Britain’s productivity paradox

In 2012 the British economy created 580,000 new jobs yet output stagnated; more work produced the same amount of stuff. Indeed, British workers were producing 2.6 percent per hour less in Q3 2012 than in Q1 2008. Labour productivity is now 12.8 percent below its pre-recession trend.

This phenomenon, of increasing inputs producing an unchanged or decreasing amount of output, which has been christened Britain’s ‘productivity puzzle’, is one of the most perplexing in current economic debate. Indeed, even Nobel laureate Paul Krugman recently declared himself stumped.  

It’s an important debate both politically and economically. Politically, because Labour can point to grim GDP figures and claim the coalition is failing while the coalition can point to impressive job growth and claim they are succeeding. Economically, because increasing productivity, producing as much with less or more with as much, is the root of increasing wealth.

The Institute for Fiscal Studies recently offered three explanations for this decline in labour productivity. First, the fall in real wages thanks to inflation has seen firms retain and/or take on more labour. Second, business investment remains 16 percent below the pre-crash peak giving workers fewer tools to work with. Third, record low interest rates and forbearance on the part of banks is propping up inefficient enterprises.

There is a grain of truth in all these explanations but we might be missing the wood for the trees. Perhaps the actual explanation for the productivity puzzle is both simpler and more profound. Labour productivity is determined by two things: the skill of labour, and the quantity and quality of the capital at the disposal of that labour. On both fronts Britain has done pretty poorly.

Britain’s labour force is losing its qualitative advantage over others, notably in East Asia, thanks to a hideously dysfunctional state education system. According to the Programme for International Student Assessment which compares students across countries, in 2000 Britain ranked 7th in reading, 8th in maths and 4th in science. By 2008 it had slumped to 17th in reading, 24th in maths, and 14th in science. Any measures which can improve this dismal performance could be expected to improve British labour productivity in the longer term.

It is a similar story regarding the capital available to its workers. In 2001 it was estimated that a British worker had 25 percent less capital to work with than an American worker, 40 percent less than a French worker, and 60 percent less than a German worker. Why is capital so vital and how might we get more of it?

There are two types of goods: capital goods and consumption goods. Consumption goods are those that immediately meet our needs, what Carl Menger called “goods of first order”. Capital goods, what Menger called “goods of higher order”, are those which meet our needs indirectly. Bread is a consumption good, the flour and the milling stone (among others) are capital goods.

If our need is to eat we can satisfy it immediately via the labour intensive method of picking apples from trees or berries from bushes. Obviously this source of food would sustain very many less people on much more monotonous diets than we have today. We are able to eat more and better because we have capital which enables us not only to produce and consume more but also to produce and consume things we couldn’t have before with purely labour intensive methods.

Thus, to borrow Murray Rothbard’s example, Robinson Crusoe could pick 20 berries per hour from a bush by hand but could shake 50 berries out in an hour with a stick. Alternatively Crusoe could make the milling stone, grind the flour, and undertake the other capital production needed to make a loaf of bread. He could enjoy something he couldn’t enjoy in any quantity at all previously.

But making the stick or the milling stone will take time, time we cannot spend either picking berries or relaxing. We must forgo an act of consumption, either of berries or of leisure. We must save, in other words. This is the essential truth of capital accumulation; it comes from saving.

So does maintenance of the capital stock. To borrow from Rothbard again, a truck with a working life of fifteen years which makes 3,000 trips can be said to be using up 1/3,000 of itself each time it participates in the transformation of bread from ‘higher order’ wholesale to ‘first order’ sandwich. If saving is not undertaken to allow for the replacement of the truck at the end of the fifteen years this production process will cease. The capital, the truck, will have been consumed in every loaf it carried on those 3,000 journeys.

This is why countries that grow rich are those that save; they accumulate the capital per worker which enables them to produce ever greater amounts. In the late 18th century British textile workers earned six times what Indian textile workers earned because they had the capital goods to make them six times more productive. This is why we see saving nations in the Far East becoming wealthier as we wonder how our current standard of living will be maintained.

Britain, meanwhile, has some of the lowest savings rates even in the generally savings-averse developed world. We are seemingly attached to the Keynesian idea that consumption, rather than something we do when we are rich, is something we do to become rich. We have a government which can hand out leaflets on budget day telling savers they are on their side while turning a blind eye to quantitative easing and 0.5 percent base rates.

The result is that by deskilling and capital consumption we have become a lower productivity, lower wage economy. There is only a puzzle because we are reluctant to face this grim truth. Greece was recently reclassified as an emerging market. Might Britain be on its way to joining her?    

This article originally appeared at The Commentator

In defence of economics

The truth is dismal

Economics has always had a dodgy reputation. 160 years ago Thomas Carlyle famously branded it “the dismal science” when he surveyed the gloomy predictions offered by the classical economists. More recently it has been said that economists are heartless calculators who ‘know the price of everything and the value of nothing’. And with economic turmoil raging economics and economists are in the cross hairs again.

In a new book called Economists and the Powerful, Norbert Häring and Niall Douglas argue that modern ‘neo-liberal’ economics has gained its perceived primacy not from any great validity as a theory but because, as a doctrine which justifies the increasing wealth of the rich, its propagation has been well funded by those same rich folks. To borrow from EH Carr, study the economist before you begin to study the facts.

Like so much else surrounding economics this is really just an old debate in new clothes. The classical school of Smith, Malthus, Ricardo, and Mill built on the foundation of the labour theory of value and economics of contending classes, diminishing returns, and stagnation. Karl Marx simply took all this and worked it through to its logical conclusion. Paul Samuelson was correct in saying that “From the viewpoint of pure economic theory, Karl Marx can be regarded as a minor post-Ricardian.”

But the classical economists were wrong on this and so was the theory Marx derived from them. Separately and almost simultaneously in 1871 William Stanley Jevons and Carl Menger developed the marginal theory of value, a subjective theory which devastated Marxist economics almost in its crib. The Marginal revolution and the neo-classical economics it spawned opened up the vista of a growing economic prosperity which would enrich all, a prediction which has largely been borne out. Marxist economists, from 1871 to the present day, have responded by branding neo-classical economics a pseudo-science designed by lackeys of the rich to justify their increasing wealth.

What lies behind the current outbreak of economics bashing is the continuing brutal fallout of the credit crunch. For years governments across the west have been making extravagant spending commitments without devoting much thought to how they would pay for them. They could get away with it as long as the tax revenues from unsustainable bubbles flowed in. But now they have dried up and we are finally being forced to face up to the fact that our governments will be showering us with far fewer goodies than we had come to expect.

This is a painful prospect but it is what it is. America’s government debt doubling in four years and Britain’s increasing by 60 percent in five years are problems, massive problems. We are not worried about them because mercenary economists in the pay of the Rand Corporation are telling us to be worried about them; we are worried about them because we ought to be. And we are nowhere near as worried as we should be.

What books like Häring and Douglas’s – and a notably dimwitted entry, Don’t Buy It, by a strategic communications consultant called Anat Shenker-Osorio who thinks that debts and deficits will vanish if we stop talking about them – are trying to argue is that there is no such thing as economic reality, that our situation can be simply what we choose it to be. The juvenile dumbness of this wishful non-thinking is hard to overstate.

This article first appeared on The Commentator

Got milk? – Yes, plenty thanks


There is something about the countryside. Perhaps it is its beauty; perhaps it is its seemingly ancient and unchanging way of life. Whatever the reason, the countryside and the agricultural sector has the ability to send otherwise reliable economic compasses haywire.

The Telegraph illustrated this last week when it threw its weight behind the burgeoning campaign to get a ‘fair’ milk price for dairy farmers.

This language ought to set people’s teeth on edge. What is a ‘fair’ price? Whenever one person is willing to sell a good or service at a given price and another is willing to buy it at that same price the exchange will take place. Both parties might prefer some other situation; the seller might prefer a higher price and the buyer a lower one. Doubtless both would consider their respective preferred situations ‘fairer’.

But that is the beauty of an exchange economy. It reconciles differing, subjective ideas of ‘fairness’ (of which there are as many as there are economic agents multiplied by the number of transactions they undertake) to arrive at a mean of what society deems ‘fair’.

Food is an essential for life. Thus its price elasticity is low, meaning that when its price increases people do not curtail their consumption, they just pay more. The alternative is starvation. Unless they can’t pay more, then they will curtail consumption.

Increases in food prices hit those on lower incomes hardest. They will pay a disproportionate share of the ‘fair’ price. Well-heeled Telegraph hacks might want to ponder that before pontificating.

Campaigns for ‘fair’ prices are simply attempts by some sectional interest group to use either the bully pulpit or legislation to assert its particular notion of ‘fairness’ over the market derived societal mean.

The Telegraph isn’t alone in being lured into a thicket of economic nonsense. In the Guardian dairy farmers, Helen and David Banham, told us that “The typical day for us starts at 5am and finishes at any time after 7pm, seven days a week, 52 weeks a year, Christmas Day, New Year’s Day; days when you don’t feel like getting out of bed and wished you could have a day off sick; irrespective of the weather, from -15C to 30C, rain, snow or sun”

Interesting enough but from an economic perspective completely irrelevant. The value of a good or service to society is not a function of the amount of effort expended on its production. That was the lesson of the Marginalist revolution in economics led by Carl Menger, William Stanley Jevons, and Leon Walras.

The marginalists showed that value was not derived objectively from the labour expended in production, as classical economists liked Adam Smith and Karl Marx had believed (examples to the contrary were too numerous to name), but was a subjective property assigned by individuals.

As sometime economist Bishop Whatley put it, “Pearls are not valuable because men dive for them; men dive for them because they are valuable.” If we want to judge the ‘fairness’ of a price the effort expended by Mr and Mrs Banham is neither here nor there.

But it would be harsh on the classical economists to tar them with the same brush of economic ignorance as the ‘fair’ price people. Smith understood that one of the vital sources of The Wealth of Nations was increasing productivity, the amount of output we can produce with a given amount of inputs; think of his famous pin factory.

As Matt Ridley recorded in The Rational Optimist

“A half-gallon of milk cost the average American ten minutes of work in 1970, but only seven minutes in 1997. A three-minute phone call from New York to Los Angeles cost ninety hours of work at the average wage in 1910; today it costs less than two minutes. A kilowatt-hour of electricity cost an hour of work in 1900 and five minutes today”

This is caused by increasing productivity, producing more with as much or the same with less. Increasing productivity, making things cheaper, allows us to buy things we couldn’t before. It is what increasing wealth is all about.

236 years later this seems to have been lost on the ‘fair’ price people. As Tim Worstall explained in the Telegraph, between 2000 and 2010 the milk yield, the amount of milk produced per cow, increased by 22 percent, an increase in productivity.

If demand for milk is unchanged then obviously, as Worstall points out, the answer to the Telegraph’s question – “Does Britain need dairy farmers?” – is: fewer than we have now.

The productive factors freed up can go into producing something else. It might be something that doesn’t exist yet, but aren’t we better off than our ancestors now that increased agricultural productivity means that we can produce many times the amount of food with a fraction of the workers so that we can eat well and have people producing TVs, fridges, planes…?

Under market capitalism prices are the signals which direct resources toward more productive ends. Despite what the Guardian thinks, farmers are not entitled to a profit. Profits must be earned by taking inputs and adding value such that society judges your outputs to be worth more than your inputs.

If society thinks your outputs are worth less than your inputs – you are destroying value in other words – you will incur a loss. As Worstall puts it, society is telling you to stop so that the resources you are using can be utilised by someone else who will add value to them.

Joseph Schumpeter called these “gales of creative destruction”. Next time right wingers argue that we shield dairy farmers from these, replace ‘dairy farmers’ with ‘coal miners’ and ask why they argued for leaving them to face their full force.

True, HE Bates never wrote a novel romanticising coal mining, but economic logic is economic logic. We can’t embrace it when it affects left wing union members and reject it when it affects Tory voting rural dwellers. That really wouldn’t be fair.

This article originally appeared at The Commentator

A roundup

Snowed under

Its been a busy few weeks. Christmas and new year saw me in the States and since I got back I’ve been hard at work (round the job) on a project. Watch this space and all that…

Ive scribbled a couple of things though which have sort of fallen between the old blog and here. The Commentator, for which I’m Contributing Editor, has carried a couple of my articles this month. First was The economic reality of 2012, a look at the prospects for the global economy in the coming year. Its grim reading but then I think it will be a grim year.

Next up came an article on the coalition government’s attempts to cap the amount of benefits a family can receive to the level of the average national wage. This is such a no brainer in terms of fairness that you wonder how anyone has the gall to oppose it but there you are. I should add that The Commentator have changed the title of every item I have ever sent them. Not this time though, so read up on Why Britain is f*****

I also occasionally contribute to Global Politics and with the US Presidential race revving up I pondered the tricky question of the foreign policy of my favoured candidate, Congressman Ron Paul. Reading is most recent book I found myself wincing at times but I can put that to one side this election because the big question is not whether the US should bomb Iran but whether it will be able to afford to. Anyway, you can read all about it in the unimaginatively named Ron Paul and Foreign Policy

I enjoy writing for Middlebrow Magazine under a non political pseudonym. I try and steer clear of the sorts of topics I cover elsewhere and cover other interests like film, drama, music etc. But my article Animal spirits, Asymmetries and Austrians is a run down of some of the most popular of the spate of recent books on the economic crisis.

That’s all for now. More old rubbish is on the way so, in the words of Shaw Taylor, keep ’em peeled.


The private origins of public institutions

Welfare before the state

This is the first draft of the introduction to a pamphlet I hope to have published soon titled ‘Galloping Horses – The private origins of public institutions’

Public policy and the microeconomic theory which underpins it is replete with justifications for state provision of a wide range of services. Under the general heading of ‘market failure’ concepts such as asymmetric information, externalities or public goods are all seen to be solved in modern mainstream microeconomics by some degree of state intervention.

The message is that state provision of these public institutions is a necessity if they are to be provided at all. Obviously, the flipside is that no more state provision of these services means the services will cease altogether.

This concern has animated much of the opposition to the Conservative Party’s ‘Big Society’ agenda. Along with the predictable opposition from producer interests, much of the concern with the Big Society stems from the notion that if the state doesn’t provide these services they won’t get provided at all. The influence of the market failure paradigm runs deep.

Away from the models of economic textbooks we see that this is not, in fact, the case. We see, all around us every day, the results of human action taken in the private sphere to increase our welfare. And just as often as we see this private human action working to reduce our welfare, we see some state action doing the same.

Indeed, the idea that human action can, in fact, provide the services which mainstream public policy microeconomics and market failure theorists say it can’t is seen in the very fabric of some of our most hallowed and cherished public institutions who’s continued attachment to government, microeconomics tells us, is so vital to their continuance.

This pamphlet will take a critical look at some of the key concepts of market failure concepts. It will then look at three public institutions in three very different sectors; unemployment insurance, the National Health Service and the London Underground. The standard theory tells us that these could not exist without government but we will see that their existence actually predates state control and that the state did not create these public institutions, it simply took over what human action in the private sphere had already built. Or, as EG West wrote of the state intervention in education, “it jumped into the saddle of a horse that was already galloping”

Finally, we will look at the theory of the evolution of money developed by the nineteenth century Austrian economist Carl Menger and apply it to the evolution of public institutions more widely. It will help us to explain what the standard theory cannot; how unemployment insurance, healthcare and underground railways can be provided without the state.

For exactly 100 years, since the National Insurance Act of 1911 elbowed many perfectly good private arrangements for insurance against unemployment, injury and old age out of the way, the trend of British public policy has been that the state steps in and people step out. Reversing that trend is the goal of the Big Society. It is a large concept dealing with deep issues of psychology, sociology, history and economics. It has proved difficult to communicate which is one reason why it has proved so difficult to get off the ground. This pamphlet aims to go some way to redressing that.