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Professor Geraint Johnes
Professor of Economics at Lancaster University
T 020 7976 3516
Professor Geraint Johnes

Director's December Report

Authors: Professor Geraint Johnes

11 December 2014

The Chancellor’s Autumn Statement earlier this month set out plans for restoring budget balance by 2018-19. These are welcome not least because they have stimulated debate across the political spectrum about how fast government should go in closing the deficit.

Economic policy both affects and responds to conditions in the broader environment. In 2007-08 public sector net borrowing amounted to only 2.7% of GDP. In response to the recession it rose to 6.7% and then 10.2% in the following two years. Reversing this has proved to be difficult. After two years of austerity, the rate at which inroads have been made into the deficit has slowed considerably. In many respects this was a good thing. The economy was flatlining, and, with monetary policy already as relaxed as it could be, putting the brake on further fiscal tightening probably prevented a second recession.

A good thing it may have been, but it was also largely accidental. Receipts from taxation have been lower than might have been expected at this stage in the cycle, and government expenditures have been higher. The reason for this is that the recovery has taken on a peculiar form. Over a million more people are in employment now than four years ago, and there are more than half a million fewer people unemployed. But the recovery has not been as remunerative for the Treasury as has been the case in the past, with real wages falling for many years after the trough of the recession. With many new jobs paying wages in the space between the national minimum wage and the Living Wage, tax receipts from the extra income have been limited, and the government has needed to pay out additional in-work benefits.

The preponderance of jobs at this end of the wage distribution is due to many factors. The supply of labour is buoyed by the implications of ageing and the abandonment of a default retirement age, and also by immigration. Global competition and technology both have adverse implications for the demand for workers of intermediate skill, as witnessed by the ‘hollowing out’ of the labour market. The key issue, however, relates to the primary determinant of real wages, namely productivity.

Productivity has stagnated in recent years. There are many reasons for this – and we have explored these in depth at the Work Foundation. There is, however, nothing inevitable about the productivity puzzle. In the US, productivity continued to rise steadily through and beyond the recession years.

The predictions made in the Autumn Statement assume that productivity will rise, bringing about an increase in real wages and hence in consumer spending. If these predictions turn out to be ill-founded, the target of closing the budget deficit within a few years will be unrealisable. That being the case, one might have expected more focus in the Statement on how business investment can be supported in ways that enhance productivity.

But of course, enhancing productivity is something that is in businesses’ own interests too. As changes in the world around us redefine how various tasks are undertaken, so businesses need to undergo a zero-based rethink of the ways in which jobs are configured. How can tomorrow’s jobs best be constructed, from scratch if need be, so that they use workers’ skills to full effect, and provide workers with career structures, progression, and growth? If employers could answer that question, they could enhance productivity in their own organisations, offer increased living standards for their workers… and solve the government’s problems with the public finances.