Monday, 25 October 2010

Can 180,000 public sector workers really be doing nothing?

Many macroeconomists are calling for more UK public sector spending,. with Paul Krugman joining the fray (though note that he calls for the postponement of cuts to a later period, rather than denying their necessity altogether) .  At the same time, many commentators complain about public sector waste. The excellent Steve Richards is, I think opposed to cuts in general, but wants sackings of middle managers in the BBC whom he says are useless. One hears similar sentiments about managers in the NHS and, dare I say it, universities.

I think this is an unexplored area: people don't like the cuts, but they can identify inefficiencies, often in the very organisations where they work.  Can economists bring any facts to the table here?

I think they can, but I think they are a puzzle.

The UK stats authorities are leading on the effort to measure public sector productivity. In most countries the output of doctors is the number of doctors.  In the UK, the output of the health service is the waiting time  adjusted output of a vast collection of medical procedures, all weighted by their cost shares.  And so on for other hard-to-measure sectors like education output (exam-result adjusted kids in school).

What's interesting about this is that these measures expand back to 1997, just before the start, in 2000, of the huge expansion of the public sector (from around 5m workers then to 6million now). What do they find?  The latest Economic and Labour Market review makes depressing reading.  Here are the facts on the table:

  1. For 1997-2008,  using the quality adjusted figures (that raise output, since e.g. waiting times have fallen), output has risen, 2.9% per annum. Inputs (that is, labour, capital and intermediates) have risen by 3.2%pa. So "multifactor" productivity (that is output per input of labour, capital and intermediates) has fallen by 0.3%.  Note that quality adjustment raises output; if we did not quality adjust, output would be even lower and productivity would have fallen even faster.
  2. Another paper here looks instead at non-quality adjusted value added per input, 1995-2008.  The market sector multifactor productivity grows at 1%pa but the industries dominated by the public sector (but not wholly public) falls by 1% pa, even more.
What do we draw from this?
  1. One possibility is that all the data are wrong. Maybe. 
  2. So lets be the most conservative. Let's suppose that public sector productivity is falling by 0.3% pa.  That means this. In 2008, to get the same output in the public sector as 10 years before when you employed, say, 100 labour and capital inputs you now have to employ 103.  If this was the private sector you would only need 90 units. 
  3. So if we ignore capital and materials, if these data are right, then in the public sector 3 people in 100 are doing nothing, whereas the private sector is getting the same output with 10 less people.  
  4. Again, if these data are right, what does that imply?  I see two depressing implications.  First, if we just asked the public sector to deliver zero percent productivity increase since 1997, we would have been able to produce the 2008 output with 3% fewer workers.  3% of 6million is 180,000.  Second, if we asked the public sector to deliver the same productivity increase as the private sector then we would have been able to produce the 2008 output with 10% fewer workers, that is 600,000 workers.
  5. (Finally, to give a yardstick, I note that the newly-formed Office for Budget Responsibility forecast earlier this summer that 490,000 government jobs would be cut by 2014-15).
Can this really be right?  To take the most optimistic number, can it really be that if we went back to 1997 productivity levels, we can get rid of 180,000 workers and have exactly the same output?  If the productivity numbers are correct, what are these 180,000 workers doing?  Can they really be doing nothing?  But if they are doing something, why doesn't it show up in their output?  I am puzzled.

Why Economic Growth is Still the Big Question and How to See It

The spending cuts dialogue seems to have moved today away from the numerator (the deficit) to the denominator (GDP).  Hooray.  Let’s not forget that growth can really help us get out of the mess we are in.

But its often hard to put over the sheer power of economic growth in a way that persuades people, who have iPhones, cars, flatscreens etc, just how remarkable modern economic growth is.  One very good method is set out in John Nye’s short piece.

Here are some facts on the table.  He starts by observing
    1. the average American’s annual income in 2000 was five times higher than thatin 1890 and
    2. 12 times higher than in the 1850s.

How best to bring this to life?  Consider the following table.  To see how much more an American worker can buy today, compare the number of hours she would have had to work to obtain various items in 1895 versus 2000.  Have a look at the bicycle row.  Today the worker needs to work 7.2 hours to earn it.  Back then, they needed to work 260 hours.  No wonder bikes sit rusting in the back garden or sell for nothing on eBay.  And, going back further in time, I’ve always been struck how in the dramatisations of Jane Austin there are so few possessions in people’s houses.   The final column compares the prices charged in the Montgomery Ward catalog with prices today, both expressed as a multiple of the average hourly wage, to give an index of productivity of making the goods consumed back in 1895 has multiplied.

Multiplication of Productivity 1895–2000: Time Needed for an Average Worker to Earn the Purchase Price of Various Commodities

For even more fascinating stuff on this, see the great Brad de Long here.

Hooray for competition : what fights discrimination?

In class we have stressed again and again the benefits of competition.  In addition, we looked today at arbitrage as what consumers might do and its consequences for the ability of firms to price discriminate.  Here's a lovely example of firms doing it and its consequences for the ability of other firms to price discriminate, from The Economist.
 Gender arbitrage in South Korea: If South Korean firms won’t make use of female talent, foreigners will
Oct 21st 2010 | Seoul

"Working women in South Korea earn 63% of what men do. Not all of this is the result of discrimination, but some must be. South Korean women face social pressure to quit when they have children, making it hard to stay on the career fast track. Many large companies have no women at all in senior jobs.

This creates an obvious opportunity. If female talent is undervalued, it should be plentiful and relatively cheap. Firms that hire more women should reap a competitive advantage. And indeed, there is evidence that one type of employer is doing just that.

Jordan Siegel of Harvard Business School reports that foreign multinationals are recruiting large numbers of educated Korean women.

South Korea is the ideal environment for gender arbitrage. The workplace may be sexist, but the education system is extremely meritocratic. Lots of brainy female graduates enter the job market each year. In time their careers are eclipsed by those of men of no greater ability. This makes them poachable. Goldman Sachs, an American investment bank, has more women than men in its office in Seoul.

 Firms will have to use all the talent they can find. If they don’t, their rivals will."

This finding is exactly that found by Sandra Black, page 41ff. She found that the opening of US state banks to competition raised the relative wages of women as new entrants hired hitherto low paid women and bid up their relative wages.

Thursday, 21 October 2010

Are Cameron, Clegg and Osbourne "clueless dorks"?

The (almost always) excellent Brad De Long blogs on the UK Spending review.

"Is the prospect of rising unemployment in the UK supposed to enhance business confidence and trigger a surge of private-sector investment? Cameron, Clegg, and Osborne don't tell us.
They don't tell us because they are clueless dorks".

Steady on Brad.

Let's get some facts on the table:
  1. Cuts take us back to 2005. According to the IFS, if the cuts are followed through, spending will return to 2005 levels. Not 1895 levels, but 2005 levels.  That is not to deny that it will be painful for all those gainers over the last 5 years: it will be, but let's not be too apocalyptic.  We are not returned to Victorian England just yet.
  2. Public sector pay is relatively high. Also according to the IFS, public sector pay has now got quite a way ahead of the private sector.  Have a look at the IFS Green Budget table 4 in Chapter 9.  Controlling for education, age etc. public sector wages (outside London) are now 5% ahead of private sector wages for men and 12% ahead for women.  And that is before pensions: that loads an additional public sector advantage.  I would guess, and I have no evidence for this, that the implied value of longer holidays and (until now) relative job security would make even these estimates a lower bound.  (Incidentally, Polly Toynbee, says that public sector pay "had lagged behind" the private sector for a decade, but that is over now).
  3.  Public sector productivity has fallen since 1997.  This is fiendishly hard to measure, but Joe Grice's team at UKCEMGA are the leaders on this and even quality adjusted, every measure they have shows falling public sector productivity, of around 0.5%pa see figure 1.1.
Let's now get two principles on the table.
  1. Spending more now has to be accompanied with a credible promise to cut in the future.
  2. Spending more now will not expand output if it just crowds out the private sector.
 What do I conclude from this?
  1. Even if we wanted to, employing more workers in the public sector is out. We cannot afford their pensions.  And in those regions of public sector pay advantage, almost certainly any public sector employment expansion will crowd out the private sector   

  2. Thus our only Keynesian expansion option, it seems to me, is for the government to (a) borrow to then (b) spend to then (c) employ workers in the private sector.  But only temporarily.  And everyone has to believe that it is temporary. 
Where does that leave us?
  1. Brad may be right that cuts may not crowd in private investment to the extent that cuts lower private sector confidence.  But it does not mean that that expansion works: a public sector employment expansion will crowd out and so any expansion will have to be managed very carefully.  And it might well be better to have a temporary tax cut such as the VAT change rather than try to engineer a temporary private sector only spend rise. To this extent, I agree with Martin Wolf in this morning's FT who suggested a temporary employment tax cut. On infrastructure, I am a maybe.
  2. I think all this says that more spending on an unreformed public sector is ruled out of court. I wonder, along with Peter Robinson, whether history will judge spending on an unreformed public sector as a mistake.

    Wednesday, 20 October 2010

    Assorted links

    1. The great Russ Roberts is in love.
    2. Where were you about two hours ago, at 20:10: 20:10; 2010?  Warney wants to know.

    More on Spending on the Science Base

    A lot of leaks before the announcements.  The Times (gated) reports the science budget is to be frozen in real terms, that is a much lower cut than the 40% being talked about.  They kindly quote my work with Gavin Wallis, which is here and explained on You Tube is hereAs they also note, David Willetts has been very energetic in defending the science base: here is one of his speeches here  and evidence in front of the House of Commons Science and Technology Committee (which also kindly quotes our work).  The spending review document confirms these rumors: page 6: "maintaining the science budget in cash terms over the
    Spending Review period with resource spending of £4.6 billion". Hats off to David Willetts and those campaigning for Science.  Note that the science budget, unless something has changed that I don't know about, includes all research council monies, so includes research spending on arts and social sciences.

    Update.  Here's the FT after the spending review day

    UK science spending flat at £4.6bn a year
    Science escaped the big cuts that some researchers had feared from the government’s spending review unveiled on Wednesday. The government’s core “science budget” will remain flat at £4.6bn a year over the next four years, amounting to a likely reduction of around 10 per cent in real terms.

    "Asked what had changed since the 1980s, when the Thatcher government slashed research spending, David Willetts, science minister, replied: “The scientific community has been able to produce empirical evidence about the economic returns from research. The Treasury buys the argument that scientific research contributes to long-term growth.”

    Tuesday, 19 October 2010

    The Spending Cuts

    Here are some thoughts in advance of tomorrow's spending review announcements.  I start from Danny Blanchflower in Monday's Guardian:

    "The austerity package is likely to turn out to be the greatest macro-economic mistake in a century. We will fight them on the beaches. We will never surrender. That is the British way."

    Steady on Danny.

    Lets get some points of principle down that we can all agree on.  The Keynesian "public-spending-now" (or somewhat refined, "not-so-much-cutting-now") argument rests on two hypotheses.

    1. That everyone believes that increases in spending today are cut back tomorrow; or: you may disagree with cuts today, but people have to believe you will cut tomorrow. 
    2.  That, in addition, increases in public spending today will only expand output if they do not crowd out private sector activity.
    So what can we say about this?
    1. I fear that the Labour Party's stance on (1) is not credible. It does not help that MilliE was elected by the public sector unions.  He can promise not to sack public sector workers today, but it's going to be mighty hard for him to convince people he would sack them tomorrow.  Alan Johnson's refusal to take questions after his statement on Labour's plans yesterday I don't think helps at all.  Labour, and anyone else leaning in this way, need an institutional fix for this.  I also fear that entering this recession with such high borrowing may well have condemned Keynesian policy as a non-starter before we started.  
    2. Crowding out, in an underutilised economy, would not at first sight seem to be a problem.  But the devil is in the detail.  The IFS, Green Budget, see their table 4 in Chapter 9, highlights the public sector wage advantage: controlling for education, age etc. public sector wages (outside London) are now 5% ahead of private sector wages for men and 12% ahead for women.  And that is before pensions: that loads an additional public sector advantage.  So even the most ardent Keynesian knows that we could not employ more public sector workers: we cannot afford their pensions and advertising new public sector jobs at these prevailing wages would simply attract private sector applicants.  With this crowding out scenario then, we are reliant on private sector employment. 
    So what's left?  The answer is to focus on public spending that crowds in private spending or that raises growth.  Supporting the science base is one option for which we have positive evidence of both crowding in and raising growth.  Basic education is another.  Subsidies for aircraft carriers with no aircraft or for middle class benefits looks like they will have to wait until we fix our current problems.

    Addendum, 20:10, 2010
    A couple of people have kindly replied to the above post.  They point out that the government could simply employ private sector workers for a temporary time, to build infrastructure, houses, roads etc.

    I agree with building infrastructure if it has positive effects (externalities) on the productive capacity of the economy.  But once again, I think the devil is in the detail.
    1. The US stimulus experience of infrastructure building seems very disappointing since it turned out to be hard to find "shovel ready" projects.  Here's President Obama himself on this. And the US is a relatively planning free economy.  If it takes a long time there, I hate to think how long it will take here where planning restrictions are so tight that rents in Birmingham are 44% higher than in Manhattan.
    2. I would like to form a clearer view of what infrastructure projects we want to build. I presume we don't want to build another Humber bridge to nowhere or another 10 Olympic stadia.  Roads?  I don't know how this fits into our carbon strategy. Public transport?  Sure, but if that passes a usual cost-benefit test, we don't have to wait for a recession. 
    3. Are we worried about continued cartel behaviour in the building tradeafter the bid rigging findings? Such behaviour means taxpayer's money subsidies illegal monopolies.
    4. Are we sure that infrastructure projects will employ the people we want to help, that is young unskilled men in unemployment blackspots?  Does that mean we have to build infrastructure in those neighbourhoods? Are unskilled building jobs mechanised now, so that most employment is for skilled electricians etc?  And will we end up employing mostly Hungarians (which is perfectly fine, but not, I think, what Keynesians have in mind).  I don't know, but I would like to know something about this before we start.
    The infrastructure option gets a maybe from me, but it's not an immediate employment generator and needs forensic intervention by a network of government agencies.

    OECD innovation strategy and intangible investment

    In August the OECD launched their innovation strategy.  Our COINVEST research team was very chuffed to be featured in Figure 1.  And comparative data on intangible investment, produced by our team is here.  A link to our UK survey work is here.

    Corporate tax rates, 2010 data

    Following from last week's lecture, what do you think would happen to corporate tax rates as the world becomes more globalised?  To check your answer have a look at page 29 of today's KPMG report.

    Monday, 18 October 2010

    Readings for Students from last week's lecture

    Some recent posts to complement last week's supply-and-demand sessions

    1. The incredible Brad de Long on markets, consumer and producer surplus.
    2. From Freakonomics a long and thoughtful piece on whether people really do respond to incentives
    3. Supply and demand in the university market
    4. Monetary estimates of externalities from the Department of Transport, para 46.  Thanks to Geoff Riley for the tip.  

    Why we need an IKEA Champion now

    The BBC's excellent technology correspondant Rory Cellan-Jones reported on the Today programme this morning that this week is Get Online Week. I have to say that I was unaware of this effort until this morning.  Nor was I aware that we had a Digital Champion, Martha Lane Fox, who promotes it (with a mix of private and public money).  She has launched her Manifesto for a Networked Nation which aims to "get everyone of working age and those preparing for retirement online within the lifetime of this parliament".

    Cellan-Jones reports the information provided by the Champion: "More than nine million Britons have never used the internet, and they tend to be more elderly and less well-off. Events promoting web use will take place across the UK. The campaign will hammer home a simple message, that the internet can save you money. Research by UK Online Centres, which was set up by the government to provide public access to computers, found that a third of new internet users reckoned they had already saved more than £100 by being online."

    The number of eBay, Facebook and Google users (let alone of online pornography) makes me think it's unlikely that people are having much trouble logging on.  So let's have a champion to help with something that's really difficult.  I mean of course putting up IKEA furniture.  To test this proposition, I tried cutting and pasting IKEA for "online" and "internet" into the paragraph above.  It reads:

    "More than nine million Britons have never used IKEA, and they tend to be more elderly and less well-off. Events promoting IKEA use will take place across the UK. The campaign will hammer home a simple message, that IKEA can save you money. Research by UK Online Centres, which was set up by the government to provide public access to computers, found that a third of IKEA users reckoned they had already saved more than £100 by using IKEA."

    This IKEA test suggests to me that Online week is a waste of money. Why don't we use this public money instead to help with the Science Budget the evidence for which suggests very high returns?

    For students of economics, I offer the following thoughts.  Economists genererally justify public subsidies if the activity produces public goods (R&D) and taxes if public bads (carbon).  What public good does this campaign produce?  Internet usage confers a private benefit to the user, which is why we generally trust users to get on without public money.  But there is some public benefit over and above that since new use of the internet improves things for others (a "positive externality")by expanding the network with whom one can communicate. How much is that positive externality?  In the Competition Commission's 2002 inquiry into Mobile Phones, this argument was used by the Phone companies.  They argued it that monopolistic termination charges (charges levied by operators to users on other networks) were socially optimal since they helped subsidise handsets so expanding the network.  Mr. Justice Moses, the High Court judge who eventally had to adjudicate on this, awarded a fraction of a penny per call for this social externality.  So I don't think this is a wise spend of public money.

    Sunday, 17 October 2010

    Why the Science Budget Should be Ringfenced

    My friend Gavin Wallis and I have done a lot of work trying to measure the impact of the Goverment's spending on the Science Budget.  This is spending on public sector R&D, which is grants to Research Councils (which then go to universities), plus direct spending on Civil and Defence R&D by governments. Our data indicates very substantial payoffs to Research Council spending, which of course is determined by competitive bidding by academics in competition with each other (another reason why competition is good). The paper is here and my debut on You Tube is here (you gotta wait 38 seconds but you also get to see the excellent Romesh Vaitilingham and Ammon Salter).


    We went to see Birdsong last night, an evening made more pleasurable by bumping into both one of my students (hello Daneesh) and our cousins (hello Emma and Sarah).  Verdict: a bit like your favourite guitar player doing an acoustic version of Bat Out of Hell: it's just missing something.

    Markets everywhere reports that Fifa is investigating allegations that two of its officials offered to sell their votes in the contest to host the 2018 World Cup.  The key assumption in Economics is of course that people respond to incentives.  Do other social sciences have this at their core? I'm not sure.  One might say of course that most of the officials at FIFA are not selling their votes: but if enough do, that would be enough to determine the outcome of the competition.  Second key economic insight: everything is determined at the margin.