How to create a durable economic recovery from Covid

Simply pumping up demand and hoping productivity growth will follow is unlikely to succeed

Chris Giles

Advanced economies are enjoying a stronger recovery than we expected a few months ago. 

This silver lining stems from an improving outlook for health, the power of government insurance which protected incomes during lockdowns and central banks facilitating cheap government borrowing. 

But it is still just a recovery. 

Not even the US has increased activity to pre-pandemic levels yet, let alone achieved the output expected before the virus struck.

Until economies sustainably exceed the levels of gross domestic product forecast before Covid-19, no one should use the phrase “build back better” as something that has been achieved. 

To succeed, advanced economies must raise the productivity of their workforces. 

Only with more efficient economies will we be able to improve wages, raise living standards and service coronavirus debts without additional strain.

But productivity has been the Achilles heel of all leading economies this century. 

In the UK, the growth rate tumbled 1.76 percentage points after 2005, from a 2.21 per cent annual average the previous decade to only 0.45 per cent. 

The US decline was almost as steep, while Japan holds the dubious honour of performing best, while still experiencing a 0.8 percentage point annual drop.

Much has been written seeking to explain this poor performance, with little resolution. 

There has been a knee-jerk willingness to blame the 2008-09 global financial crisis and few attempts to pinpoint common causes.

A new study from the Oxford Martin School seeks to resolve many of these issues with careful use of international evidence and an acceptance that there will never be a completely clean answer. 

It manages to rule out some possible causes, including a fall in the skill levels of employees, which only seems to matter in Germany, or mismeasurement of the data, which cannot explain more than a fraction of the crisis.

Instead, the authors identify causes that are significant in size and common to all countries. 

These are lower investment growth across all forms of capital — digital, machinery, transport equipment and intangibles — and the deteriorating workings of capitalism. 

Investment growth issues split roughly in two between a cyclical component caused by a lack of demand after the financial crisis and structural forces such as a shift towards intangible investment in which a slowdown of growth is more damaging to wider economic progress. 

Elsewhere, more deep-seated failures of the system have reduced competitive pressure, allowing companies to increase profit margins without the normal improvements in efficiency.

The work is helpful because it gives us a framework to judge the Covid-19 recovery policies countries are putting in place. 

Simply aiming for a “high-pressure” economy by pumping up demand and hoping productivity growth will follow is unlikely to succeed. 

This element, the paper estimates, accounts for a maximum of 0.4 percentage points of the drop, so more demand and spending must be coupled with an attempt to improve the functioning of economies, making life less comfortable for companies, intensifying competition and recommitting to globalisation.

They show that there are definitive steps countries can take to improve the lives of their citizens without having to hope that new technology produces a productivity wave they can simply ride. 

The Biden administration, for example, would score highly on improving demand and seeking to raise investment, but still falls short on its commitment to greater international competition with its Buy American trade policy.

The economics world is too often riven between those advocating strong demand and those wanting supply-side policies to bring back the dynamism of past decades. 

The truth is that both are needed and, even then, they still cannot guarantee success. 

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