In an overdue mea culpa, the Office for Budget Responsibility (OBR) has admitted that since its inception in 2010 it has persistently overestimated future productivity growth. An assessment of its forecasting record has concluded that in all of its twice yearly projections showing productivity growth rapidly recovering to an annual rate of around 2 per cent in the following years it has miscalculated by a factor of ten. After some fourteen erring forecasts the OBR has been forced to concede that over the next four years, annual productivity growth is likely to average 0.2 per cent rather than the 1.6 per cent that it forecast in March.
As Nobel Laureate, Professor Paul Krugman succinctly observed, productivity isn’t everything, but in the long run it is almost everything. Productivity — defined as output per hour per worker — is the key driver of economic growth and living standards. Regular readers of blog will not be surprised by the OBR’s revised forecast for productivity performance but the interesting question is why has it taken the OBR so long to realise its error? Why has it repeatedly, despite evidence to the contrary, bet that productivity would return to its pre financial crash rate of growth? Why has the behaviour of a well-funded, erudite organisation been more akin to a gambling addict engaging in repetitive behaviour in the vain belief that next time it will get lucky?
The fact is that UK productivity is no higher now than it was just before the 2008 financial crash. Had the pre-crash trend persisted, output per hour would now be 20 per cent higher than it is. Forecasting by its nature is prone to error, but the growing gulf between reality and the OBR’s forecasts was, by any yardstick, inexplicable. What OBR’s humiliating admission revels is that its productivity forecasts appear to have been based on little more than hope. As productivity growth supports wage growth and hence household expenditure and tax revenue, optimistic forecasts for productivity translate directly to the politically desirable outcome of better times ahead. It follows that the OBR’s admission points to economic and political difficulties just as the government grapples with the disaster of Brexit.
Based on the OBR’s irrational exuberance Philip Hammond thought he had about £26bn over the next five years to help him through the pain of Brexit – though this would not even cover the cost of the EU exit bill let alone the billions that will be lost to traders. Commentators have been quick to focus on the adverse implications of the OBR’s revisions for the Chancellor’s forthcoming Budget. And understanding the implications for government expenditure provides a clue as to the reason for the OBR’s lamentable record for forecasting productivity. Could it be that the OBR is not quite so independent? There is evidence that the Treasury has sought to influence the OBR’s published forecasts. In February 2016 a report by the Treasury Select Committee concluded that a senior minister and Treasury officials had demanded changes to the OBR’s published forecasts that ‘strayed beyond the factual’. In short, the Treasury’s interference breached the rules of independence; moreover, the Committee went on to observe that such interference appeared to have been routine.
An alternative perspective is that rather than openly bending to its paymaster’s interests the OBR has been captured by the ‘optimism’ bias of the proponents of austerity. Could it be that the OBR has something in common with the primitive Cargo cults of the south Pacific. These cults developed during the nineteenth and twentieth centuries against a background on economic stress and all held the belief that engaging in ritualistic acts – particularly economic sacrifice – would result in the delivery of material wealth. Put crudely has the OBR’s close association with the government subconsciously instilled the ‘right wing’ belief that austerity, in painfully dismantling the old social order, will bring forth higher levels of productivity growth? That is, keep expecting an event and eventually it will happen.
That the OBR’s productivity forecasts have relied more on hope than evidence may, in part, be explained by the fact that there is little agreement as to the cause of the UK’s productivity woes. My preferred explanation is the UK’s persistent, pitiful performance when it comes to business investment. Technological advances are embedded in new machines and along with improving human capital provide the basis of productivity growth. Resort to cheap labour rather than expenditure on new machines and skills may boost the bottom line but only at much greater longer term costs. For too long UK businesses have devoted too little funding to new technology and skills but since the financial crash the position has deteriorated. Companies’ fixed capital spending is currently only 5 per cent above its pre-crash peak. In comparison, in the decade following the economic slowdown at the start of the 1990s it increased by 30 per cent. Acceptance of this explanation naturally turns attention to its causes. Many blame the attitude of banks who in the aftermath of the financial crash necessarily focussed on rebuilding their capital reserves which – despite historically low interest rates – constrained their lending. Unfortunately, just as the banks have more-or-less recapitalised, business investment has been dealt another blow with Brexit.
Funding is necessary but not sufficient to encourage investment. Above all businesses must have confidence and Brexit in creating a situation of unprecended uncertainty has ensured that the UK’s pathetic rate of business investment growth will continue for several years or more. This does not appear to concern the Brexit zealots. Indeed, the mindset of the zealots in rejecting the UK’s membership of the EU has much in common with the primitive ideas of Cargo clubs. In their deluded minds, if Brexit diverts businesses from productive activities, the consequential economic trauma and sacrifice will eventually boost productivity and hence per capita economic wealth to record breaking levels. Unfortunately, like the OBR’s hope based forecasts they are doomed to disappointment.
28th October 2017