Analysis of the Coalition’s public expenditure cuts shows that the Treasury caused UK productivity to stop growing in an ill-informed attempt to maximise the headline ‘GDP growth’ figure. The analysis supports Business Minister Vince Cable’s recent claim that when implementing austerity the Treasury had cut public sector investment as well as day-today spending because they couldn’t tell the difference. This could mean that the Office of Budget Responsibility understated the situation when it said in 2013 that austerity was holding back the economy. The cuts to public R&D spend best illustrate the Treasury’s mistake, and with similarly-motivated cuts in adult education they explain what the Office of National Statistics calls ‘the unprecedented seven-year standstill‘ in UK workers’ productivity. The great austerity experiment for the first time shows that this key variable is under government control – if it can be made to go down it can be made to go up.
How UK R&D funding fell during 2010-2015
Figures from Campaign for Science and Engineering (CaSE) now show that the Treasury has selectively targeted items of the publicly-funded Research and Development (R&D) budget depending on whether or not international accounting standards classified the expenditure as capital investment in the GDP statistics. ‘Capital investment’ thus defined would add to headline ‘GDP growth’. That explains why they increased the ‘capital budget’ (funding for new equipment) by £800m while reducing the ‘resource budget’ (funding for scientists who would use the equipment) by over £3bn (Figure 1). The Treasury must have assumed that resource funding was not added as investment in the GDP calculation, so this targeting would increase headline GDP growth while imposing austerity.
The reality is that the capital expenditure is wasteful if there is nobody to make use of it, so this decision aimed at boosting short-term GDP inevitably destroyed value. As CaSE laconically remarks: ‘If resource and capital budgets are not tied, the disparity between the two will grow, resulting in inefficient use of public funds’.
But that’s not the worst news for the economic record. What the Treasury apparently did not factor in was that long-overdue moves were afoot in the international accounting standards bodies to reclassify R&D resource funding as capital investment and to recalculate GDP retrospectively. This took effect in 2014, and the new recalculated figures for 2008 onwards allowed the Chancellor to announce in his autumn statement that year that GDP had overtaken its 2008 level during 2013, some time earlier than previously thought. (Per capita GDP, the usual measure of industrial performance, is still below its 2008 level).
If the Treasury had tied the capital and resource budgets together as CaSE recommends, the Chancellor could have been able to announce an even greater increase in GDP during his tenure. The Treasury had been following an out-of-date rule book when they should not have been following a rule-book at all, but should have been following the advice of experts. Germany, already spending twice as much on publicly-funded R&D as the UK, did not reduce its overall R&D budget and came out of a deeper recession twice as fast. The R&D that the UK lost over the life of the Parliament 2010-2015 can never be regained.
How about Further Education funding?
Two years ago I pointed out that known shortcomings in the GDP calculation might encourage governments to inflate GDP in the short term by diverting capital investment away from ‘intangible’ assets like R&D or training (one of the areas identified by Vince Cable as investment) and towards steel-and-concrete investments with limited pay-back. The Financial Times quoted these findings and academics confirmed that incorrectly excluding intangible assets from GDP statistics had significantly altered UK growth rates for 2009-12. This mis-measurement of UK GDP can explain why UK productivity (GDP per hour worked) appears to be 30% below France or Germany, but a different explanation is necessary for the unprecedented halt in productivity improvement in the UK which has continually widened the gap since 2009. The explanation is that the Treasury has chosen to cut public expenditure in other areas, besides R&D, that traditionally cause continuous productivity growth.
Given the incorrect treatment of training investment in the international standard GDP calculation, it is not surprising that from 2010 to 2015 the Treasury also drastically reduced the adult education budget. The Coalition proposes to virtually eliminate it in the next Parliament except for funding for apprenticeships (which show up as ‘job creation’ in the economic headlines). This may result in another ‘own goal’ for the GDP maximisers because training is likely to be an early candidate to be reclassified retrospectively as investment by the international accounting bodies, boosting the GDP of countries that maintain their spend.
It is hard to imagine any group of people more important to the economy than workers who cannot afford to pay for adult education but are motivated enough to give up their family and leisure time to qualify themselves further. The consequences of depriving the country of this potential may explain the worst aspect of the long-running ‘productivity puzzle’.
Career development increases productivity
Britain’s real productivity puzzle is the phenomenon in which the long-term trend towards ever-higher GDP per hour worked has stalled while other countries have returned to the long-term trend after the recession (Figure 2).
Figure 2: France and Germany have resumed productivity growth trend
The UK ‘productivity puzzle’ is accompanied by low wage growth and low capital investment. The normal upward trend in productivity improvement results from a continuous increase in skill level among the working population, something that most individual workers aspire to. As average skill levels improve, workers move to higher-productivity jobs and employers and it becomes hard to find unskilled workers who will remain long at the lowest level. To avoid the need to continually replace such workers, the least-skilled occupations disappear and are replaced by automation. This happens in supermarkets, for example, where few workers want to remain on the checkout for their whole careers so it becomes common to replace that lower level with self-checkout equipment.
This upward mobility happens in retail because there is a career path to management and beyond. It happens less in self-employment, which is where an increasing number of UK workers find themselves. There is little in the way of a career path or ongoing on-the-job training for hand car-wash operatives or minicab drivers, and no help from the State if cuts to the adult education budget mean there is no easy way to upskill or even for immigrants to learn English. The number of students of English for Speakers of Other Languages (ESOL) fell from 500,000 in 2007 to 139,000 in 2014. Cuts of this magnitude to funding for adult education can explain why UK productivity growth has stopped.
For some, though, there is a simpler explanation: the slump in productivity growth is the result of indolence. This was famously articulated by Lord Heseltine, who said that there was no productivity puzzle because the UK shortfall compared to other countries was the result of the British worker not working hard enough and not getting up early enough.
Those who prefer evidence-based policymaking will find plenty of relevant evidence in the records of the Treasury’s recent cuts in public expenditure. The valuable data gathered by the Office of National Statistics during the Coalition’s attempt to put the economy into reverse shows for the first time that the key productivity variable is under State control. If cutting investment can reduce productivity, increasing investment can increase it. We didn’t know that before.
11 April 2015
 The Times, 6 March 2015 p. 43; Guardian, 5 March 2015 http://www.theguardian.com/business/2015/mar/05/vince-cable-calls-for-relaxation-of-spending-controls
 House of Commons Library Standard Note SN06982, 30 October 2014
 Solving the Productivity Puzzle, or how to game the GDP calculation http://theinternetofhumanbrains.com/ProductivityPuzzle4March2013.pdf