Pieria Debate on the UK Productivity Puzzle — Confessions of a Supply-Side Liberal

Miles Kimball, Jonathan Portes, Frances Coppola and Tomas Hirst discuss the mysterious case of the UK’s falling productivity. This post first appeared on Pieria on May 24, 2013.

Miles Kimball: A big issue that the Bank of England is worried about is that the UK may not be far below the natural level of output at all. They’re very interest in the productivity puzzle and I’m hoping they’ll put out a prize for research into it one of these days.

Tomas Hirst: We’ve had some interesting discussions on Pieria about how we can explain the productivity puzzle – including how it might reflect miscalculations of output and growing problems in the UK labour market.

Jonathan Portes: Do they really think that we’re not far below the natural level of output at the moment?

Miles Kimball: Well opinions differ. I think it’s safe to say there’s a very active debate on exactly that question.

Tomas Hirst: The minutes of the MPC’s most recent meeting suggest that there’s something of a schism opening up in the committee between those worrying about the risks of further QE purchases (who are currently in the majority) and those worrying about the continued weakness of output. Do you think it reflects this debate?

Miles Kimball: Pieria really ought to talk about this more. For many other economies it seems crystal clear to almost everybody with an ounce of sense that output is below the natural level but I don’t know if it’s true in the UK. It’s not even clear to me, I just don’t know.

The broadest sphere of the debate should really be trying to get a hold of that productivity puzzle. In addition to measures that could add to aggregate demand for the UK I think a great deal of work needs to be done to assess whether it really is below the natural level of output or not.

Tomas Hirst: I think in the UK people have been too focused on headline figures of inflation and unemployment, for example. What people have missed is the fact that core inflation has been below target throughout the crisis, which might itself justify further stimulus.

Miles Kimball: Well remember that the new remit from the Treasury says that the MPC should look through government-administered prices.

Tomas Hirst: Yes, but could that change in mandate not be a response to this problem of growing doubts in the usefulness of headline figures?

Miles Kimball: What I’m saying is that the remit could suggest that the BoE is being asked to look more at core inflation. It’s actually a little bit of a mixed message as they’re being told that their target should remain linked to headline inflation but are being told to look through the headline numbers at what’s happening to core inflation. Pushing them towards core inflation is important.

On the productivity puzzle, there are things that can be solved by expansion and things that can’t. In the recession the government is not as willing to let firms go bankrupt so you get a long tail of unproductive firms carrying on. If you convince everybody that you’ve got all the aggregate demand you want you can allow for more bankruptcies, which will mean some of the puzzle will automatically correct.

Frances Coppola: I’ve heard that argument a lot but I’m not 100% convinced. You’ve got to look through the recession to see what the long-term secular trend is.

Over the last few years we’ve seen a huge increase in self-employment and at the same time self-employed incomes have crashed. That can’t be to do simply with unproductive companies.

Jonathan Portes: It’s an aggregate demand problem.

Frances Coppola: Exactly!

Jonathan Portes: Actually it was part of David Blanchflower’s recent paper that discussed a growing number of people in the UK who want to work more hours and can’t get them. If you’re self-employed and you want to work more hours the only thing that is stopping you is a lack of demand.

Frances Coppola: Speaking from personal experience, as I am self-employed and have been for a long time in a business that requires specialist skills, things were fine until two years ago. Since then demand has collapsed. And it’s not just singing. I’ve never seen the situation out there this bad.

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