The unprecedented monetary policies that have been in place during the decade since the financial crisis, characterised by record low interest rates and quantitative easing, have left many market participants questioning long-held beliefs. But it is a different topic that has perhaps been the biggest source of introspection: the ‘productivity puzzle’.
This is the realisation that, in defiance of supposed fundamental laws of economics, an era of technological innovation has not led to a pick-up in productivity growth.
When productivity growth lags wider economic growth it is usually deemed a ‘late-cycle’ phenomenon – that is, a period when economic expansion has been happening for some time, with consumers and businesses in exuberant mood and borrowing more, resulting in a growth rate that is built on debt and will soon reverse.
By some estimates, the normal economic cycle lasts about seven years. As the current period rumbles on into a second decade, with growth still positive in most economies, economists of a bearish disposition point to the level of global debt and posit that when interest rates rise, a collapse will occur to rival that of the financial crisis a decade ago. This, they argue, is because all of the growth that has occurred since the financial crisis is the result of higher debt levels, not higher productivity.
The rise in the level of debt in the US in the decade since the financial crisis stands at $11.6trn (£9trn), an amount financial adviser David Scott, of advice firm Andrews Gwynne, describes as “vaporous”. He says the extra debt has gone not to boosting the productive capacity of the economy in order to fuel long-term economic growth, but rather to increase asset prices, leaving debt in the system that is supported only by volatile markets.
The QE link
John Chatfeild-Roberts, a fund manager at Jupiter, believes extraordinary monetary policy is itself the source of the productivity problem. He says that if interest rates were at more normal levels, and the economic cycle more typical, then the least productive companies would be unable to borrow the money they needed to stay afloat. This would lead to only the most productive companies surviving, meaning a boost to overall productivity levels. The economist Joseph Schumpeter named this process “creative destruction”.
The UK’s productivity rates are often compared unfavourably with those of France, but critics of this argument claim it simply underlines the limitations of using productivity growth as a measure of the health of an economy. Both long-term unemployment and youth unemployment in France are significantly higher than in the UK. Therefore, in a job market as dormant as that of France, the argument is that only the more skilled workers can get a job, and as more skilled workers are more productive, productivity per worker is high in France.
But a look at Germany shows it does not have to be a question of either higher productivity or higher employment: the country combines UK employment levels with French productivity rates, meaning its economy is healthier than either.
Other headline figures may be more misleading. A report that emerged from the Office for National Statistics (ONS) earlier this year said the UK household savings rate – the proportion of regular income that people are able to put aside for a rainy day – fell to a record low in 2017.
That data appeared to endorse the bearish arguments of those who claim the economic growth of the past decade is partly due to people spending more of their income, and borrowing more. The ONS data implied that people were on average saving just 1.7 per cent of their income.
But 24 hours after the ONS issued its data, Steve Webb, head of pensions policy at Royal London, pointed out the introduction of the pension freedoms meant many more people were now able to withdraw money from their retirement savings. When the savings ratio data was calculated in previous years, it included money in pension pots that consumers couldn’t access, recording this as savings.
According to Mr Webb, data produced by the ONS this year didn’t factor in the change caused by retirees accessing that money, and instead treated it as people putting less into their savings. He said the figures showed the danger of “relying on a single data point”.
A productive time
Measurement is also an issue when it comes to productivity. Policymakers around the world continue to wrestle with the challenge of how to gauge the changes to productivity, and the rest of the economy, caused by technological disruption. To this end, James Carrick, global economist at Legal & General, believes the answer to the productivity puzzle is simply time.
The last major wave of innovation was sparked by the invention of the internal combustion engine at the start of the 20th century. When Henry Ford wanted to expand his car plant, he needed to construct and fit out a factory, build machines and employ workers, all of which was very good for employment data.
But during the current wave of technological change, a firm such as Google can expand in a way that requires relatively little capital investment, meaning the expansion doesn’t appear to contribute to the productivity data.
Part of the value big technology firms such as search engines and online retailers offer is they allow consumers and businesses greater ability to shop around, and to find the lowest-cost provider. This ability to buy more for less would explain how consumer spending has risen consistently faster than wage growth, or productivity growth, in the years since the financial crisis. It also dents the argument that the growth achieved since the crisis is solely the result of higher borrowing prompted by lower interest rates.
Mr Carrick points to the US economy at the start of the 1990s as an example of statisticians being unable to keep up with the data. He said the popularisation of computers in business in the late 1980s and early 1990s occurred at a time when productivity and GDP growth were low, prompting many to question whether the then emerging technology was a positive for the economy.
According to Mr Carrick, those charged with compiling the data were ultimately able to measure the impact of the shifts in technology, and by the mid-1990s the global economy was booming.
Investment impact
Fund manager Nick Train has positioned his portfolios for a change in the way consumer spending occurs. He says that economic growth throughout history has ultimately been powered by the price of essentials falling as a result of innovation. The excess is then spent on luxury items, in turn generating the cash for innovators to turn those luxuries into products cheap enough to be considered essentials, and create a market for the next wave of luxuries.
Mr Train believes technology will make the price of many everyday items cheaper, so luxury items such as investment products and premium alcohol will be consumed in greater quantities. For this reason he is invested in companies such as Hargreaves Lansdown and Diageo, which sell products that people often buy more of as they get wealthier.
Perhaps the biggest threat to the rosy scenario envisaged by Mr Train is the increase in political uncertainty around the world, particularly the prominence of politicians whose actions will lead to a fall in immigration.
Speaking about the outlook for the UK economy to the Treasury select committee in February, Andy Haldane, chief economist at the Bank of England, said “all things being equal”, the UK’s decision to leave the EU would reduce GDP by about 0.5 per cent a year in terms of economic growth. He said this was because immigration tended to boost productivity and economic growth, by adding more workers to the economy relative to the population that are either too old or too young to work.
Mr Haldane added that immigrant workers tended to be more productive, meaning overall productivity falls when immigration dips, having a negative impact on economic growth.
As is often the case, the puzzle presented to investors is the choice between focusing on the long-term trend, or wrestling with slings and arrows of politics in search of clarity.
David Thorpe is investment reporter at FTAdviser.com
