Fortnightly insight into the current state of the economy and how it relates to Dorset by Nigel F Jump, Chief Economist of Strategic Economics Ltd (a Dorset Company) and Visiting Professor in Economics at the Universities of Bath and Plymouth.
See: www.strategiceconomics.co.uk
Happy New Year to all readers and contributors to Dorset Eye. This first Economic Story of 2013 looks at fundamental reasons why the economy will remain constrained and suggests how Dorset business and agencies, such as the Dorset Local Enterprise Partnership, should react.
First, the New Year started with US policy makers pulling back from the ‘fiscal cliff’. Fiscal policy sets the mix of government spending and taxation. The ‘cliff’ represented a mixture of legislated tax increases and spending cuts that would have undermined economic growth, at least in the short term. The last minute political agreement avoided immediate market panic but merely delayed the real decisions that Washington (White House and particularly Congress) needs to take to address its long-term fiscal imbalances.
The next decision will be about extending the debt ceiling. At last, it has now become clear to many more people that underlying US fiscal problems are at least as bad as those in the euro-zone. The process and progress towards fiscal sustainability, in America and Europe, will be a recurring theme for the markets and the news media through 2013. The question is whether this keeps the level of uncertainty high enough to suppress business investment and, thereby, to restrain real growth.
Uncertainty about fiscal austerity is not the only drag on growth. A second factor is the historically unusual low level and change in UK productivity. In the third quarter of 2012, for example, three measures of productivity – output per worker, output per job and output per hour, were lower than they were a year earlier. Indeed, this data – just released – shows UK output per hour was 2.4% below its year ago level and still 3.3% below the level achieved at the peak before the downturn in the second quarter of 2008.
As the chart shows, it is very unusual to have productivity still falling in the fifth year after the onset of a recession. (With the individual peaks set at 100, the chart shows how output per hour moved, relatively, thereafter). After the 1973, 1979 and 1990 recessions, productivity had recovered to well above its previous peak by now – more than four years after the start of the downturn. The failure to do so after 2008 is stark.
Productivity growth is a key indicator of the different path the economy is taking this time around. Usually, the pattern is: 1) output drops before employment and, therefore, productivity plummets; 2) but when employment then declines, and output hits bottom, productivity starts to improve; and 3) that improvement boosts returns and encourages new corporate investment to fuel the recovery. This time, less severe rises in unemployment and persistently flat output have meant on-going low productivity that is dissuading business investment. Since the government is also cutting back on investment to address fiscal deficits, the whole economy is effectively stuck. We need to see a return to productivity growth before any recovery in growth can be sustainable.
Of course, there are other factors at work in this UK downturn, including 1) constraints on access to bank credit, 2) the liquidity trap induced by prolonged loose monetary policy, 3) falling real household incomes and 4) the global malaise in trade. Nevertheless, as we enter 2013, my diagnosis and prognosis of why the economy will remain sluggish is this underlying combination of worldwide fiscal austerity and the national low productivity.
At a local level, whatever your politics or policy preferences, this economic background implies attention needs to be given to raising the productivity of Dorset businesses. The quickest way for a local firm to do that is to reduce hours and/or sack people. Some companies will have to do this if demand remains below capacity and low productivity is undermining financial viability. However, unless ‘surplus labour’ is reallocated to growing businesses quickly – unlikely in current conditions, one company’s need to lay off staff risks being another company’s drop in final demand.
Therefore, a long-term approach to sustained and sustainable growth is required. The productivity-led growth chain is always the same. It requires entrepreneurial development of capacity and capability … in other words, investment in innovation and skills. It also requires entrepreneurial engagement in market competitiveness – locally, nationally and internationally. Dorset business will outperform its peers if it can “do things better” and “do better things’. Pursuit of this implies a reaching out for new methods, new outputs and new markets. The process of growth is not the issue. The issue is whether the confidence and incentives exist at a micro level that can boost local development despite the suppressed overall macro ‘new normal’.
Let’s hope that the business representatives running the Dorset Local Enterprise Partnership take advice on how to recognise these priorities and address the real issues as they develop their ‘Heseltine Growth Strategy’.
Professor Nigel Jump
