
Labour came to power claiming it would transform the performance of
the British economy. During the course of the Government it claimed that
its policies had done this. For example, in the 2006 Budget, Brown
(2006) stated:
"The test of our monetary policy is that we are achieving
sustained stability and growth, not just for a year or two but for the
long term.
And the test of our fiscal policy is that we match a commitment to
balance the current budget over the economic cycle with an ability to
make the necessary long-term investments."
On the basis of these two tests, Labour's policies have been
an obvious failure. If we compare economic growth from 1997 to 2009 with
that of the previous Government from 1979 to 1997 Labour comes off
badly. However this is a consequence of the fact that 2009 marked the
trough of a depression while 1979 was a cyclical peak and 1997, if not a
peak was at least a year of stable economic activity.
A more nuanced assessment is achieved by comparing Britain with the
other G7 countries. On this basis we can see that, in terms of variables
like GDP per capita, net national income per capita and labour
productivity, Britain has improved its relative position; the key to
note is that this is true despite the trough of the economic cycle
falling in 2009. Thus, although Britain has performed relatively badly
during the recession, a poor performance since 2007 has not been enough
to offset the good performance between 1997 and 2007. However, labour
market performance has been disappointing.
The recession is likely to have permanent costs. There is a wide
variety of different estimates because there is no precise basis for
estimating this; we expect the output loss to be around 5 per cent, with
the impact on per capital GDP lower because the aftermath of the crisis
is likely to result in less immigration than there had been up to 2007.
It is probably too early to say whether Britain is more affected by
the long-term consequences of the recession than are the other advanced
economies. Everyone suffered, to some extent, from a belief that a
cyclical boom was a permanent improvement. But, given that even
including 2009 Labour's record on productivity, growth and income
per head is good relative to the other G7 countries, this assessment
will change only if Britain suffers more than the other G7 countries
from the aftermath of the recession. Being realistic, it is unlikely
that this issue could ever be resolved with the required precision.
But it does seem that the degree of illusion suffered in the UK
with regard to the public finances was greater than in most other
countries. Indeed this is both the one area where, despite a reasonable
performance in the period before the recession, the United Kingdom has
performed worse than every other major country. Unless, which we do not
expect, revenues revive sharply during the recovery, resolution of this
problem is one of the biggest economic problems that the country faces.
The process of fiscal stabilisation is likely to take up most of the
current decade and, once debt levels have been stabilised, the
Government elected on 6 May, or its successor, will have to address the
problem of reducing debt levels to the point where the country can
afford the budgetary costs of the next recession. This is bound to come
in the end and the most important lesson for policymakers of the recent
crisis is that macroeconomic policy should never be run on the
assumption that recessions cannot happen again.
The particular problem to be faced in sorting out the public
finances and reviving the economy is that the mechanisms which have
supported growth in the past, rising land prices and buoyant public or
private consumption, cannot be used if, at the same time, the saving
rate is to be raised to a sustainable level. Of course, if the economy
is competitive enough, demand can be provided from overseas and the
combination of buoyant exports and restrained consumption results in
higher saving. But it is quite possible that further depreciation of the
exchange rate will be needed to deliver this.
doi: 10.1177/0027950110372731
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NOTES
(1) Even the sharpest critics of the Government's fiscal
management, like the National Institute, did not advocate the sort of
fiscal surpluses which governments need to run in normal times so as to
manage the possible costs of recessions. But there is no reason to
believe that, had such suggestions been made, their authors would have
been taken seriously by policymakers, politicians or by the media.
(2) Reinhart and Rogoff (2010) suggest that the various debt
conversions of the 19th century and the War Loan conversion of 1932 were
partial defaults because the interest rate payable on the debt was
reduced. In fact they were nothing of the kind. The prospectuses of the
securities in question allowed the Government to redeem them at short
notice. At the time of these conversions it was in the taxpayers'
interest to convert the debt because the coupon on the debt was higher
than the market rate. Miller (1890) provides an informed account of
Goschen's conversion.
Iana Liadze and Martin Weale *
* We are particularly grateful to Ray Barrell for considerable
help, to Simon Kirby for providing figure I and also to other members of
the National Institute's Editorial Board for their comments.
Table 1. Growth rates (per cent per annum)
Growth Rate Rank
1979 1997 1997 1979 1997 1997
-97 -2007 -2009 -97 -2007 -2009
Canada 2.5 3.3 2.5 3 1 1
France 1.9 2.4 1.8 7 4 4
Germany 2.1 1.6 1.0 5 5 5
Italy 2.0 1.4 0.7 6 6 6
Japan 3.0 1.2 0.5 1 7 7
UK 2.2 2.9 2.0 4 3 3
US 2.9 3.0 2.3 2 2 2
Source: OECD and NIESR.
Table 2. Growth of GDP per capita (per cent per annum)
Growth Rate Rank
1979 1997 1997 1979 1997 1997
-97 -2007 -2009 -97 -2007 -2009
Canada 1.3 2.3 1.5 7 2 1
France 1.4 1.7 1.2 6 4 4
Germany 1.9 1.6 1.0 4 5 5
Italy 2.0 1.0 0.2 2 7 7
Japan 2.5 1.0 0.4 1 6 6
UK 2.0 2.4 1.5 3 1 2
US 1.8 2.0 1.3 5 3 3
Source: OECD and NIESR.
Table 3. Net national income per capita at current
purchasing power parities (US = 100)
US = 100 Rank
1979 1997 2009 1979 1997 2009
Canada 86.4 75.5 80.8 2 2 2
France 76.4 70.9 69.8 4 6 5
Germany 78.0 73.4 73.2 3 3 4
Italy 71.8 70.7 60.5 5 7 7
Japan 69.8 73.1 65.8 6 4 6
UK 68.3 72.9 76.6 7 5 3
US 100.0 100.0 100.0 1 1 1
Source: OECD and NIESR. 2009 figures are calcualted by adjusting
OECD 2008 figures for the change in real GDP per capita between
2008 and 2009.
Table 4. Labour productivity growth rates (per cent per
annum)
Growth Rate Rank
1979 1997 1997 1979 1997 1997
-97 -2007 -2009 -97 -2007 -2009
Canada 1.2 1.4 1.0 7 6 6
France 2.2 1.9 1.4 2 3 4
Germany 2.0 1.5 1.1 4 5 5
Italy 1.9 0.3 -0.2 5 7 7
Japan 2.3 1.8 1.5 1 4 3
UK 2.2 2.2 1.7 3 1 2
US 1.6 2.0 2.0 6 2 1
Source: NIESR.
Table 5. Contributions of capital deepening and total factor
productivity growth to labour productivity growth (per cent per
annum)
Capital deepening Rank
1979-97 1997-2009 1979-97 1997-2009
Canada 0.5 0.6 5 5
France 1.0 0.9 1 1
Germany 0.6 0.7 4 4
Italy 0.8 0.5 2 7
Japan 0.5 0.6 6 6
UK 0.6 0.8 3 3
US 0.4 0.9 7 2
Total factor Rank
productivity
growth
1979-97 1997-2009 1979-97 1997-2009
Canada 0.7 0.4 7 5
France 1.2 0.5 4 4
Germany 1.4 0.4 3 6
Italy 1.0 -0.7 6 7
Japan 1.8 0.9 1 2
UK 1.6 0.9 2 3
US 1.2 1.2 5 1
Source: NIESR.
Table 6. Labour productivity (US= 100) at 2005
purchasing power parities
Output per hour
worked US = 100 Rank
1979 1997 2009 1979 1997 2009
Canada 83.5 81.5 73.8 2 5 5
France 76.5 93.1 88.8 5 2 2
Germany 77.9 92.0 81.6 4 3 3
Italy 80.0 89.9 71.1 3 4 6
Japan 48.8 66.6 63.9 7 7 7
UK 66.8 76.9 75.5 6 6 4
US 100 100 100 1 1 1
Source: OECD and NIESR.
Table 7. Inflation rates (per cent per annum)
Inflation rate Rank
979-97 1997-2009 1979-97 1997-2009
Canada 4.6 1.6 4 4
France 4.9 1.4 5 3
Germany 2.8 1.2 2 2
Italy 8.7 2.3 7 7
Japan 1.8 -0.8 1 1
UK 5.8 2.0 6 5
US 4.0 2.1 3 6
Source: NIESR.
Table 8. Unemployment rates (per cent of labour force)
Unemployment rate Rank
1979 1997 2009 1979 1997 2009
Canada 7.5 9.1 8.3 6 4 5
France 5.4 11.0 9.5 4 6 7
Germany 3.2 9.9 7.5 2 5 2
Italy 7.8 11.8 7.7 7 7 4
Japan 2.1 3.4 5.1 1 1 1
UK 4.7 7.1 7.6 3 3 3
US 5.8 4.9 9.3 5 2 6
Source: OECD and national sources.
Table 9. Activity rates (per cent)
Activity rate (a) Rank
1979 1997 2009 1979 1997 2009
Canada 65.8 67.9 72.3 5 4 2
France 64.7 60.8 64.2 6 6 6
Germany 66.2 64.5 71.3 4 5 3
Italy 55.6 52.5 59.0 7 7 7
Japan 70.1 75.3 76.9 2 1 1
UK 70.8 69.5 70.9 1 3 4
Us 67.6 73.0 68.6 3 2 5
Source: OECD and NIESR.
Note: Per cent of population aged 15-64.
Table 10. Average annual hours worked per worker
Annual hours
worked per worker Rank
1979 1997 2009 1979 1997 2009
Canada 1825 1767 1725 5 4 3
France 1868 1649 1541 2 6 6
Germany 1770 1509 1392 7 7 7
Italy 1859 1863 1798 3 2 1
Japan 2126 1865 1713 1 1 4
UK 1819 1741 1632 6 5 5
US 1828 1846 1767 4 3 2
Source: OECD and NIESR.
Table 11. Net saving rates (per cent of GDP)
Net national saving Rank
1979-97 1998-2008 1979-97 1998-2008
Canada 6.6 9.4 5 1
France 6.9 7.2 4 2
Germany 8.3 7.0 2 3
Italy 7.3 5.0 3 5
Japan 12.4 5.1 1 4
UK 3.4 4.1 7 6
US 5.3 3.6 6 7
Source: ONS and NIESR.
Note: The second figure for Japan covers 1998-2007.
Table 12. Gross public debt (per cent of GDP)
Gross debt Rank
1979 1997 2009 1979 1997 2009
Canada 44.1 96.0 79.9 5 5 4
France 30.1 68.8 83.3 2 4 5
Germany 25.4 58.3 68.8 1 1 1
Italy 84.1 127.8 120.8 7 7 6
Japan 42.4 97.2 188.8 4 6 7
UK 58.2 58.3 73.9 6 2 2
US 39.6 66.5 79.0 3 3 3
Source: NIESR.
Table 13. Gross budget deficit (per cent of GDP)
Gross budget
deficit Rank
1979-97 1997-2009 1979-97 1997-2009
Canada 5.8 -0.5 6 1
France 3.0 3.1 3 6
Germany 2.4 2.0 2 2
Italy 8.3 2.9 7 4
Japan 2.2 6.3 1 7
UK 3.5 2.5 4 3
US 3.9 3.1 5 5
Source: NIESR.
Table 14. The profile of the recession in the G7 countries
Q2-2008 Q3-2008 Q4-2008 Q1-2009
Change in output since Q1-2008 (per cent)
Canada 0.1 0.2 -0.8 -2.5
France -0.4 -0.7 -2.1 -3.4
Germany -0.6 -0.9 -3.3 -6.7
Italy -0.6 -1.5 -3.6 -6.2
Japan -1.1 -2.4 -5.0 -8.4
UK -0.1 -1.0 -2.8 -5.3
US 0.4 -0.3 -1.7 -3.3
Ranking
Canada 2 1 1 1
France 4 3 3 3
Germany 5 4 5 6
Italy 6 6 6 5
Japan 7 7 7 7
UK 3 5 4 4
US 1 2 2 2
Q2-2009 Q3-2009 Q4-2009
Change in output since Q1-2008 (per cent)
Canada -3.4 -3.2 -2.0
France -3.2 -3.0 -2.4
Germany -6.3 -5.6 -5.6
Italy -6.7 -6.2 -6.5
Japan -7.0 -7.2 -6.3
UK -6.0 -6.2 -5.8
US -3.5 -2.9 -1.6
Ranking
Canada 2 3 2
France 1 2 3
Germany 5 4 4
Italy 6 5 7
Japan 7 7 6
UK 4 6 5
US 3 1 1
Source: OECD.
Table 15. Unemployment in the recession (per cent)
Jan. 2008 Feb. 2010 Increase Rank
Canada 5.9 8.2 2.3 4
France 7.7 10.1 2.4 5
Germany 7.8 7.5 -0.3 1
Italy 6.7 8.5 1.8 3
Japan 3.9 4.9 1.0 2
UK 5.1 8.0 2.9 6
Us 5.0 9.7 4.7 7
Source: OECD. UK February 2010 figures estimated.
Note: OECD standardised unemployment.
Table 16. Budget balances in the recession (per cent of
GDP)
2007 2009 Change Rank
Canada 1.6 -5.1 -6.7 5
France -2.7 -7.9 -5.2 3
Germany 0.2 -3.1 -3.3 1
Italy -1.5 -5.3 -3.8 2
Japan -2.5 -8.0 -5.5 4
UK -2.6 -11.2 -8.6 7
US -2.8 -11.1 -8.3 6
Source: NIESR.
