The cracks begin to show: a review of the UK economy in 2015 (part two)

Thus, the ultra-flexible UK labour market (“with employers in the driving seat”, in the government’s own charming words) – to be enhanced by the repressive new Trade Union Act – has had the effect of causing productivity to fall. Read part one here.

Jeremy Smith John Weeks Özlem Onaran Andrew Simms Ann Pettifor Richard Murphy
5 January 2016

Read part one here.

2015: Growth based on shaky foundations without a healthy recovery in wages 

Özlem Onaran 

Growth in Britain is still based shaky grounds as it is driven by a massive increase in private household debt, and will remain fragile to any increase in interest rates in 2016. Just as before the Great Recession, working people are obliged to rely on debt to maintain their living standards in the absence of a healthy growth in their wages and salaries.

The rise in inequality and stagnation in wages are among the fundamental flaws in our economic model, which have been at the root of the Great Recession, and we are far from correcting this imbalance. Real pay is still 9% lower compared to its peak in early 2008. After the longest and most dramatic period of decline in real wages since the Victorian times, waged and salaried people in Britain are looking to a recovery in their incomes not much before 2017.

The share of wages in UK GDP fell from 67.7% in 2007 to 65.8% in 2015 (See Figure 1). This two percentage-point fall in labour’s share in income comes on top of a three decade long fall in the share of wages from its peak of 76.2% in 1975.

Figure 1: The share of wages in GDP in the UK, 1960-2015


Note: Labour compensation adjusted for the labour income of the self employed as a ratio to GDP at factor cost; 2014 is provisional data; 2015 is forecast. (source: AMECO).

The lack of a full recovery in wage income continues to be a drag on household confidence and demand, which in turn discourages business investment in the absence of a healthy growth in domestic demand. Our research shows that in Britain a lower share of wages in national income leads to both a lower GDP and lower private private investment. Despite increasing profits private investment remains to be weak.

Next to wage restraint and rising inequality, financialization is the other major brake against investment and growth. According to recent research at the Greenwich Political Economy Research Centre on the investment behaviour of non-financial corporations in Britain, not only high dividend payments, but also increasing financial revenues of firms due to their surging financial activities, crowd out private investment in physical machinery and equipment. Lower wages lead to increasing profits, but bleak prospects in terms of demand, and this in turn discourages investment despite high profitability; in the meantime firms direct their profits to financial speculation.

Perversely financial activities do not provide more funds for productive activity. In the absence of strong investment performance, it is no wonder that productivity in Britain is lower than other developed countries. There is no productivity puzzle! This is also why Britain’s export performance is so weak despite falling labour costs: international competitiveness is more about productivity than labour costs, particularly in a world of race to the bottom in labour costs.

A strong recovery with decent jobs as opposed to fragile debt driven growth requires a strong recovery in wages embedded in a broader macroeconomic and industrial policy, financial regulation and corporate governance framework. Only then will investment and productivity follow. Simply improving trade union legislation could take us a long way: if the trade union density were to increase back to its level in 1980, when half of the employees were member of a trade union (as opposed to the current level of union density of 25%), the share of wages in national income could increase by up to 9%-point, and GDP per capita in the UK could increase by £444 (or 1.6%).

2015: Productivity Unpuzzled

Jeremy Smith

The fact that concerns over the UK’s low productivity are still so strong, both as a long-term international trend, and in particular since the financial crisis, speaks volumes about the nature of the UK “recovery”, based as it is on low productivity and lower real wages.

The government is caught on the horns of a dilemma.  Should it celebrate the (real but skimpily-remunerated) increase in employment over the last 3 years?  Or see this as the result of a dysfunctional low productivity economy, increasingly of its own shaping?  Of course, it tries to gloss over their incompatibility.

In July, alongside the post-election budget, the Government issued a report on productivity, “Fixing the foundations: Creating a more prosperous nation” (a mandatory Osbornian building metaphor!). The ministerial Foreword blurs the issues:

“Productivity is the challenge of our time. It is what makes nations stronger, and families richer. Growth comes either from more employment, or higher productivity. We have been exceptionally successful in recent times in growing employment. We are proud of that. But now in the work we do across government we need to focus on world-beating productivity, to drive the next phase of our growth and raise living standards.”

The Executive Summary says

“In every member country of the Organisation for Economic Co-operation and Development (OECD) where average wages are above UK levels, productivity is also higher”

This is certainly true – and says a lot about the UK’s low wage culture and policy - but in several cases, this is because unemployment is also far higher.  France (see here for my long comparison with the UK) has roughly the same population and GDP, but a far higher labour productivity – and a chronically higher unemployment rate.  So we need to be careful – one can raise productivity without boosting GDP or overall living standards, and without improving the public finances - if there is insufficient aggregate demand.

The Government identifies two pillars for improving productivity – in which the government gives itself no role as “actor”, but merely as hopeful “encourager” of long-term investment, and “promoter” of a “dynamic economy that encourages innovation and helps resources flow to their most productive use”.

And when it gets down to its “fifteen-point plan”, what it mainly does is to recycle and repackage existing government policies based on laissez-faire ideology… and Top of the List:

“An even more competitive tax system, bringing business and investment to Britain… High rates of corporation tax distort incentives and stifle business investment. During the last Parliament the main rate of corporation tax was cut from 28% to 20%”.

This is a very odd priority in this context. For the period during which Corporation Tax has been progressively cut coincides precisely with the period in which labour productivity has been at its lowest! Many higher productivity countries have higher corporation tax rates. This is a pure example of ideology trampling over evidence.

So let’s come to the evidence.  We have tracked real GDP and labour productivity since late 1979 to the end of Q2 2015 (at the time of writing, ONS have not published Q3 labour productivity numbers). You will see from the chart that the correlation between GDP and productivity is very strong – when GDP goes up, so does productivity. And when it goes down, so does productivity, sometimes with a slight advance or delay. Increased demand tends to enhance productivity.


Since supply-side measures like better education and training take many years to feed through, and then gradually, we may fairly infer that in the short to medium term, it is demand side factors that are more important.  And indeed, the periods of growth in GDP and productivity are (unsurprisingly) also tightly correlated over time with increases in overall investment.  Yet the first victim of the post-2010 austerity programme was the government’s capital investment programme – a classic false economy.

The orthodox supply-side consensus is that productivity was improving gradually at a steady rate up to 2007, and has since fallen dramatically for a range of (disputed) factors.  Thus Professor Richard Jones, Pro-Vice-Chancellor, Research and Innovation, University of Sheffield (great job title):

“The UK is in the midst of an unprecedented peacetime slowdown in productivity growth. Labour productivity – the economic output produced per hour worked – has, for many decades, grown steadily at 2.3 per cent a year. All that changed in 2007, since when it has stubbornly flatlined.”

“Flat-lined” is an odd word to describe the post 2007 gyrations, including the precipitate fall in productivity at the peak of the crisis as demand and output collapsed.  But the chart shows that, from 2007 to 2011, productivity tracked GDP (and vice versa) reasonably closely, but when austerity and the Eurozone crisis kicked in in 2012, GDP slowed (to 1.2%) but productivity declined more sharply.  The two years that diverge somewhat from the norm are 2013 and 2014, when GDP increased at a reasonable overall rate (2.2%, 2.9%) while productivity rose only 0.4% and 0.2% respectively.  But in 2015, with somewhat higher real pay finally coming through, and a modest (if slowing) rise in GDP, productivity has also risen after a poor Q1.

Behind all this, we need to recall that – in real terms – total average pay fell year on year for 6 long consecutive years, a totally new phenomenon since records began, while total employment was rising for most of the time.   Only since 2014 has the process been reversed, with real pay starting to rise.  As at Q3 2015, however, it still remains an enormous 7.8% below the peak Q1 of 2008.

It is really inescapable that the economy – under the government’s gaze - has evolved, since the financial crisis, in a direction of lower cost, more plentiful labour.  Employment growth is concentrated in a range of service sectors (many of which are based on low pay), rather than on industrial production.  Table 1 shows how growth in employment and cuts in real pay have come together since 2010 (all data from ONS):


Thus, the ultra-flexible UK labour market (“with employers in the driving seat”, in the government’s own charming words) – to be enhanced by the repressive new Trade Union Act – has had the effect of causing productivity to fall. And whatever government says about wanting higher productivity, this is the necessary consequence of its overall policy stance to date. 

It will require a huge change in policy to achieve a high productivity UK economy. A large, sustained, government-driven programme of investment (in infrastructure, research and development, skills etc.) to enable us to prepare for our digital, post-carbon society, is by far the best way to combine increased economic activity (GDP), higher pay, and thus higher productivity.

2015: Economics, Energy and Climate Change

Andrew Simms

The politics and economics of energy and climate change - two, huge, linked themes - dominated the year. And nowhere, from governments to anti-austerity oppositions on the left, are the full implications for economies being appreciated.

The Paris climate talks fell in December 2015 setting the year’s agenda so that almost all environmental issues were seen in the context of agreeing a replacement, international deal on global warming, including the process to set a new, universal Sustainable Development Goals.

Shocking compared even to the mendacity of the tobacco industry, which suppressed scientific evidence on the link between smoking and cancer, were revelations that the oil company Exxon had known for decades about the science of climate change and yet obfuscated and lobbied against action that would inconvenience the fossil fuel industries.

It then emerged that Exxon were not alone. From the late 1970s, oil majors from Shell to Texaco, Mobil, Amoco, Gulf Oil and others all knew.

For nearly 40 years, therefore, fossil fuel companies had been conducting a massive, knowing geo-engineering experiment with the planet’s atmosphere for enormous private profit, and accepted for the transitory, ancillary benefits it provided in powering a growth and high energy-based economy.

We all now live with the consequences and challenge of reversing out of the economy’s subsequent fossil fuel-powered growth dependence. Setting the scene for how to approach the challenge, the Human Development Report of the United Nations Development Programme, reminded that there is no automatic link between economic growth and human development. Countries with similar income like Chile and Equatorial Guinea can have very different human outcomes, while countries with similar levels of development like Gabon and Indonesia, can have different levels of income.

Separately, the attractive idea that technology and efficiency alone might allow the wealthy world to deal with climate change without a fundamental change in economic direction was dashed by research revealing that the long-promised (and longed for) decoupling of growth from resource use was mostly illusory and an artefact of incomplete accounting.

Research published by the US Proceedings of the National Academy of Sciences found that, “Achievements in decoupling in advanced economies are smaller than reported or even nonexistent…. As wealth grows, countries tend to reduce their domestic portion of materials extraction through international trade, whereas the overall mass of material consumption generally increases.” So, just as growth does not guarantee human development (although obviously for very poor countries it may accompany it), you cannot grow your way to reducing your environmental impact. Hence, there is no environmental Kuznets curve in a growth economy, just an upward slope of impact at the aggregate level like the rising line of emissions and greenhouse gas concentrations in the atmosphere. Information and service driven economies tend merely to export their environmental impact.

The Paris agreement to some extent set a new framework for these issues. For diplomats the agreement was a resounding success and the mother of all New Year’s resolutions. For some scientists, good presentation masked a fudge on the climate science and obscured its economic implications.

The agreement commits signatories to act to halt temperature rises, “well below 2°C above pre-industrial levels and to pursue efforts to limit the temperature increase to 1.5°C above pre-industrial levels.” Inclusion of the 1.5°C figure was considered a triumph for lobbying by the recently formed ‘climate vulnerable’ group of countries, who broke ranks from the traditional G77 negotiating block which carried major fossil fuel interests.

Pledges made by countries are non binding, but for the 180 plus countries making commitments they are obliged to publish and regularly ‘upward review’ their pledges such that, and “the efforts of all parties will represent a progression over time.” An initial stock take will happen in 2018.

However, depending on whose estimate you take, the pledges made in Paris leave the world committed to somewhere between 2.7 – 4°C of warming. As anywhere in this range is beyond the point that domino effects begin it means a course of potentially irreversible, catastrophic warming.

Even then, the models used to arrive at the lower, but still dangerous levels of warming, make assumptions that test reality. Some assume either that global emissions peaked in the past – when they are still rising – and others that in the future non-existent, speculative technology will be able to remove at scale vast quantities of greenhouse gases. Some models assume both.

Other key points of Paris were: recognition of the loss and damage to vulnerable nations from warming already locked into the climate system, but without acceptance of the need to compensate; a modest pot of money for low income countries’ adaptation; a long term goal of achieving net zero emissions (however meaningless if irreversible warming begins first); and the fact that there are no sanctions for not meeting commitments.

It was in this stark context that many viewed several decisions by the UK government as decidedly odd. Cuts to clean energy, a decision to allow fracking for gas beneath National Parks, re-opening the previously closed book of aviation expansion via a new runway at Heathrow, privatisation of the Green Investment Bank with a related potential dilution of its mission, cuts to key environmental departments in government and, as severe flooding hit several parts of the UK, an inability even to protect its own population from increasing weather extremes of a kind set to become more common in a warming world. Indeed, cuts to clean energy incentives were justified by the government on the grounds of opposing a ‘permanent subsidies’ model, even in a year when George Osborne, Chancellor of the Exchequer, announced new fossil fuel subsidies, and the government introduced a new legal obligation for the maximum use of North Sea oil and gas.

But then, the mainstream Labour Party too, showed that it hadn’t really got the message either. It wasn’t a good look when, the day after the Paris climate deal was agreed, Labour MP Sadiq Khan, the Party’s candidate for London Mayor, called for UK aviation expansion. And, through effective lobbying, aviation had once again been left out of the climate agreement. Almost everyone wanted to celebrate a diplomatic success in Paris, but no one, it seemed wanted to develop a logical path for subsequent action. The Confederation of British Industry pushed for Heathrow’s third runway even as it applauded the agreement. But, as an understanding that much of our remaining fossil fuels are now unburnable spreads, and the movement for divestment from its industry grows, such voices will look increasingly anachronistic and out of touch.

More broadly an economic model of debt-fuelled overconsumption has steadily reasserted itself in the UK, with the consumer debt that has been worrying the Bank of England rising again in a pattern that preceded the 2007-2008 financial crisis.

As 2016 looks set to be hotter still than 2015, our greatest challenge will be to learn how to flourish within planetary boundaries. Those on the left of economics cannot provide a meaningful alternative to neo-liberalism by critiquing austerity for its failure to deliver growth. There needs to be a positive vision articulated for how everyone can live well respecting environmental thresholds. In rich countries like the UK that means replacing consumption-led growth for a new kind of materialism that respects and cares for the material world, and tackles human need and aspiration through better distribution and a more creative approach to the art of living.

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