I wrote a few days ago about the widespread belief in Britain that there has somehow been a dramatic collapse in the economy’s potential. The Financial Times columnist Martin Wolf adds much more in a recent column, plus a link to a very important paper written by the economists Bill Martin and Robert Rowthorn — titled “Is the British Economy Supply Constrained II? A Renewed Critique of Productivity Pessimism” — that, by my reading, very effectively debunks that belief.
There’s a lot of technical detail, but as I see it the main point is that we see a sharp drop in measured British productivity that could be the result either of some mysterious structural shift or the much more ordinary notion that many firms have held on to “overhead” labor in the face of what they expect to be only a temporary fall in sales. And the data just don’t support any of the proposed explanations for the supposed structural shift.
Specifically, the popular line here is that it’s due to the loss of all those high-value jobs in finance, which sounds plausible until you do the arithmetic and find that the figures are way, way too small. This bears a strong family resemblance to stories about alleged structural unemployment in the United States that focus on the shift out of construction; again, this sounds good until you do the numbers and find that it’s tiny.
This matters,a lot. If Britain has not experienced a mysterious productivity collapse, it is suffering much more than acknowledged from a lack of effective demand — and also has a much smaller underlying budget problem than the government claims. The British may be poor-mouthing their economy — and in so doing creating a self-fulfilling prophecy, in which excessive pessimism about potential leads to policies that in fact impoverish the nation.
Do I know for sure that this is the truth? No. But it looks more plausible than the official line. And surely policy should take into account not just the so far purely hypothetical risk of a loss of confidence by the bond market, but also the very real chance that vast amounts of potential production, not to mention the future, are together being squandered through excessive pessimism.
The Trouble With Vanity
Martin Wolf nails it in a recent blog post at the Financial Times: Prime Minister David Cameron’s government made a terrible mistake by going all-in for austerity doctrine — and now cannot change course, because to do so would be to admit its mistake.
“It may be humiliating for the government to offer such a speech now,” Mr. Wolf wrote on May 28. “But there is no reason why the people of the U.K. should suffer for its mistake, indefinitely.”
But there is a reason, of course: the ambition and vanity of politicians.