Medium/long term growth prospects for the UK

Nick OultonCentre for Economic Performance

London School of EconomicsWelsh Government Conference on

“Recession and Prospects for Growth”, Cardiff, 18 October 2011

OUTLINE

• Prior to the financial crisis, the UK’s productivity performance was good.

• The UK was also rapidly increasing its ICT intensity. • The main effect of the crisis will likely be on the level

of GDP. The long run growth rate will (probably) not be affected.

• ICT will continue to have an important and positive effect on UK growth.

2

BACKGROUND

Earlier work N. Oulton , Journal of Monetary Economics, 2007 N. Oulton , CEP Discussion Paper no. 1027, November 2010

Data EU KLEMS Database, November 2009 release

Market sector can be broken out Methodologically consistent ICT income and output shares available for 19 countries, of which 15 in EU

ICT relative prices: U.S. NIPAs

3

4.26

4.07

3.91

3.85

3.79

3.64

3.47

3.46

3.21

3.09

2.53

2.08

1.89

1.85

1.83

1.52

0 .5 1 1.5 2 2.5 3 3.5 4 4.5 5

JapanIrelandFinland

BelgiumFranceSpain

AustriaDenmark

NetherlandsGermany

ItalySweden

U.K.Canada

AustraliaU.S.A.

Mean growth rate, 1970-1990, % p.a.Real GDP per hour in the market sector

4

3.57

3.49

3.23

2.87

2.44

2.36

2.29

2.06

1.96

1.84

1.83

1.70

1.64

1.46

1.15

1.01

0 .5 1 1.5 2 2.5 3 3.5 4

IrelandFinland

SwedenU.K.

U.S.A.AustriaJapan

FranceAustraliaBelgium

GermanyCanada

NetherlandsDenmark

SpainItaly

Mean growth rate, 1990-2007, % p.a.Real GDP per hour in the market sector

5

Long run growth in the one-sector model

Long run growth rate of GDP per hour

Growth of TFP

Labour share

6

0

10

20

30

40

50

1970 1975 1980 1985 1990 1995 2000 2005 2009

Computers Software

Communication All ICT

Source: U.S. NIPAs, Table 5.5.4.Note: All prices relative to price of non-farm business sector output. ICT: computers, software and communication.

Rate of decline of relative price of ICT productsin U.S., % p.a.

7

A growth theory perspective

Two ratios matter:

• ICT share of income (β)--- Profit attributable to ICT assets as a % of GDP

• ICT share of output --- value added in ICT production as a % of GDP

8

Long run growth in a two-sector model

Assume that ICT is a second form of capital, that all ICT goods are imported, and there is no ICT production. Then:

↗ICT use effect

Growth of GDP per hour

Growth of TFP in non-ICT sector

Labour share

ICT income share Rate of decline of ICT relative price

Labour shareplus

9

Long run growth, with some ICT output

↗ICT output effect

Growth of GDP per hour

Growth of (non-ICT) TFP

Labour share

ICT share Rate of decline of ICT relative price

Labour share

ICT share Rate of decline of ICT relative price

incomeplus

plus output

10

02

46

Beta, %

1970 1980 1990 2000 2007year

ICT income share in the UK, % of GDP

11

0 1 2 3 4 5 6 7

SwedenU.S.A.

U.K.Finland

DenmarkBelgiumAustralia

JapanHungary

NetherlandsCanadaFranceSpain

Czech Rep.Germany

AustriaItaly

SloveniaIreland

Note Mean of 2000-latest year, market sector

Income share of ICT, %

12

13

0 1 2 3 4 5 6 7 8

FinlandIreland

HungaryJapan

GermanySlovenia

Czech Rep.SwedenAustriaU.S.A.

DenmarkItaly

FranceU.K.

BelgiumSpain

NetherlandsCanada

Australia

Note Mean of 2000-latest year, market sector

Output share of ICT, %

14

0 .1 .2 .3 .4 .5 .6 .7

SwedenU.S.A.

FinlandAustraliaBelgium

DenmarkJapan

U.K.HungaryCanada

Czech Rep.Spain

NetherlandsFranceAustria

GermanyIreland

ItalySlovenia

Note Calculated using shares averaged over 2000-latest year;ICT relative prices assumed falling at 7% p.a.

ICT use effect on long run growthof consumption and GDP, pppa

AUS

AUT

BELCAN

DNK

FIN

FRA

GER

IRL

ITA

JPN

NLD

ESP

SWE

UK

USA

1

1.5

2

2.5

3

3.5

4

GD

P p

er h

our

grow

th, 1

990-

2007

3 4 5 6 7ICT income share, 2000-2007

Note: R squared = 0.40; Ireland excluded from regression line

Market sector, 16 countriesProductivity growth versus ICT intensity

15

Terrific! ... But haven’t you forgotten the Great Recession?

• Was the preceding boom partly an illusion? • What will be the effect of the recession on the GDP

growth rate? • What will be the effect of the of recession on the

GDP level?

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Was the boom a statistical illusion?

• “A large part of growth in the boom was due to growth of the financial services industry. This was mostly toxic rubbish and won’t be repeated. So the past was not as good as we thought at the time”.

• WRONG: the ONS measures real annual growth largely from the expenditure side [C+I+G+X-M]. Quarterly growth is adjusted to fit the annual path (with a lag). Most of the “toxic rubbish” is intermediate, so drops out of the expenditure side.

• The contribution of financial services to the expenditure side measure of GDP is mainly FISIM sold to households (2.7% of GDP in 2008). The “toxic rubbish” is in net exports (quite small: 1.5% of GDP in 2008).

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Long run outcome of the Great Recession

0

1

2

3

0 20 40 60 80 100time

log GDP trend

Optimistic

0

1

2

3

0 20 40 60 80 100time

log GDP trend

Pessimistic

0

1

2

3

0 20 40 60 80 100time

log GDP trend

Very pessimistic

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Effect of recession on the growth rate

1. TFP is meant to be what comes for free. But in practice measured TFP growth may include the effects of intangible investment which is mis-classified as current spending (R&D, design, training, etc) [Corrado et al. (2009); Marrano et al. (2009)]. This type of spending has likely fallen in the recession along with measured capital investment (e.g. BERD fell by 4.1% in 2009 over 2008 [source: ONS]). So measured TFP growth is likely to fall in the short run.

1. The Great Recession may lead to changes in institutions and policies which impact the long run growth rate. After all, we are still living with the consequences of the 1st World War and the Great Depression --- world trade was freer before 1914 than it is today.

Upside: Reform of the banking system will make the economy safer (end to boom and bust?)

Downside: World-wide collapse into protectionism, revival of “industrial policy” and of cartelization (a rerun of the 1930s) [Broadberry & Crafts, 1992]

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Effect of recession on GDP growth rate

Conclusion: In the absence of large changes in policy, no long run effect on growth rate.

20

Effect of recession on GDP level: theory

1. If interest rates are higher post-recovery, then K/L will be lower and consequently Y/L will be lower too. But effect is small, e.g. 0.5% of GDP.

2. In short/medium run higher unemployment causes loss of human capital but this effect disappears in long run (through death or retirement).

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Effect of recession on GDP level: empirics

1. Great Depression in the USPerron (1989); Ben-David et al. (2003): The Great Depression reduced the long run level of US GNP by about 17-19%, but left the long run growth rate unchanged. Recall that the US depression started in the US in 1929, that the peak-to-trough decline in GNP was about 27%, and that real output did not regain its 1929 level till 1939. 2. Post WWII banking crisesCerra and Saxena (2008); Furceri and Mourougane (2009): These studies find large effects of banking crises on GDP levels but do not distinguish clearly between short run and long run effects. 3. Provisional resultBased on 61 countries, 1950-2010, and Reinhart-Rogoff data on banking crises, the average effect of a banking crisis is to reduce the level of GDP per worker by 0.8% for each year of crisis, i.e. by 4% for a 5 year crisis.

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Conclusions• Most of the gains in productivity growth come from ICT use,

not ICT production.• The future impact of ICT on long run productivity growth in

the UK, at the present level of ICT intensity, is large: about 0.6 percentage points per annum.

• Factors favouring ICT adoption --- low levels of labour and product market rigidities, high level of graduate education --- may also favour innovation and hence TFP growth in general.

• The Great Recession may reduce the level of labour productivity by as much as 4%. But it probably won’t reduce the long run productivity growth rate.

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THE END

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