Britain has got used to the narrative of pessimism since the credit crunch with the country’s economy struggling to regain its pre-crisis verve. That now looks set to change.
A new report released today by the Organisation for Economic Cooperation and Development (OECD) shows that UK GDP is finally back above its pre-crisis level and the pace of its recovery has now overtaken France and is quickly closing on Germany (although the US and Canada remain some way ahead).
This has come in no small part through two things in particular — record levels of employment and plunging household and business saving.
On the former, the UK has experienced what many are calling a “jobs miracle”. Unlike during previous recessions the UK saw unemployment rise by far less than might have been expected considering the severity of the crisis, and fell far quicker during the recovery.
This “miracle” has been facilitated in now small way by the labour market reforms that began in the 1980s under Margaret Thatcher’s government and were continued even after New Labour took power in 1997. In particular, these reforms reduced the power of labour unions by forcing a ballot before strike action could be taken, limiting collective wage bargaining and banning “secondary picketing” whereby strikers could picket locations they were not directly connected to.
Collectively the reforms sharply reduced the appeal of joining a union in Britain. Union membership peaked at over 13 million in 1979 but this figure has more than halved since then with only 6.5 million employees in the UK a member of a union in 2013. This has made it easier for companies to hire and fire employees and to negotiate terms of employment (including wages) on a case-by-case basis.
However, there have been trade-offs. As the OECD explains (emphasis added):
Structural reforms have strengthened labour supply. Welfare, pension and immigration reforms have lowered reservation wages, and declines in labour unionisation have reduced labour’s bargaining power. These reforms have lifted the participation rate, which otherwise would have been falling if only accounted for by population ageing. Increased labour supply has put downward pressure on productivity and it may take time for the capital stock to adjust to the higher level of labour. Moreover, recent job growth has partly been concentrated among individuals who may have lower-than-average productivity, moving into employment with generally lower skills and/or remaining self-employed.
That is to say, a more flexible labour market has allowed more people who are looking for work find jobs but it has also meant that these additional workers have helped keep pay rises down. Moreover, a substantial proportion of recent job gains have been concentrated in low-skill and relatively low-productivity areas.
Another problem that 1980s reformers are unlikely to have thought too much about is that when labour is cheap and capital expensive (such as after a financial crisis) firms can bring in more workers to meet rising demand rather than invest in new machines or technology to make their businesses more efficient. This capital-labour substitution could be one of the reasons behind the stagnation of productivity among UK workers. After all, the Office for National Statistics (ONS) estimates that investing
in new technology and equipment accounted for over 40%
of labour productivity growth between 1998 and 2008.
This could help explain why both the productivity and wage gains that have been seen in previous recoveries have so far failed to materialise since 2008.
So with real wages having seen substantial declines over recent years and productivity flat-lining, it would be reasonable to ask how on earth Britain is able to fuel its recovery. It hardly looks as if the Coalition government’s hopes of an economic rebalancing towards exports has come to fruition with the UK’s trade deficit (the value of goods and services exported minus the value of imports) rising to £34.8 billion last year, its highest level since 2010.
Instead, the country is once again relying on that ever-reliable source of apparently insatiable demand — the UK consumer. After a few years of saving to repair damaged household finances Britons have once again recaptured the confidence of old and are spending again — and they are finally encouraging businesses to do likewise.
This engine of growth, however, is heavily reliant on that weak wage growth turning around so that consumers can continue to spend without having to increase already high levels of household debt further or dip into their savings. This, in turn, will require businesses and government to increase investment in productivity enhancing measures so that wage gains do not cause inflation to spike.
The OECD report notes that the UK’s “investment ratio was trending downward and was low in international comparison prior to the crisis” and it was hit even further during the crisis both by the damage to demand and the restriction in the supply of bank credit. UK government investment in infrastructure is also low relative to other countries, and the OECD labels its investment in transport as “poor” compared to its peers. This period of low investment coincided with a period of slowing productivity growth — hinting at, though not proving, that the two could be linked.
But it seems that if this investment is going to materialise consumer spending is going to have to lead the way. As Bank of England Governor Mark Carney said in November’s Inflation Report press conference, expected wage growth of between 3.25% to 3.5% between 2015 and 2016 is “needed to achieve the inflation target over the forecast horizon.”
That is, far from worrying about wages pushing prices up too quickly, the Bank is relying on faster wage growth to get the economy back to something close to potential growth over the next few years.