Anthony Hilton: A new take on productivity could bring us all a bonus

Economics: Andrew Smithers thinks productivity comes from investment

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1 October 2019

Economists have perfected the art of holding on to bad ideas. They believe the quarterly figures for gross domestic product in spite of the fact they are inevitably adjusted as more data come in, often reversing the previously observed trend.

They worry about growth, or currently recession, and hope shares will get a boost from more quantitative easing by central bankers. Nobody points out that while they tell central bankers to be more open minded, they do not show such openness themselves. They ignore the fact that QE may not work today, if it ever did before.

Mind you, economists are not alone. The scientific establishment works the same way. Far from embracing new ideas, it resists them in spite of pressure from the younger scientists. Only when the old guard dies off, and a younger set comes in, does change happen.

Andrew Smithers has a beef about productivity* and wants his ideas to be debated, which currently they are not. He thinks it is supply not demand that will boost productivity. This is in contrast to the political consensus, which is demand driven, trying to make consumers spend more.

He thinks productivity comes from investment, because new machines with enhancements are better than old, so output per employee improves. With productivity comes growth, because those employees can earn more because they make more.

Companies can sell more because they can cut prices. Only then can consumers buy more because they are also employees and they like falling prices. Firms can make more profit from better sales so they can invest more, and so the cycle begins again.

Instead of consumers suffering a decline in living standards as is now the case, productivity would produce a virtuous circle of enhanced incomes.

Smithers is a stickler for facts and data, and uses them to support his model of the economy. Most economists, and particularly those in the City boutiques, investment banks and big companies, instead start with a theoretical model, then find those facts which lend it support, while ignoring others which don’t. Politicians and journalists rely on investment banks, big business and economists. Thus economists’ errors become errors of politics and spread by journalism, the economy becomes misdirected, and all but the prosperous few suffer. That is what has happened these past 20 years.

This brings us to productivity. Economists think investment is languishing because of the financial crisis, and because we have not got enough tech firms.

But Smithers shows how productivity and investment turned down well before the financial crisis and before the internet and the iPhone.

So there has to be some other cause. If not investment will stay low, productivity will continue to languish and people will continue to get poorer, until there is a blow-up.

Politicians have also moved the goalposts. Worried about the decline in investment they decided to include intangible assets like software as investment, which previously were written off against profit. (They thought it was too much to include advertising as investment also, though they might as well have.) As a result investment, though poor, looks a lot better than it should.

The trouble is some people may not like what Smithers proposes instead, the most contentious of which is to put a curb on management bonuses. Bonuses hit investment, because they hit profits in the short term.

Shareholders cannot curb bonuses either because they also benefit from the short-term thinking which delivers early profits and pushes the shares up. It is similar to their love of monopolies, which also deliver excess profit but none of which are good for consumers.

He does not want bonuses to be stopped, as Labour’s John McDonnell does, because this will antagonise companies and encourage them to get round the rules. Instead he wants to nudge firms in the right direction by taxing them if they don’t. Companies should show in their accounts every year how much productivity has improved or not.

Companies should receive a credit, equal to the amount they invest, to lower their tax bill. And he thinks it absurd that debt interest should be tax deductible, and therefore encouraged by companies, while equity is not.

Most of all he thinks executives can keep their metrics for bonuses but there should be an overriding measure to raise productivity. If companies do not apply these measures, they should be additionally taxed, as should the executives.

This he thinks should encourage investment and therefore productivity. And it matters. We are already seeing the consequences of falling incomes. It could get much worse if we continue on the current wrong path. At the very least his ideas should be debated.

*Productivity and the Bonus

Culture by Andrew Smithers. Oxford University Press

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