no, Sunny, the chart you are showing is labour productivity.

the output gap is the gap between actual output and potential output (the level of output above which inflation would accelerate)

they are not the same thing – the chart does not “make the simplistic case”. The simplistic case would be made with a graph that contrasts trend output with actual output.

to see why labour productivity is a different idea, suppose labour productivity had continued to rise on trend, but half of the workforce had been laid off – so you graph would be showing a smooth line, but we’d have a huge output gap.

or conversely, suppose labour productivity had halved, but nobody had been laid off, your graph would look similar (show a sharp decline) but we’d have no output gap.

“They say the crash permanently knocked out a substantial part of the UK’s capacity”

Or alternatively that a lot of the growth in the 10 years prior to the crash consisted of a speculative bubble, and therefore talk of returning to pre-2008 ‘business as usual’ is a bit of wishful thinking.

I’ve got a lot of sympathy for that view, as someone who thinks that barring technological advances which allow growth to be accommodated without growing environmental damage, scrabbling around for infinite growth is a really bad idea.

But that doesn’t mean all state services are unsustainable and cannot be afforded, nor that massive unemployment is inevitable. The only reason the Tories believe so is because they think the top 1% have an inalienable right to continue being rewarded as if the economy were still growing. If they are not being rewarded as before it must be because someone undeserving somewhere is taking more than their ‘fair’ share.

We can agree that George Osborne is probably one the worst chancellors ever.

But the biggest problem for Labour come 2015 is that the economy does start to recover, even if it’s not fantastic. That means that the Tories are in power as people find themselves getting better financially. Will they vote for something unknown and potentially still with fresh memories of the disaster that happened during Labour’s turn in office or will they vote for more of the same? I suspect the later.

I agree with Luis.

In any event, the size of the output gap is contentious because the trend position of the economy is estimated, whereas the actual position is observed. Those believe that the economy is always at or near to equilibrium will presumably claim that there is no gap.

Estimates of the gap between actual and potential output range from 14% in: Is the British economy supply constrained II?, by Bill Martin and Bob Rowthorn in May last year, to this in the IFS Green Budget for 2013:

We judge that there is currently a significant amount of spare capacity in the UK economy, with the output gap estimated to have been 5% of potential output in 2012. The financial crisis is likely to have caused substantial permanent damage to potential output, but the vast bulk of this damage has already occurred and we expect potential output growth to average 1.9% over the period from 2013 to 2017. Such a large output gap will provide the conditions for the recovery to gain momentum over the medium term, with GDP growth expected to accelerate from 1% in 2013 to 2.9% in 2017. Our forecasts are not dissimilar from those of the Office for Budget Responsibility, but are above the market consensus over the longer term
http://www.ifs.org.uk/budgets/gb2013/GB2013_Ch2.pdf

My guess is that the coalition parties will continue to blame Labour for the inherited “mess” and say either that Labour will return to its profligate traditions, if elected to government, or, ignoring Jonathan Portes, say that Labour has no credible plan for paying down the coalition’s budget deficit. The outcome of the election will depend on which lot the electorate mostly believes.

also, one has to be careful about the distinction between levels and growth rates

for example: “the crash permanently knocked out a substantial part of the UK’s capacity, which means we can’t actually grow all that much”

the crash having knocked a chunk out of the UK’s capacity need not mean our growth rate has changed.

Graphically, this is the different between the slope of a line and its height (the line in question being real GDP graphed over time). It could be that the crisis has permanently knocked a chunk out of the the UK, but this might only mean the line has shifted downwards, not that its slope has changed. Growth rates and levels are different things (often confused)

What will hurt labour in 2015 is spending the last couple of years relentlessly banging on about growth. The economy will grow before 2015 and when it does the Tories will say look our policies are working. Shifting the debate on to other things will look like whataboutery and moving the goalposts. Politicians banging on about growth means the public internalise that message and are never going to consider things like lower trajectories. Don’t let the vile socialist back in to ruin our growing economy will be the Tory message because that is the target that Labour has set them. The Tories own target of eliminating the deficit which they will not achieve will be forgotten.

I am in the optimistic pessimist camp. Hard to believe under what circumstances the last five years would not have permanently destroyed some of the UK’s supply capacity. That matters because the non-accelerating inflation rate of unemployment NAIRU could be as high as 6.5% i.e. UK full employment is 6.50% unemployment. The persistence of domestic inflation is a huge hint of an economy supply constrained.

Therefore, reforming the supply side from better infrastructure, taxation reform, education, training, regulation bottlenecks and competition will be required to reduce the NAIRU. Just spending more to boost the demand side of the economy will not achieve much. This is a scenario that the Conservatives want to be true but the problem for Labour is it may actually be true. Immigration of skilled workers that helped to achieve trend growth covered up a lot of the supply problems in the UK over the last decade and a half. That option is now more constrained as all the main parties have turned into British nationalists. How Labour advisers see this debate will determine how a possible Labour government will govern.

If there is a “gap” between potential and actual output of Britain’s economy – as Bill Martin, Bow Rowthorn and the IFS say – economic growth is constrained by insufficient demand.

George Osborne evidently agrees as he cheers on Quantitive Easing (QE) by the Bank of England (inventing money to buy government bonds from banks and insurance companies so as to raise the prices of bonds and lower yields) and the Bank’s Funding for Lending Scheme (FLS) (lending money to banks at cheap rates providing the banks use their borrowing to lend on to businesses and for mortgages).

Both of these “monetary policies” are intended to boost aggregate demand but neither seems to have been especially effective. The latest news of 19 April on bank lending to business was:

“Lending to businesses in the UK has fallen by a further £4.8bn in the three months to February, the Bank of England has said.” [BBC website]

If the economy is demand constrained, demand must increase for the economy to grow by more public spending funded by borrowing, consumer spending, business investment or an improvement in the current balance of Britain’s international payments.

The government is saying government borrowing mustn’t increase – in fact, borrowing was almost the same last year as the year before. Consumers are heavily indebted. In the final quarter of last year, business investment was down by £200m on the previous quarter by revised figures.

On the latest figures in March, the current account balance of international payments in the final quarter of 2012 showed a modest improvement on the third quarter:

“The United Kingdom’s (UK) current account deficit was £14.0 billion in the fourth quarter of 2012, down from a revised deficit of £15.1 billion in the previous quarter. The deficit in the fourth quarter equated to 3.6% of GDP at current market prices, down from 3.9% in the previous quarter.” [ONS website]

Without more aggregate demand, Britain’s economy will continue to “bump along the bottom”. That may cheer the Greens but job prospects will remain poor and there won’t be much improvement in tax revenues – which is why Osborne is trying to extract more tax from the multinationals operating in Britain. Without an increase in tax revenues, government borrowing won’t come down – which it isn’t, so far.

Luis – you’re right about the graph. I wrote the blog-post half asleep and linked to the wrong graph by mistake.

We’ve not been hearing TINA from Cameron for a while – There is No Alternative.

Just to recap, Jonathan Portes, director of the NIESR, has spelt out alternatives:
http://notthetreasuryview.blogspot.co.uk/2013/04/the-deficit-is-falling.html

As The Economist has remarked: ” in the G20 club of big economies, Britain’s performance ranks second worst over the past five years, above only Italy’s. No slump in two centuries has been this bad.”

On the evidence, the failure of Osbornomics isn’t disputable.

More bad news from Martin Wolf in the FT a few days ago about the limits to government borrowing: Austerity loses an article of faith

“In 1816, the net public debt of the UK reached 240 per cent of gross domestic product. This was the fiscal legacy of 125 years of war against France. What economic disaster followed this crushing burden of debt? The industrial revolution.”
http://www.ft.com/cms/s/0/60b7a4ec-ab58-11e2-8c63-00144feabdc0.html

@3. SadButMadLad

“We can agree that George Osborne is probably one the worst chancellors ever.

But the biggest problem for Labour come 2015 is that the economy does start to recover, even if it’s not fantastic. That means that the Tories are in power as people find themselves getting better financially. Will they vote for something unknown and potentially still with fresh memories of the disaster that happened during Labour’s turn in office or will they vote for more of the same? I suspect the later.”

Perhaps not. This article (you will need to register, but there is a limited free option)

http://www.ft.com/cms/s/0/66312e88-b0b8-11e2-80f9-00144feabdc0.html#axzz2RvuvqlCT

argues that a recovery is good for Labour as people are more inclined to take a chance if the economy is looking good.

A declared Conservative columnist in Tueuday’s FT – Janan Ganesh – is saying that a weak economy is more likely to result in a Conservative win at the general election since voters would be more inclined to risk another Labour government if the economy is performing strongly.