Where has all the productivity gone?

Maybe joining Euroland isn’t that bad after all

Two booms, two depressions: British and Irish real GDP detrended, 1955–2013

Figure 1: Real GDP per British and Irish aged 15-64, converted to 2013 price level with updated 2005 EKS purchasing power parities, 1955-2013

image

Source: Computed from OECD Stat Extract and The Conference Board, Total Database, January 2014, http://www.conference-board.org/economics

Figure 2 detrends British real GDP growth since 1955 by 1.9% and Irish real GDP growth  by 3.6%. The US  real GDP growth in the 20th century is used as the measure of the global technological frontier growing at trend rate of 1.9% in the 20th century. The Irish economy is more complicated story because its growth rate in figure 2 was detrended at a rate of 3.6% because it was catching up from a very low base. Trend GDP growth per working age Irish for 1960-73 was 3.6 per cent (Ahearne et al. 2006).

Figure 2: Real GDP per British and Irish aged 15-64, converted to 2013 price level with updated 2005 EKS purchasing power parities, 1.9 per cent detrended UK, 3.6% detrended Ireland, 1955-2013

image

Source: Computed from OECD Stat Extract and The Conference Board, Total Database, January 2014, http://www.conference-board.org/economics

A flat line in figure 2 indicates growth at 1.9% for that year. A rising line in figure 2 means above-trend growth; a falling line means below trend growth for that year.

In the 1950s, Britain was growing quickly that the Prime Minister of the time campaigned on the slogan you never had it so good.

By the 1970s, and two spells of labour governments, Britain was the sick man of Europe culminating with the Winter of Discontent of 1978–1979. What happened? The British disease resulted in a 10% drop in output relative to trend in the 1970s, which counts as a depression – see figure 2 .

Prescott’s definition of a depression is when the economy is significantly below trend, the economy is in a depression. A great depression is a depression that is deep, rapid and enduring:

  1. There is at least one year in which output per working age person is at least 20 percent below trend; and
  2. there is at least one year in the first decade of the great depression in which output per working age person is at least 15 percent below trend; and
  3. There is no significant recovery during the period in the sense that there is no subperiod of a decade or longer in which the growth of output per working age person returns to rates of 2 percent or better.

The British disease in the 1970s bordered on a depression. There was then a strong recovery through the early-1980s with above trend growth from the early 1980s until 2006 with one recession in between in  1990. So much for the curse of Thatchernomics?

Figure 1 suggests a steady economic course in Ireland until the 1990s with a growth explosion growth with the Irish converged on British living standards up until the global financial crisis.

Figure 2 shows the power of detrending GDP growth and why Ireland was known as the sick man of Europe in the 1970s and 1980s with unemployment as high as 18% and mass migration again. The Irish population did not grow for about 60 years from 1926 because of mass migration.

Figure 2 shows that real GDP growth per working age Irish dropped below its 3.6 per cent trend for nearly 20 years from 1974 , but more than bounced back after 1992. The deepest trough was 18 per cent below trend and the final trough was in 1992  –  see Figure 2.

The deviation from trend economic growth made the Irish depression from 1973 to 1992 comparable in depth and length to the 1930s depressions (Ahearne et al. 2006).

The Irish depression of 1973 to 1992 can be attributed to large increases in taxes and government expenditure and reduced productivity (Ahearne et al. 2006). There were two oil price shocks in the 1970s and many suspect Irish policy choices from 1973 to 1987.

There were three fiscal approaches: an aggressive fiscal expansion from 1977; tax-and-spend from 1981; and aggressive fiscal cuts from 1987 onwards. In the early 1980s, Irish CPI inflation at 21 per cent, public sector borrowing reached 20 per cent of GNP.

To rein in budget deficits, taxes as a share of GNP rose by 10 percentage points in seven years. The unemployment rate reached 17 per cent despite a surge in emigration. The rising tax burden raised wage demands, worsening unemployment. Government debt grew on some measures to 130 per cent of GNP in 1986 (Honohan and Walsh 2002).

From 1992, Ireland rebounded to resume catching-up with the USA. The Celtic Tiger was a recovery from a depression that was preceded by large cuts in taxes and government spending from the late 1980s (Ahearne et al. 2006). Others reach similar conclusions but avoid the depression word. Fortin (2002, p. 13) labelled Irish public finances in the 1970s and to the mid-1980s as a ‘black hole’.

Fortin (2002) and Honohan and Walsh (2002) disentangle the Irish recovery into a long-term productivity boom that had dated from the 1950s and 1960s, and a sudden short-term output and employment boom since 1993 following the late 1980s fiscal and monetary reforms.

Honohan and Walsh (2002) wrote of belated income and productivity convergence. The delay in income and productivity convergence came from poor Irish economic and fiscal policies in the 1970s and 1980s.

This was after economic reforms in the late 1950s and the 1960s that started a process of rapid productivity convergence after decades of stagnation and mass emigration; Ireland’s population was the same in 1926 and 1971. During the 1950s, up to 10 per cent of the Irish population migrated in 10 years.

In the 1990s, many foreign investors started invested in Ireland as an export platform into the EU to take advantage of a 12.5 per cent company tax rate on trading profits. Between 1985 and 2001, the top Irish income tax rate fell from 65 to 42 per cent, the standard company tax from 50 to 16 per cent and the capital gains tax rate from 60 to 20 per cent (Honohan and Walsh 2002).

What happened after the onset of the global financial crisis in Ireland  and the UK are for a future blog posts.

British economic recoveries compared

Recoveries from recessions across the G-7

The looming fiscal crisis in the USA

Has New Zealand been in deflation since 2012?

All agree that the consumer price index (CPI) is biased and overstates inflation. In 1996, economists hired by the Senate Finance Committee estimated that the U.S. CPI overstates annual inflation by 1.1% (Boskin et al. 1996). That estimated CPI bias has not gotten smaller with time. It is now up to 1.5%, even 2%.

One of the rationales for the inflation target of the Reserve Bank of New Zealand of 0-2% was the 2% was to account for the consumer price index was biased upwards. Targeting 0% would lead to mild deflation when inflation was properly measured.

The main biases in the consumer price index everywhere come from how to handle changes in the quality of goods and services and how to deal with completely new goods and services.

I thought I might see what happened if I took this one and a half percentage point annual bias in the CPI estimated for the USA and adjusted the New Zealand CPI inflation rates available at the Reserve Bank of New Zealand’s website over the last 20 years or so with this number.

image

If these consumer price index bias adjustments are correct, and they are roughly correct, inflation came to a dead stop  in New Zealand after the global financial crisis in 2008, spiked again, and then moved into deflation in 2012. If anything, there’s been a mixture of price stability and the deflation since 2012.

People get quite hot and bothered with deflation. The New Zealand economy has been in a deflationary phase since the beginning of 2012  but it is recently grown so quickly that  it is referred to in the media as the rock-star economy.

Breathless journalism aside , fears of inflation are just a legacy of the great depression in the 1930s. The only depression where deflation was accompanied by mass unemployment was the Great Depression. Mild deflation with good growth is a common phenomena as Atkinson and Kehoe found:

Are deflation and depression empirically linked? No, concludes a broad historical study of inflation and real output growth rates.

Deflation and depression do seem to have been linked during the 1930s. But in the rest of the data for 17 countries and more than 100 years, there is virtually no evidence of such a link.

Levels of output are nowhere near returning to pre-crisis trends

via FRB: Potential Output and Recessions: Are We Fooling Ourselves?.

Why are Europe’s strong employment protection laws still popular with the Left?

The countries with the more liberal labour markets are recovering fastest from the Great Recession and the Global Financial Crisis.

This includes Germany where there were major labour market reforms a couple of years before the onset of the Global Financial Crisis. For that reason, German unemployment rates didn’t rise much in 2008 and after and are now falling quite rapidly because of their labour market liberalisations. Germany has the lowest unemployment rate in Europe.

Average tax rates on consumption, investment, labour and capital in USA, UK and Canada, 1950-2013

Income taxes in the USA and UK didn’t change all that much after the mid-70s. Prior to that, income tax rose quite steadily in the UK in the 1950s and 1960s and not surprisingly, Britain was the sick man of Europe in the 1970s. Income taxes rose quite steadily in Canada for most of the post-war period up until 1990 and then levelled out for most of that decade before a small tapered downwards.

image

Source: Cara McDaniel.

Taxes on consumption expenditure were very different stories across the Atlantic. There has been a tapering down in the  average tax rate on American consumption expenditure since 1970 after modest increases before that. Canadian taxes on consumption expenditure rose steadily until the 1970s, then drop steadily  in the 1970s  and than rose  in the 1980s and dropped again after 1992. British taxes on consumption expenditure rose sharply in the late 1960s,  dropped sharply and then rose again in the 1970s and was pretty steady after that.

image

Cara McDaniel.

The sleeper tax in all three countries was payroll taxes to fund social security and the welfare state. These rose steadily in the USA, UK and Canada up until the 1990s.

image

Source: Cara McDaniel.

Despite all that nonsense about neoliberalism from the  Left over Left, the average rate of tax on capital income did  not appear to change much at all over the last 50 years. There was a modest taper in US capital income taxation from the mid-30s to the mid-20s over the entire post-war period. The average Canadian tax rate on income from capital rose steadily in the 60s, fell steadily in the 70s before  rising again in the  mid-1980s and fell again after 2000. The average British tax rate on capital income rose steadily in the 60s and 70s, coinciding with the emergence of Britain as a sick man of Europe, and then stabilised in the the 1980s onwards but with a dip in the late 80s before a rise in the early 1990s.. Despite the large cuts in the statutory corporate tax rate in the UK, there was only a mild taper in the average tax rate on capital income in the UK. 

image

Source: Cara McDaniel.

The average tax rate on investment expenditures is pretty stable in the USA  for the entire post-war period. The only significant increase in the average tax rate on investment expenditures in the UK  coincided with the emergence of the sick man in Europe after a drop in the early 70s. The average tax rate on investment expenditures do not change at all in the UK after the 1970s. The Canadian average tax rate on investment expenditures is higher than elsewhere. It rose steadily in the 50s and 60s, dropped in the 70s and rose again in the 80s before tapering  from 1992 onwards.

image

Source: Cara McDaniel.

These higher on rising taxes and the UK and Canada did nothing for either country in catching up  with the USA. The figure 1 below shows real GDP per working age per American, Canadian and British.

Figure 1: Real GDP per Canadian, British and American aged 15-64, converted to 2013 price level, updated 2005 EKS purchasing power parities, 1950-2013

image

Source: Computed from OECD StatExtract and The Conference Board, Total Database, January 2014, http://www.conference-board.org/economics

The USA is pulling away from Canada and the UK in GDP per working age person. The exception is British economy from about 1990 onwards which caught up with Canada.

Figure 2, which is detrended GDP data, illustrates the British economic boom in the 1990s. Each country’s annual economic growth rate is detrended by 1.9%, the detrending value currently used  by Ed Prescott. A flat line is growth at 1.9%, a rising line is above trend growth, a falling line  is below trend growth.

Figure 2: Real GDP per Canadian, British and American aged 15-64, converted to 2013 price level, updated 2005 EKS purchasing power parities, detrended 1.9%, 1950-2013

image

Source: Computed from OECD Stat Extract and The Conference Board, Total Database, January 2014, http://www.conference-board.org/economics

Figure 2 shows that Canada has been in a long-term decline since the mid-1980s  with much of this decline coinciding with periods of rising taxes on income from labour.

The British economy boomed in the 1990s, after the tax hikes of the 1970s and early 80s were reversed. This growth dividend was squandered by the Blair government in the 2000.

Figure 2 also shows that US growth was rather stable with some ups and downs up until 2007, expect during the productivity slowdown in the 1970s. The first major departure from trend growth of 1.9% was with the onset of the great recession.

Real GDP per Japanese and American aged 15-64, 2013 price level, updated 2005 EKS PPP, detrended, 1970-2013

image

Source: Computed from OECD StatExtract and The Conference Board, Total Database, January 2014, http://www.conference-board.org/economics.

Note: When the line is flat, the economy is growing at its trend growth rate. A falling line means below trend growth; a rising line means of above trend growth. Detrended with values used by Edward Prescott.

The Japanese decline after 1992 are the Lost Decades. Japan recently returned to its 3.2% trend growth rate of the 1970s and 1980s for working age Japanese.

It could be argued that Japan is now on a permanently lower growth rate that implies no further catch up with the USA.

New Zealand, Australian and US real housing price index, 1975–2014, 2005 base

The housing spikes in Australia and New Zealand preceded the global financial crisis, starting in about 1999, and were largely unaffected by the GFC. Housing prices in the USA were pretty calm except in the lead up to the GFC, and took a dive with the onset of the global financial crisis and great recession.

image

Source: Dallas Fed; Housing prices deflated by personal consumption expenditure (PCE) deflator.

.

Employment losses after recent financial crises

Recent New Zealand economic growth

Trans-Tasman trends in real equivalised mean household income since 1982

Real household mean incomes rose during Rogernomics; fell during the deep recession at the beginning of the early 1990s; then rose strongly until 2009 and the onset of the Global Financial Crisis.

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