The uncertainty over wages and productivity requires more humility from the Bank of England

5th August 2014 by The Harried House Hunter

The UK economy has received some more welcome news this morning. The purchasing managers index or PMI for its services sector could hardly have been more positive for output and growth. As you can see below the headline was extremely positive.

UK service sector continues to expand sharply in July

Indeed we see that the review was positively gushing about the state of play.

The July PMI showed the sector expanding at the fastest rate since last November, as demand for services continued to increase at a rate rarely seen in the survey’s 18-year history.

If we continue into the detail we see that there was also good news in many of the component parts.

Moreover, another considerable increase in new work also drove activity up over the month,

Demand from both at home and abroad reportedly strengthened

The latter piece of news provides something of a counterpoint to the media barrage we have been subjected too recently which has informed us that many of the UK’s businesses are struggling for export business after the rise of the UK Pound. If this survey is correct then our service sector appears to be shrugging off any change in price competitiveness.

Also the trend for employment looks strongly positive.

services employment continued to increase at a historically marked rate.

A feature of the survey data during recent months has been increased hiring activity amongst UK service providers…..Staff were recruited to help support efforts to keep on top of current workloads and in anticipation of further growth in the coming months.

So if the service sector is any guide we can expect the UK economy’s strong employmnt gains to continue. However there was a consequence of these gains.

There were reports from companies that a key driver of higher operating costs was an increase in wages.

This poses several questions. The first is whether the official numbers for average earnings will pick this up? We have been in a situation where private-sector estimates of wages growth have been more optimistic than the official ones for a while now. Also we are left wondering whether the pick-up in wages will be enough to stop the falls in real wages and perhaps a miracle of miracles for these times some actual growth in them.

What is the state of play in the UK labour market?

This for a while has been an example of the good (employment), the bad (wages) and the ugly (real wages). If we start with the good then the optimistic sheen for employment signalled above was joined by the latest forecast from the NIESR (National Institute for Economic and Social Research) yesterday.

We remain optimistic about further job creation and expect unemployment to fall below 6 per cent later this year.

I wish to look a little deeper into this because if you consider the numbers below alongside the fact that we have only marginally exceeded pre credit crunch levels of output you get to the core of the current debate about the UK economy.

Total employment is more than 4 per cent higher than it was at the start of 2008, and the employment rate has returned to its 2005 peak.

So more people employed with output virtually the same has this inevitable consequence.

The productivity performance, therefore, remains abysmal. With output per hour worked still around 4.5 per cent below the pre-crisis peak (2007Q4), we expect pre-crisis productivity levels to be regained only in the latter half of 2017– although, given the continuing puzzle about the causes of poor productivity performance, large uncertainties remain.

There are to my mind all sorts of issues here. As the credit crunch era has progressed we have seen statistic after statistic turn out to be less reliable than we either thought or hoped. I suspect that the productivity numbers will be critiqued and would suggest that the root of the problem is that we were not doing as well back in 2007/08 as we thought we were back then. If we consider one major sector which is banking and finance there are clear examples of over recording of output and hence productivity. We have been reminded of one of those only this week as several of our major banks have increased their provisions for Payment Protection Insurance miss-selling. The total for this is now of the order of £23 billion which should be subtracted from pre credit crunch output. I do hope we are not doing any double-counting by leaving it in the numbers back then and counting it as a boost to the expenditure numbers now.

The other major issue in the wages and productivity debate is what is happening to the self-employed? The official average earnings figures do not include them and neither does the main annual ASHE survey which means that it is not only first world war commenerations which have the lights out.  So we have very little idea as to what they are being paid. However the official numbers do count their levels of employment and output which are often in the service sector and accordingly are not so easy to measure. We could easily have got it wrong and maybe very wrong. Especially if we consider that the self-employed are likely to be a very diverse mix from the extreme those in thriving industries to those who have moved to it because of no other alternative. There may be no connection between their circumstances at all.

In short the list of things we do not know is nearly as long as the things we think we do and then we plough treating 0.1% changes in economic output as if they are significant! At best our knowledge of our economy is equivalent to being in a darkened room with only a candle to push back the shadows.

What about the Bank of England?

If we switch to central banking policy it is my suggestion and indeed recommendation that their policies should reflect the uncertainty I have highlighted above. Bank of England Chief Economist Andy Haldane has reflected some of this in an article published today in the Central Banking Journal. But he strongly hints he prefers this alternative option.

In this world, it would be very difficult for monetary, regulatory and operational policy to beat an orderly retreat. …….In this world, macro-prudential policy to lean against the financial cycle could become more, not less, important over time……In this world, central banks’ operational policies would be likely to remain expansive.

There are all sorts of problems with this in my view, but we have not yet reached the full consequence of such a plan.

In this world, central banks’ words and actions would be unlikely to diminish in importance. Their role in shaping the fortunes of financial markets and financial firms more likely would rise. Central banks’ every word would remain forensically scrutinised.

Apart from the obvious moral hazards here my argument against such a policy is highlighted by our uncertainty about the actual state of play in our economy. The sort of central planning forever philosophy apparently supported by Andy Haldane has the problem that it will be based on flawed data and so the central planners are as likely to lead us in the wrong direction as the right one.

As to their role as regulators I have three words in response, Banco Espirito Santo.

Comment

In a way it was kind of Andy Haldane to confirm one of the earliest themes of this blog which was that central bankers would delay withdrawing from the economy. A bit like Frodo and the ring of power they will find it very hard to give it up. Back in 2009 my main fear was that they would be too slow to respond to any upturn but now I am just as concerned that central bankers do not wish to give their power up at any point. As well as being seductive their power is also apparently addictive.The issues of UK wages and productivity and the uncertainty surrounding them show that a lot more humility should be displayed and that the current recovery should be used by the Bank of England to retreat from the peaks of its power. Otherwise it is trapping both it and us in ever increasing circles for it but decreasing ones for us.

Still perhaps banking is all round contrary as look what our economic recovery has done for our banks.

Moody’s changes outlook for UK banking system to negative from stable

13 thoughts on “The uncertainty over wages and productivity requires more humility from the Bank of England”

  1. Pavlaki says:

    I certainly endorse the wariness about the accuracy of economic figures! Having run several manufacturing and selling operation all at once I can confirm that consolidated figures are revised all the time and that is when you have farely accurate numbers coming in from each business. How on earth we expect estimates for the entire economy to be precise,given the complexity involved, I just can’t imagine. And as for the Southern Med Euro members……….add in a dash of political meddling and the numbers are very suspect.

    The B of E is always behind the curve in their rate setting and I expect that this is still the case. They should pay great attention to the private sector feedback as it is very likely correct. Unfortunately the markets attention span is so short no one looks at the history (except Shaun) which should happen as it would make people take the economic figures as a little less ‘carved in stone’.

    1. Anonymous says:

      Hi Pavlaki

      In some ways it was always going to take something like a credit crunch for there to be a full examination of economic statistics. In the period before it there was some growth and who could tell between 1% and 2% except over a decent period?

      However with all the changes and disruption there is a much higher risk that our figures are very wrong. So this is not a time for fine tuning and central planning…

  2. Anonymous says:

    Great column Shaun. Yesterday Erin Ade interviewed OECD economist William White in Toronto, and what he said was similar to your views. He said he wasn’t surprised that easy monetary policies hadn’t produced a lot of inflation so far but that didn’t mean there weren’t big risks going forward. Given the fragility of models of aggregate demand and supply it was easy for a central bank to make a costly mistake.

    http://rt.com/shows/boom-bust/177980-us-public-private-debt/

    Unfortunately it seems that the same kind of “fine tuning” arrogance that used to afflict fiscal policy now seems to have moved over to monetary policy.

    Andrew Baldwin

    1. dutch says:

      All easy money has done is push down velocity from what I can see.

      To the victor the spoils.

  3. Yoda says:

    Yessss, yesssss. Powerful your senses are, padawan Shaun.

    1. Anonymous says:

      Thank you Yoda.

  4. forbin says:

    Hello Shaun,

    It does make me wonder too over 0.1% changes – I mean even with GDP there’s the admission of hookers and pot ” guesswork” to the figures and not a mention of error bars – not that MSM looks back to the previous 12 months figures and the correction done afterwards – it all Rah Rah Rah!

    still what do I expect from a bunch of Art student Uni failures who’s only job is to entertain……. ( dont look behind the curtain ,Dorothy! )

    I think the TPTB plan has worked to the degree that they think like Bankers and have , so far , avoided a 1930’s style depression of stocks and shares , that lead to main stream economy ( ie making things like cars, etc) tanking.

    This time they pumped / printed the way out , or atleast a way forward…… but still I really don’t think they have a plan to wind down QE , the rest of the real economy will have to catch up

    And theres the rub …..

    Forbin

    PS: Yes we have a problem now of accountability , Who do we vote for to change the Governor of the BoE? With such power democratic responsibilty should come

    Seems a bit late in arriving ….

    1. Anonymous says:

      Hi Forbin

      There are many issues here on display but past economic history is sometime changed quite substantially and the points most changed are the ones when central banks are most likely to intervene. According what they think at the time is rarely actually the state of play.

      It has been both a bad and sad feature of the times that more and more power has gone to those who do not stand for election.

  5. Paul C says:

    Shaun,
    I subscribe to all of your commentary on power and reluctance to give it up. They think they have some big levers with excellent feedback loop but I suspect the tanker is well adrift. With respect to productivity, it is an embarrassing figure and a poor reflection on the management of the economy but not a widely understood or daily pre-occupation in the mainstream media.
    It is a slippery measure, easy to abrogate and smoke screen stories about smart phones, tablets and online banking can effect a veneer of modernity. I would not expect any Politician or Central Banker to put their hand up and say the falling productivity is my fault, they will say “its a conundrum” or needs further investigation.
    We shall drift well past the election with persistent inflation in product and service pricing but the politicians will hold-up isolated examples of stability – lower wheat and fruit prices alongside forecourt fuel to pretend that the ship is still viably afloat.
    Paul C.

    1. Anonymous says:

      Hi Paul C

      The march of the central bankers has been facilitated by the way that our democratically elected politicians like to surround themselves these days with functionaries and technocrats. That way there is invariably someone to take any blame!

      I have written before that in such a technological era we should have much of the data to hand almost instantly yet if anything we seem to have lost ground.

  6. dutch says:

    It’s a weird sort of Hobson’s choice world that they must be living in.

    Keep the easy money and we go down down slowly.

    End the easy money and we go down fast.
    A bit like deciding whether to pull off a plaster quick or slow.

    1. Anonymous says:

      Hi Dutch

      All the central bankers choose option one and hope that the problems do not become too large before it is time for someone else to take up the reins of power. Also they have the chance of being bailed out by a new discovery like thorium reactors becoming viable technology.

      1. Anonymous says:

        Thorium is technically possible, but do not expect electric “too cheap to meter”. Thorium waste needs to be disposed of. Today’s taxpayers are picking up the tab for waste disposal of 40+ year old reactors.

        Theoretically the new 4th generation reactor designs can burn much of the waste as fuel – helping to provide low carbon electricity and solving much of the disposal problems. They won’t be cheap – even if we have the sense to copy EDF -> built 1, debug it and roll out many identical copies.

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