Hamish McRae: What about long-term growth rates?

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The Independent Online

What is the UK's sustainable long-term growth rate and has it changed for the worse? It is a question for the entire developed world, but it's a particularly important one for us since we are wrestling with a larger public-sector deficit, relative to GDP, than any large Western economy.

For the past century underlying growth in the UK has been around 2.25 per cent a year, driven mostly by increasing productivity and participation in the labour force, but also by steady growth in population. So growth in living standards has been somewhat slower than growth in the total economy.Nevertheless we have not had to face, at least until recently, the possibility that there will be no overall rise in living standards for the next generation, something that seems to have happened in the United States.

Now, however, the economy is still well below its previous peak in output, although employment is almost back to its peak. That would suggest there has been a sharp fall in output per person. There probably has been some decline because much of the rise in employment has been in part-time work. But maybe they were not producing so much as was thought when the economy was at its peak.

All this leads into a debate about the real level of productivity and the output gap – the amount by which the economy is below its productive potential. Could the ground that we have lost as a result of the recession be recovered, or is that wealth that has been lost for ever?

If you look at all this in cyclical terms, my guess is that the economy was running somewhat above its long-term sustainable level between 2003 and 2007 and is now running quite a bit below. So we can expect to recover some of the ground lost. This could take a very long time, but things do eventually revert to a mean.

But what about the structural issue: has something radical changed? The argument is that it is easier to increase productivity in manufacturing than in services, but for a number of reasons the former is likely to employ fewer people – compare a highly automated car factory with the complex staffing needs of a large general hospital.

So the key in the future will be to find ways of getting much higher productivity in service industries.

It is too big an issue to do more than sketch it, but I think that while there will be some services where you really cannot do much about productivity – care for the elderly, for example – there are many others that we have only begun to think about increasing and improving output and using fewer people to do so, including public administration. That will be the key to maintaining the underlying growth rate.