Productivity: It's a gas

Last November I experienced a leak in my gas supply which required the replacement of a pipe. All seemed to be well until last week when I again smelled gas. Having tried to call the original engineer to rectify the problem – to no avail – I contacted a different local engineer. He discovered that the person responsible for installing the replacement pipe had allowed soldering flux to drip onto it, despite the fact that the instructions for fitting such pipes advised covering it to avoid any contact with flux, with the result that it had started to corrode and required replacing. Away went the gas engineer to get a new pipe, only for him to find that the one he obtained did not fit which necessitated a second trip to the wholesale supplier.

In the end the job was successfully completed, but what should have been a simple one hour job last November turned out to require four hours of work spread over 8 months due to the shoddy initial job and the failure of the second engineer to measure the pipe before purchasing a replacement. This got me thinking about productivity and the reasons why it is so low.

Compared with the rest of the G7, UK productivity lags behind. On data to 2016, output per head in real terms across the other G7 countries was almost 6% higher than in the UK with German output per head 4% above UK levels and the US 7.4% higher. A study conducted by NIESR for the Department for Business, Innovation and Skills in 2015 concluded that although the UK performs well in an international context on the basis of the contribution of higher skills (i.e. university education) to productivity, “the UK’s intermediate (practical, technical and occupational) skills are of more concern.” This would accord with my own anecdotal experience in which an apparent lack of training resulted in poor basic skills with the result that fairly simple jobs take longer to complete than necessary (not to mention costing more money).

But it is not just a British problem. Policymakers have been exercised in recent years by the weakness of productivity growth, which has been one of the marked features of the recovery from the global financial crisis of 2008-09. Only 6 out of 36 OECD countries recorded faster productivity growth over the period 2010 to 2018 compared with the years 2002 to 2007. Across the OECD as a whole, labour productivity has averaged growth of 1% per year since 2010 versus 1.7% between 2002 and 2007. In the euro zone, where productivity growth was not especially rapid before the GFC, it has slowed from an average of 1.1% per year to 0.8% whilst in the US the slowdown has been much more pronounced (from 2.1% to 0.9%). The slowdown in the UK has been almost as severe, leaving the rate of productivity growth at a paltry post-GFC average of 0.6% per annum versus 1.7% in the five years prior to the recession.

Aside from impact on wasted time and higher outlays, why do we care? In the first instance, productivity is the key driver of living standards. In an economy where labour is paid roughly according to the amount of value added it generates, there is a strong link between (real) wage growth and output per worker. Thus, if productivity growth slows, so too will real wage growth and over the period 2008 to 2014 real wages in the UK fell by 9%. The “puzzle” in all of this is that the sustained general pattern of productivity stagnation contrasts with the pattern following previous economic downturns, when productivity initially fell but subsequently recovered towards the previous trend growth rate. Something has clearly changed but we cannot be sure what it is.

Chart 1, 2 and 3 show UK GDP, productivity (output per worker) and employment trends (respectively) in the current cycle compared to  the three major recessions since the 1970s (click to enlarge). The current GDP upswing broadly matches that of the 1970s and early-1980s but lags the 1980s and 1990s. But employment growth has far outstripped previous recovery phases whilst productivity has lagged. To the extent that output is a function of labour input, capital investment and technological progress, it appears that British companies have increased output by expanding labour input rather than capital investment or technological improvements. If these workers are lacking in the appropriate training, it is likely they will take time to get used to the systems and processes required to enable them to do their jobs efficiently with consequent adverse effects on productivity.

It also appears to be the case that there is a widening gap between the performance of firms in the upper quartile of the productivity distribution and those lower down. One reason for this is perhaps that the best educated workers tend to gravitate towards the best paying firms who then improve the company’s productivity performance and are then rewarded for their efforts. In other words, there is a self-reinforcing spiral which rewards those who already have the requisite skills. What is thus required is a more efficient transfer of skills throughout the economy. This is a problem which has long been recognised and the government’s apprenticeship scheme is a way to help give decent vocational training to younger workers (though changes to the Apprenticeship Levy in 2017 may be hampering the operation of this market).

However, there is no quick fix for poor productivity. In any case, measuring it is particularly difficult in an economy in which services account for an increasing share of output. Last December the OECD had a closer look at the way in which it measures productivity and concluded that once we account for differences in the way we measure labour input, particularly with regard to the way in which holidays are treated in the data, the UK’s international productivity does not lag quite as much we had previously thought. Ironically, if my original gas engineer had been on holiday when I called him last year, maybe I would have been spared the result of a lack of training. There again, I would have missed out on a learning experience.

Brexit demographics revisited

More than three years after the Brexit referendum, many of those who promoted the idea are more adamant than ever that the UK should leave the EU. We only need to listen to the candidates for the Conservative Party leadership attempting to outdo themselves in terms of their commitment to the Brexit cause to realise that something unpleasant has taken root in the public debate over the past three years. One of the contenders, Jeremy Hunt who in 2016 supported the Remain campaign, responded in a TV interview to the question whether he was prepared to let businesses go to the wall in the event of a no-deal Brexit that he “would do so but I would do it with a heavy heart … if in order to do what the people tell us to do, we have to leave without a deal, I would do that.“ In all my time watching UK politics, I do not think I have ever heard a politician say something as stupid – and there is a lot of competition.

Brexit has now become an article of faith in which politicians tell us that the will of the people has to be respected. These are the same politicians who respect the will of the people so much that they have twice changed an elected prime minister without consulting the wider electorate. Or, to put it another way, the next prime minister will be a leader without a general mandate, of a government without a majority, promising an outcome that is not deliverable to an unrepresentative slice of the electorate and foisting it on a public that arguably no longer wants it. Let there be no doubt that what is being offered today – a hard Brexit – is not what people voted for in 2016. Of course, a no-deal Brexit may not result in the worst case scenarios that many of us have highlighted. But the simple truth is we do not know what will happen, in which case politicians have a duty not to take unnecessary risks with the livelihoods of the electorate which they represent.

As a reminder, the 2017 Conservative manifesto promised “a strong economy that works for everyone.” It also promised “We will seek to replicate all existing EU free trade agreements and support the ratification of trade agreements entered into during our EU membership … We will introduce a Trade Bill in the next parliament.” So far it has failed to deliver on the first two of these and the Trade Bill has still not been ratified. Brexit is clearly not proceeding as planned. That being the case, what is stopping the government from putting the terms of the EU exit to the electorate for ratification?

What appears to be stopping them is that the Conservatives have nailed their colours to the Brexit mast, and it is far from certain that they will be able to get a second Brexit referendum across the line. A quick look at the demographics highlights the extent of the problem. Based on data through 14 June 2019, we know that 1.34 million people aged 65+ have passed away since the referendum in June 2016. By the same token, roughly 1.16 million young people who were not old enough to vote three years ago are now eligible to do so. Of course, not all those aged 65+ who are now deceased will have supported Brexit and not all those now old enough to cast a vote will necessarily support Remain.

I have thus made some assumptions based on varying degrees of Brexit support for deceased voters aged 65+, ranging from 50% to 75%. Similarly, new voters are assumed to support Brexit over the range 25% to 75%. In simple terms, the higher the degree of support for Brexit amongst deceased voters and the lower the degree of support from younger voters, the more the margin in favour of Leave narrows. This is illustrated in chart 1 (above). In the case where deceased voters are assumed to have voted 75% in favour of Brexit (right-hand column) whereas only 25% of new voters support it (top row) the margin in favour of leaving the EU narrows to 15k. Conversely if deceased voters only voted 50% in favour Brexit (left-hand column) and younger voters are 75% in favour (bottom row), the margin comes in at 1.85 million. Recall that the margin in favour of Remain in 2016 was 1.27 million.

On the basis of the figures presented here, there are no circumstances in which the demographics alone will flip the referendum result. Matters look slightly different if we account for a swing in voters’ preferences on top of the demographics. A swing of 2% in favour of Remain opens up the prospect that the result could be overturned (chart 2). A 4% swing would certainly make a Leave vote a realistic prospect (chart 3). Evidence to suggest there has been a swing in public opinion comes from the poll conducted by YouGov since summer 2016 asking whether people think the vote to leave in 2016 was right or wrong. Those who believe it was the wrong decision now hold a seven point lead over those who believe it was the right decision, whereas in summer 2016 they lagged by three percentage points.

With the Conservative Party comprised of mature voters with a clear bias towards Brexit, no candidate worth their salt is going to promise a second referendum. But the very narrowness of the victory margin in 2016 meant that it was always going to be vulnerable to small changes in demographics and voter preferences. Whilst a second referendum which produces a narrow vote for Remain will not resolve the issue either, it is clear that those politicians who argue that the electorate clearly supports Brexit (“do or die” to quote Boris Johnson) are deluding themselves and large parts of the electorate. The new prime minister has a big job on their hands to restore political unity – the evidence suggests that delivering a no-deal Brexit will not be the way to do that.

Factbombing

The old joke has it that you can prove anything with statistics but the evidence from the political debate over recent years is that the opposite is true. There is indeed such a thing as too much information. Full Fact, the charity that tries to assess the claims and counterclaims made in the course of the UK public debate, has called the weapons grade use of statistics ‘Factbombing’ which is a highly evocative and entirely accurate description of the phenomenon.

I first became aware of the extent to which politicians throw out huge quantities of statistics during George Osborne’s budget speeches without being able to put my finger on what was happening. But it has been taken to new levels in the course of day-to-day parliamentary business, particularly in the wake of the Brexit referendum. Full Fact quote a case from prime ministers’ questions in January when Jeremy Corbyn made 13 separate factual claims in the course of one question, which then did not relate to the question he subsequently asked. Of course, this makes it impossible to give a sensible answer, which is precisely the intention: Much of the pointless trading of facts is designed to gain political advantage and not to enhance the quality of the debate. The flip side is that data overload makes it very difficult for the average voter to follow the twists and turns of the debate.

As for accuracy, fact bombers do tend to quote accurate statistics, although they are often cherry-picked and therefore quoted out of context which reduces their usefulness when the subject matter is put under further scrutiny. But by the time we get to that point, the debate has moved on and nobody cares whether “a Labour government properly funded the police force” or that the Conservatives are responsible for “rising crime, less safe streets.” Perhaps an even bigger problem is that politicians are generally not trusted, so it is questionable whether the electorate believes or cares what “facts” politicians quote in the course of debate which further undermines the case for evidence-based policy.

Of course, one of the reasons why politicians are not trusted is that when they do lie, they lie big. Think about the claim made in 2016 that the UK could save £350 million per week by leaving the EU. This is based on the gross contribution to the EU budget before rebates and the amount returned in the form of EU funding. It is true that over the period 2013 to 2016 the UK’s gross contribution does correspond to this figure, but the net figure is 45% lower (£190 million per week). To the extent that UK fiscal finances never work off the gross figure but off the net number, which means that such a large figure never enters the budget calculations, it is simply untrue to quote the £350 million figure, as the UK Statistics Authority Chairman pointed out to Boris Johnson in 2017. Not that British politicians have a monopoly on untruth: One of the masters of the dark arts is Donald Trump (see here for a rebuttal of some his more egregious comments) and let’s not get started on Watergate.

One of the great problems in the use and misuse of economic statistics is the lack of context. I have made the point previously (here)  that spending “millions” on government outlays is to miss the point that overall revenues are measured in billions and the size of the economy is in the trillions. For example, an outlay of £100 million is worth 4.7% of annual GDP today compared with 9.7% 20 years ago. “Record spending” on the NHS is misleading if it has not kept pace with the overall size of the economy, particularly when the population is growing older and demands on healthcare resources are rising.

It is not just politicians who are guilty of overegging it. The Department for International Trade made a similar howler recently by sending out a tweet pointing out that “exports in the 12 months to April 2019 grew by 4.0% to a record high of £645.8bn.” Exports at a record high in money terms, yes. But as a share of GDP they are still below the high recorded in Q1 2012. Indeed, it is pretty likely that the latest release of economic time series such as exports or GDP will always post record highs so long as they continue to show positive growth. In statistical terms, such series are non-stationary, meaning that their mean and variance are not constant over time. I would be much more impressed if growth (which is statistically stationary) reaches a record high. But in a world where we need to reach for the superlative, it is much easier to go with the lazy headline regarding all-time high levels of exports.

Perhaps the real problem with Factbombing is that it diminishes the quality of debate. We need to know which facts we can trust and which we can discount; which are germane to the debate at hand and which are irrelevant? In a world where we are bombarded with information on a daily basis, it is more important than ever to remember that the singular of data is not anecdote.

The Swiss won't be rolled over

Although it has tended to fly beneath the radar screen, overshadowed as it is by Brexit, Switzerland has been involved an acrimonious dispute with the EU. Unfortunately for the Swiss, it is the fallout from Brexit that has brought matters to a head as the EU seeks to demonstrate that countries that do not play ball will feel the effects of exclusion from the EU market.

To put this into context, although Switzerland is not a member of the EU it has a series of bilateral agreements which allow access to parts of the European single market. One of the prerequisites for maintaining access to the single market is that the network of bilateral agreements be replaced with an overarching framework agreement. This would include a mechanism for settling any legal disputes between Bern and Brussels. Negotiations on these institutional issues began back in May 2014 but progress has been slow due to domestic political feeling, primarily opposition from the right-wing populist SVP which whipped up a storm by highlighting the role of “foreign judges” in Swiss affairs. At the end of 2017, the EU raised the pressure by granting Swiss stock exchange equivalence only for a year unless progress was forthcoming, and at the end of 2018 a further six month extension was granted. But no further progress has been made and at the end of June 2019, exchange equivalence expires.

In practice, this means that Swiss stocks cannot be traded on EU exchanges (and vice versa, thanks to the Swiss decision to reciprocate). Nobody knows what it will mean in practice. But Swiss companies account for around 20% of the Stoxx 50 market cap and 30% of the trading in Swiss large cap stocks takes place on other EU exchanges, primarily London. The companies involved remain sanguine, with a large chunk of trading expected to switch to Zurich and foreign trading shifting to markets such as New York. There is no doubt that this is more than a minor inconvenience and could have potentially damaging market impacts. But the bigger issue reflects global politics, and not for the first time Switzerland finds itself squeezed by the actions of far larger economic blocs.

In the wake of the 2008 financial crisis, pressure from the US and EU forced Switzerland to water down its banking secrecy laws by requiring it to share account data with foreign authorities. Ironically, the state of Delaware remains one of the world’s most important tax havens, and protects the identity and personal information of privately held corporate business owners from public record. Nor is the record of EU Commission President Juncker exactly spotless: After all, he was Prime Minister of Luxembourg when its tax avoidance regime, which was conducive to foreign companies wishing to minimise their tax bill, was set up. It is therefore understandable that the Swiss electorate is not prepared to roll over in front of yet more international pressure on their economic model.

In the current case, the actions of the EU to put pressure on Switzerland have to be seen in the context of the Brexit debate in which the EU wants to be seen to be intolerant of foot-dragging on the part of those countries which do not adhere to their commitments. The UK will watch with interest given that the EU has chosen to make an issue of market equivalence. In the absence of a more concrete plan, the Withdrawal Agreement drawn up between the UK and EU will allow UK financial services providers to access the EU market on the basis of equivalence rather than the current model of passporting. This is granted on the basis that the rules in the UK market are deemed “equivalent” to those in the EU (which given that both sides currently follow the same set of rules is clearly the case). One of the great disadvantages of this model is that either side can end equivalence-based access at short notice, which means it cannot be used as the basis for multi-year financial planning. Nor does the EU have any equivalence-based rules for commercial lending, deposit taking or parts of the insurance sector. Those who can bear to tear themselves away from the unfolding drama of the Conservative leadership race should take note of the EU’s ability to exert pressure.

As for Switzerland, it now finds itself in a very awkward position. The journalist Steffen Klatt has pointed out that there is an inherent contradiction between the will of the people as expressed in the Swiss direct democracy model and the membership requirements of international organisations. The UK might argue that it is in a similar position today. But the crucial difference is that the UK operates a system of representative democracy, and resorting to referendums is an abrogation of responsibility on the part of MPs who the electorate pays to take decisions. Swiss access to the single market was negotiated on the basis of its long-standing commitment to direct democracy - in this sense Switzerland enjoys a far higher degree of democratic engagement than the EU. Unfortunately, it is the EU that has changed its stance more than Switzerland and its criticism is based on the fact that Swiss laws have been slow to adapt to changes in EU internal market law.

Ultimately, the dispute boils down to a conflict between social and economic objectives. Concern about immigration into Switzerland has been rising for some time. Roughly 24% of the Swiss population is foreign born and in 2014 the electorate narrowly voted to support a popular initiative “against mass immigration”. This undermined relationships with the EU, and at the time Switzerland was seen as a European outlier in terms of immigration concerns. However, immigration levels remain the biggest issue for voters across the EU according to the most recent Eurobarometer which is why the likes of the AfD have been making ground in Germany.

Whilst the EU does have legitimate concerns about the way single market laws have been applied in Switzerland, there is also a sense that the EU is using its economic muscle to force compliance at a time when immigration concerns expressed by the Swiss are being reflected elsewhere. I have pointed out before (here) that the political legitimacy of the EU rests on its ability to act in accordance with its citizens’ wishes, and the results of the European Parliament elections last month suggest that there is a diverse range of opinions. The EU is certainly big enough to push Switzerland around, but this kind of behaviour will do nothing to assuage Italian concerns with regard to the EU’s approach to fiscal matters and will only enrage Brexiteers. Sometimes the whole point of carrying a big stick is that you never actually have to use it. In striking at the Swiss, whilst failing to sanction member states such as Poland or Hungary for their flagrant breaches of EU democratic norms, the EU may be lashing out at the wrong target.