7 December 2016

Our lost decade is nothing to worry about


Mark Carney, Governor of the Bank of England, tells us that we’re experiencing a lost decade. This is the first time since the 1860s that real incomes haven’t risen over a 10 year period. Last time around, it was caused by the collapse of Overend Gurney – a “too big to fail” bank as we would call it today. History might not repeat itself, but it does have an echo.

Owen Jones says that this is clear proof that we need a radical revolution in the structure of the economy:

“This is a crisis of radical proportions and as such it has only radical solutions. This is a critical point.”

Well, no, not really. For we must distinguish between structural failures of the economy – which do require radical action –  and cyclical changes, which require little more than time to come right.

British industry being sucked up the tail end of socialism required the radicalism of St Maggie. The aftermath of a horrible recession meaning a fall in wages does not. Falling wages is the cure for an awful recession.

Clearly, we don’t want wages to fall forever, nor even not grow forever – we are all interested in improving the human condition. Yet one useful description of a recession is that wages have risen too high to sustain the value of the output from employing labour.

Say, at the end of the longest economic boom in modern times, we’re all rather too confident about the future and what it holds.

Unemployment falls and wages are bid up and then, Whoops! We realise that some part of that wealth we though we had is ephemeral. It doesn’t really exist.

Labour gets laid off, wages start to fall – as even Keynes would point out, this is the solution to the problem.

Wages which were too expensive for the value of the output will be priced back into work and the cycle sets off again. All of that Keynesian demand management stuff, the tax and spend fiscal policies, is only an attempt to make this happen faster.

A good example is Greece. It’s common knowledge that the country was living beyond its means. The solution is a fall in real wages. But being locked into the euro they have to do it the hard way: with internal devaluation and 25 per cent unemployment rates.

Britain, being blessed with a flexible labour market and a floating currency, can do it with static nominal wages and a bit of inflation.

Same end result: real wages fall, economic recovery happens and after some time real wages will be higher than originally.

The worse the recession, the longer this will take. We’ve just had the worst recession in modern times and GDP per capita is above 2008. Real wages will follow very shortly.

That is, our lost decade is not a result of structural problems requiring radical action. It’s just that we had that damn recession and a temporary fall in real wages is the solution to one of those.

And do note that Carney is not predicting a second lost decade – we’ve just about recovered the ground lost and now expect real wages to grow from here on in.

What we needed to do we’ve already done. In fact, as Carney’s own chart shows the 1870s were a period of significant real wage growth – as the 2020s are likely to be. On exactly the grounds that the last decade hasn’t been so hot. Reversion to the mean is a real thing you know.

Tim Worstall is senior fellow at the Adam Smith Institute.