Falling productivity - cause or symptom of the recession?
The annual rate of growth of output per hour worked (seasonally adjusted) for the UK economy is falling for the first time since the mid 1990s. There are good reasons for thinking that labour productivity tends to directly related to the business cycle; when demand and output is strong, firms will be making full use of their existing factor resources and capacity utilisation will be high. In a downturn, there are spare factor resources and productivity growth may suffer if businesses do not wish to adjust their labour force in response to declining demand.
The danger is that, in the absence of flexible pay that reflects lower output per hour, weaker productivity will cause a rise in unit labour costs and this will put further pressure on business profit margins and the internal funds available to finance investment. UK productivity continues to lag behind levels achieved by many of our major international competitor nations.
Q&A: Does a positive output gap always mean rising inflation?
A student asks “Does a positive output gap always mean rising inflation?”
read more...»Q&A: AD and Inflationary Pressures
A student asks: Will a rise in AD will only cause cost-push inflation if there is a positive output gap?
read more...»Q&A: What is the productivity gap?
The productivity gap is a phrase to describe a sustained difference in measured output per worker (or GDP per person employed) between one country and another.
read more...»Spare Capacity in Manufacturing
Spare capacity is a term that makes increasingly frequent appearances in AS macro multiple choice and data response questions. A survey from the British Chambers of Commerce finds that only 20% of manufacturing firms are operating at full-tilt whereas 40% of service sector businesses report that they are close to their capacity levels.
Spare capacity rises when orders and demand tails off leaving under-utilised capital and labour resources. We have seen this in the steep contraction in production in new housebuilding and in car manufacturing and this inevitably has knock-on effects for supply-chain businesses.
Operating below capacity can lead to a rise in the average fixed costs of production and therefore put pressure on profit margins. Little wonder that many manufacturing businesses have moved towards short-time working and have mothballed some of their production capacity.
This BBC Midlands news article covers a march for jobs in the West Midlands
Revision: Importance of Business Expectations
Expectations matter hugely for businesses - and changes in business sentiment have important macroeconomic effects at different stages of the economic cycle. This brief revision note looks at the role of expectations.
read more...»Obama’s pledge on R&D
“I am here today to set this goal: we will devote more than 3% of our GDP to research and development,”
If Obama succeeds in his aim, the US economy will raise investment in research and development as a share of national income - AS students might consider some of the likely demand and supply-side effects of such an aim. A good article to use when teaching supply-side policies.
The UK of course is some distance below the US levels when it comes to research and development spending.
First hints of the brain drain effect
The government’s decision to increase the top rate of income tax from 40% to 50% is pure political opportunism from a party that has given up any realistic hope of power at the next election. Cue a chance to stick a few poorly aimed knives into the body of up and coming entrepreneurs for a measure that will raise a little extra revenue but which will also do huge long term damage to enterprise in the British economy. From next year anyone earning more than £150,000 a year will pay 50% income tax. The move replaced the 45% tax bracket threatened in the pre-budget report last November. Here are the first signs of a brain drain effect taking hold. And even more worrying is the threat of a brain blockade - as highly skilled people in industries such as technology, medicine, industrial research and so son may now shun coming to the UK in favour of competing locations. Those with a cushion of wealth are best placed to relocate, in a digital age the barriers to conducting business off-shore are so much lower. The Telegraph provides a handy guide for those searching for an atlas and airline timetable this weekend.
Challenges and opportunities of an expanding population
The evergreen “Big Question” feature in the Independent today looks at demographic economics. The number of people in the UK is growing by 1,000 a day. There are 61 million people officially resident in Britain today and this is expected to grow by 4.4 million by 2016 - Is Britain going to be able to support an ever-expanding population?
Q&A: Will the UK economy’s PPF shift inwards because of the recession?
Will the UK economy’s PPF shift inwards because of the recession?
This is an interesting question and hints that a deep recession that lasts longer than we expect can have a damaging effect on the UK economy’s supply-side performance and productive potential.
read more...»Q&A: What is the accelerator effect?
What is the accelerator effect?
The accelerator effect describes a principle where how much a business chooses to spend on capital investment will be influenced by how quickly demand is growing for their products.
read more...»Supply-Side Indicators for the UK
I am about to start teaching supply-side economics with my AS students so the time has come to update some of the charts I use to illustrate aspects of supply-side performance. This is available to download as a PowerPoint file below.
read more...»Apprenticeships and Economic Performance
My Monday morning edition of the Financial Times carried an important article on the prospects for apprenticeships during the economic downturn. The broad thrust of the piece was encouraging - a number of Britain’s biggest companies have said that they do not plan to curtail the number of apprenticeship programmes on offer to school and college leavers. It is not simply a case of altruism - a number of studies have shown that investing in the human capital of the workforce can achieve a positive payback in just a few years.
“Recent studies have shown that investing in an apprentice is often cheaper than recruiting qualified workers from rivals and then having to retrain them in the procedures of their new employer…...BT had “calculated a net financial benefit of over £1,300 ($1,910) per apprentice a year when compared with non-apprentice recruitment”......A more recent study by Warwick university for the taskforce’s successor, the Apprenticeship Ambassadors Network, found that it cost £28,762 to train an engineering apprentice but the “employer’s investment was, on average, paid back in less than three years”.
Why is the success of apprenticeship schemes important for the longer-term health of the UK economy? Many of the benefits of vocational programmes show through on the supply-side of the economy:
A lower risk of structural unemployment through lower occupational immobility
Less pressure on the welfare benefits system resulting from long term unemployment
A reduction in the number of unfilled vacancies for skilled workers
Higher productivity and better paid jobs - which then boosts aggregate demand
Ultimately - higher profits for businesses with successful apprenticeship schemes
Reduced dependence on inflows of migrant workers
Better skilled workers will improve the quality of work and provide a stronger platform for greater innovation in their chosen fields
Improved customer service e.g. in industries such as gas supply, plumbing and construction
The FT article can be found here
The website of the Apprenticeship Ambassadors Network is also worth visiting
Pay cuts in a recession
Pay cuts and pay freezes are being flagged up as an increasingly common option by businesses struggling to survive in the early stages of the recession. Formula 1 drivers are being asked to consider cuts in their earnings as teams look to control costs ahead of the 2009 season; staff working for the publisher Penguin who earn over £30,000 have had their salaries frozen. Premier Rugby in Britain will agree, next month, on a reduction in the salary cap from £4m to £3.5m. And a new survey from the British Chambers of Commerce covering 300 member firms has found that 43% plan to freeze wages and salaries in the coming year. Nearly one business in ten will go a step further and attempt to cut basic pay and salaries – a measure described in this article from the Sunday Times as “almost unprecedented in the experience of today’s workers.”
read more...»Economics of energy - over a barrel
“The plunging oil price is like a dangerously addictive painkiller: short-term relief is being provided at a cost of serious long-term harm”
If you are interested in the economics of energy then the Financial Times today is well worth buying from the news stand. Ed Crooks provides a superb analysis of the effects that oil and gas price volatility is having on the economic viability of different segments of the energy industry - ranging from conventional oil to unconventional oil (including oil shale, coal to liquid and the oil sands projects) and also the impact of changing prices on demand for and the likely returns from biofuels, nuclear, coal and renewable supplies of energy. There is a superb graphic on page 11 that will grace any classroom wall and make a tremendous teaching handout for students who want to understand more about the demand outlook for different fuels.
Here is the link to Ed’s article. But best to buy your own copy of the FT today for the graphic alone!
Beta Currencies and PMD
Beta Currencies
The continued depreciation of sterling - most notably against the Euro - continues to dominate the economic headlines. One Euro now buys 95 pence and parity is much more likely than I thought when I wrote about the exchange rate last week.
For your exams remember that you need to have a clear handle on
Why the currency is falling (causation)
What the main demand and supply-side effects of this are (consequences)
The possible policy responses (intervention)
With the latter keep in mind that the government and the central bank does not have a target for the external value of the pound although they recognise that it plays an important role in influencing the components of aggregate demand (C+I+G+X-M and also changes in short run aggregate supply (SRAS) e.g. through movements in the prices of imported goods and services.
Another approach for critical analysis of the exchange rate’s fall is to use the acronym PMD
P - plusses - i.e. what are the main advantages of a fall in the currency?
M - minuses - what are the negative effects for the UK economy at this time and for different agents (businesses and consumers)
D - depends - “it depends on” is one of the best evaluation phrases you can use - sterling has fallen by more than 20 per cent (on a trade weighted basis) over the last year. This is a significant depreciation - but the effects DEPEND on many factors - here are a few:
Do exporters reduce their overseas prices or choose instead to keep prices the same and make a higher profit margin?
Do foreign consumers switch their demand to UK exports if and when our exports become more price competitive?
Will the negative real income effect of a global economic downturn offset the competitive advantage from having a lower exchange rate?
Will higher import prices help to prevent deflation in the UK next year?
Ambrose Evans-Pritchard has an article in the Telegraph today which argues that “Sterling fall is a life-saver for UK economy”
“Stephen Jen, currency chief at Morgan Stanley, said sterling is a “high-beta” currency, meaning that it is highly-geared to the global economic cycle. It shoots up during good times and plunges during bad times. It should return to health if and when the world emerges from economic winter.”
A related piece claims that the Sterling slide is the worst since 1931
“The pound has now fallen by 23pc against a basket of other currencies, according to figures from the Bank of England. The fall is sharper than the devaluations in 1992, after leaving the Exchange Rate Mechanism, 1976, when the International Monetary Fund was forced to intervene, and 1949, when a host of countries slumped against the dollar. The devaluation is only matched by the moment in 1931 when, under Ramsay MacDonald, the UK was forced to abandon the gold standard, plunging by more than 24pc against the dollar. The parallel is significant, since many economists have attributed the gold standard exit as one of the main reasons the UK enjoyed a relatively mild depression in the 1930s, while the US suffered mass unemployment and saw its economy shrink by a third.”
Who are the Bank of England’s spies on the ground?
The Bank of England has a network of Regional Agents operating across the length and breadth of the UK. Think of the Regional Agents as a form of intelligence network designed to give the Bank of England a feel for what is really happening on the ground.
read more...»The Changing Pattern of Output
I have attached the chart in a PowerPoint file in case it might be of use as a teaching handout for student annotations and calculations. More detailed statistics on UK national output can be found from the Statistics Commission.
PowerPoint Chart
David Smith
The Party is over for Shrinking Financial Sector (Sunday Times)
Poverty Trap worsens
The soaring cost of child care is worsening the poverty trap according to a new report commissioned for the save the Children Fund in Scotland. More than one quarter of Scots parents on low incomes cannot work full time because of the cost of registered childcare which has risen by more than 10 per cent this year across most of the country. The average cost of child care in Britain during the holiday season is nearly £90 per week.
The Times has this article
“Joanne Brady, a single mother of two children from Glasgow, is unable to work because she loses more in means-tested child tax credits than she gains in income. “They take 20 per cent off for each child when you go to work. You still have to pay your housing, travel and lunches and it’s just not adequate.” Ms Brady, 27, is among the 28 per cent of parents with children under 18 and an income of less than £15,000.”
And the BBC also covers the report.
When costs are too much to bear
The news on UK inflation this week wasn’t good - it is difficult to find anything positive in seeing CPI inflation surge to an eleven year high of 3.8% and the RPI climbing to just under 5%. Little wonder that the government is getting more paranoid by the hour about the dangers of losing the battle on pay restraint as a wage price spiral takes hold.
The monthly inflation data tells us what has been happening to prices for a basket of goods and services - but to my mind what is more worrying is the data on input and output prices facing manufacturing businesses. My chart above shows just how steep has been the acceleration in inflation in the costs of imported foods and raw materials - costs are rising in excess of 20% pa for both categories. There comes a point when businesses simply have to raise their prices to avoid a calamitous fall in profits - and that point seems to have been reached. Manufacturing output prices are not rising at an annual rate of more than 10% and this “factory gate” inflation will flow through from wholesale to retail level in the space of a few weeks and months. If you want an early warning of why the inflation problem will not go away in 2009 - this one of the key indicators to watch.
US human capital in decline?
Clive Crook’s excellent blog asks whether the US economy’s growth potential will be harmed by a forecast that “Over the coming years, baby-boomers departing from the labour force will have better educational qualifications than the younger workers replacing them. If the ultimate source of an economy’s ability to grow and prosper is its human capital, the US is in trouble.”
Is there an equivalent study available for the UK?
