An issue that is
likely to preoccupy economists for some time, and which I have
written the occasional
post about, is whether 2010 austerity led to a
permanent reduction in UK output. Permanent is probably too strong a
word, but we can safely substitute ‘output today’ for
‘permanent’. Let’s start by redrawing a chart I have shown many
times, which contrasts the path of UK GDP per capita with its
pre-Global Financial Crisis (GFC) trend to show the extent of the
sea-change that appeared to happen after the GFC. (Looking at GDP
alone understates that sea-change, because GDP growth in the latter
half of the period was supported by much higher immigration. GDP per
capita is also more relevant for individual incomes.)
The GFC appeared to
lead to an immediate and sustained loss of 10% in income per capita,
and rather than that gap shrinking during a subsequent recovery (as
it had after all previous recessions) the gap grew to be around 15%
by 2019. Both figures are well above calculations done at the time of
the GFC which suggested a permanent output loss of around 5% at most.
The first point to
make is that there were signs that underlying growth was slowing
before the GFC, particularly if you allow for the excessive growth in
the banking sector before the GFC, so using a constant trend line
exaggerates the amount of lost output, by a small amount in 2010 but
by much more in 2019. But there is no doubt that a significant puzzle
remains about why the 2008/9 recession led to such a large permanent
loss in output.
Output growth is all
about productivity growth, and the decline in the growth in output
per head or output per hour since 2010 is well documented (the UK
‘productivity puzzle’). A key way that productivity growth occurs
is through investment (‘embodied technical progress’), so if
investment was substantially lower as a result of 2010 austerity then
this might account for some (certainly not all) of the productivity
shortfall.
Below is a chart of
the share of business investment in GDP. I look at business
investment so as to exclude investment in housing and the public
sector.
Investment always
falls by more than GDP in a recession, so its share also falls. A
notable point we can make immediately is that the investment share
did eventually recover to pre-GFC levels by 2016, but has
subsequently fallen as a result of Brexit. Whether the share would
have risen above the pre-GFC peak without Brexit, as it did following
the 1980/1 and 1991 recessions, we will never know.
The chart below
compares how the investment share evolved in three recessions and
recoveries. (indexed to 100 at the start of each recession, and
plotted from two years before that date.)
In the 1980/1
recession the business investment to GDP share fell least, by around
8%. In 1991 the business investment share fell more sharply (by over
15%, although with a bit of a delay), but it recovered rapidly. In
2008/9 we saw similar sharp falls in the investment share, but with a
more protracted recovery.
How much potentially
productivity improving investment was lost in each recession? Suppose
we average the investment share in the three years before each
recession, calculate how much the investment share was lower than
this average during the recession, and then accumulate these losses
in investment share up until it regained that pre-recession average.
After the 1980/1 recession the investment share had recovered to its
pre-recession average by 1985, with an accumulated loss of only 2%.
After the 1991 recession the share had recovered by 1996, with an
accumulated loss of 4%. Following the 2008/9 recession, it took two
additional years for the investment share to regain its pre-recession
average, with an accumulated loss of nearly 7%, which amounts to
losing the best part of a whole year’s worth of business
investment.
The following chart
looks at the growth in productivity (output per hour) from the start
of each recession.
Output per hour
recovered more rapidly following the 80/81 recession than the 91
recession, perhaps reflecting the larger fall in investment in the
latter. What stands out, of course, is that the recovery in
productivity following the 2008/9 recession was almost non-existent
by comparison. That suggests that lower business investment is
associated with lower productivity growth, but it also points to
other factors contributing to low growth after the GFC recession, as
there was still plenty of business investment going on but
productivity hardly improved.
If we accept that
lower business investment can result in lower productivity growth,
then it also follows that anything that delayed the recovery from the
2008/9 recession is likely to have led to more postponed or delayed
investment projects, and therefore almost certainly to less
productivity growth. Without austerity, the 2008/9 recession might
have looked more like the 1991 recession, with a rapid
recovery to a higher level of GDP by 2016.
I have made the
point before that productivity improving investment often requires
output growth to make it happen. Without output growth, a firm needs
to trade off the cost of investment against the future reduction in
costs the investment will generate. In contrast if demand is growing,
the firm will probably want to invest to meet that demand anyway, and
so the trade-off largely disappears. In other words how much firms
initially invest in productivity improvements will depend on how much
they expect output to expand after a recession.
As I have already
noted, after the 2008/9 recession firms could reasonably expect a
period of reasonably strong growth. Output had fallen by nearly 5%
between 2007 and 2009, so there was still the potential for above
trend growth. That appeared to be happening, with GDP rising by 2.4%
in 2010. However these expectations were dashed over the next two
years, with growth of only just over 1% in 2011 and just under 1.5%
in 2012. At that point firms might have revised down their
expectations about future demand, and delayed productivity enhancing
investment projects.
The Chart below
looks at the growth in output per hour during and after the 2008/9
recession
Productivity fell in
the recession as it always does, as firms try to hang on to at least
some of its workforce. But in 2010 productivity rebounded as the
recovery started. The collapse in productivity happened subsequently,
as this early promise of a quick rebound from the recession was
dashed. Austerity, and in particular the large cuts in public
investment in 2011 and 2012, played
a key role in reducing output growth in 2011/12.
I therefore think
there is evidence that austerity, in creating an unusually protracted
recovery in aggregate demand from the GFC recession, did have a
negative impact on productivity growth and therefore a persistent
negative impact on output supply. What we cannot know is how long
that negative impact on output supply would have lasted in the
absence of Brexit. Without Brexit, perhaps business investment would
have stayed at 10.5% of GDP, and the productivity enhancing
investment projects that had been delayed after the weak recovery
from the GFC would have finally been undertaken.
If an economy gets
hit hard by a global economic shock, it seems reasonable to hope for
an almost full recovery fairly quickly if policymakers do the right
thing. Hit it hard again as that recovery starts, and any recovery is
bound to be more delayed and may not be as complete as it might have
otherwise been. If you hit it with a third big negative shock less
than a decade after the first, then it is much more likely that the
first two shocks will leave lasting scars.
