Hamish McRae: We're back to the productivity problem

The economy is back to its pre-crisis level — and about time too, you may say. But living standards are not, in the sense that GDP per head is still something like 4% below the peak. We are growing fast, at more than 3% a year, but we need to, and not only to rebuild living standards. The government deficit seems to have stopped falling, personal debt remains high, so we need growth to help pay off debt.

True, the growth figures will almost certainly be revised up, and there will be technical changes to the series in the autumn that will make GDP appear higher — by among other things, counting services such as drug-dealing and prostitution in national output.

True, too, part of the reason for the underperformance has been falling North Sea oil and gas output: the onshore economy passed its previous peak last year. But whatever qualifications you make, the recovery has been a disappointing one. In previous cycles, ground lost in recession is made up reasonably swiftly and the economy gets back to trend growth. It does not look as though this will happen this cycle, or at least not for a very long time.

This is not just a British phenomenon. The US is below trend, Europe is way below trend, while in Japan there seems to be no connection between the boom years to 1990 and what has happened since. So it has been a pig of a cycle for just about the entire developed world.

It is important, though, to separate the cyclical from the structural. Now that the West is on the way to fixing the problems associated with the financial crisis and is learning to live with the consequences of it, we need to think about the longer-term structural problems that the crisis highlighted.

Of those problems, the one that matters most is the slow growth of productivity. Many economists are worrying about this. For example, Larry Summers, Harvard economics professor and former Treasury Secretary under President Bill Clinton, has written and spoken about secular stagnation.

Even before the financial crisis, the US was managing to maintain a reasonable growth rate only by having, as he put it in an interview in New Republic last week, “the mother of all financial bubbles with vast erosion of credit standards and extraordinary run-up in artificial wealth creation in houses and what have subsequently been criticised as overly easy monetary and fiscal policies”.

Ouch. So something was going wrong even before the crisis. Paul Krugman, the Nobel prize-winner, famously highlighted the productivity issue in 1994 in his book The Age of Diminishing Expectations: “Productivity isn’t everything, but in the long run it is almost everything.”

There is certainly some evidence that there has been secular slow-down in growth in the US, going as far back as the 1980s. What happens in the US is hugely important because it is at the frontier of technology. It is relatively easy for other countries to catch up by applying best global practice: Japan in the 1950s, 1960s and 1970s, China and increasingly India at the moment. The UK did reasonably well in productivity growth between 1980 and 2007, but prior to that we had lagged, so a lot of that was catch-up. Since 2007 we have done particularly badly, the flip-side of our rapid growth in employment.

For the US, from the 1950s through to the 1970s, labour productivity rose by around 2.5% a year. Then it fell to around 1.5% until the 2000s, when it seems to have picked up to more than 2%, or at least it did until the crash. Since 2011, US productivity growth has been only 1.1% a year.