Almost everyone accepts that the UK has a productivity problem, but few can agree exactly what and how big it is, let alone how to solve it. This has allowed commentators and politicians to focus on their own pet hates, whether these are too many government interventions or too few, failings in the financial system, the legacy of ‘austerity’, or, inevitably, Brexit.
Some facts. Labour productivity is typically measured as output per worker, or, more meaningfully, output per hour worked. It is well known that the growth of productivity has slowed significantly in most advanced economies in the wake of the global financial crisis (GFC), but also that the UK has performed less well since 2010 than many of its peers. This is nothing new. The Office for Budget Responsibility, for example, has been pondering this puzzle since at least as far back as 2012.
The latest contribution to the debate comes from the US Conference Board which, according to the Financial Times, is forecasting that the UK will be the only large advanced economy to see a decline in productivity growth this year, something the FT attributes to Brexit uncertainty. As it happens, I wouldn’t give these projections much weight; productivity is notoriously hard to forecast even in more certain times. Instead, let’s deal briefly with the suggestion that the UK’s poor record on productivity has been exacerbated by the decision to leave the EU.
It is true that UK business investment has been sluggish since the 2016 referendum. This weakness would also be likely to undermine productivity in the longer term, if sustained. But this is a big if. Many companies may simply be putting new projects on hold rather than cancelling them altogether. Investment should therefore snap back as uncertainty clears, assuming, of course, that Project Fear is proved wrong again. This is consistent with survey evidence and hard data suggesting that the UK remains one of the most attractive destinations for foreign direct investment.
In the meantime, there is no sign of any negative impact from Brexit in the productivity data themselves. Indeed, the UK’s recent performance has actually been relatively good. Labour productivity, measured as output per hour, grew by 0.5 per cent in 2018 after rising by 1.0 per cent in 2017. Taking these together that is faster than any other two-year period since the 2008 recession.
What’s more, according to OECD data, the UK has seen bigger gains in GDP per hour worked than almost any other similar EU economy over the last two years. Only France has done any better. The picture is similar using Eurostat data for output per person employed.
So what else explains the UK’s relatively poor performance over the longer period? I would emphasise three factors, all of which lead me to more optimistic conclusions.
The first is measurement problems, which may well have affected the data for the UK more than many of its peers. In part this is because of the likely under-recording of output in more dynamic sectors where the UK is a leader. Improvements in the quality of goods produced or increases in the output of service sectors (particularly the digital economy) are not always accurately captured in the official statistics.
In addition, more recent work by the OECD has also suggested that countries making no adjustments to average hours worked measures extracted from the original source, including the UK, appear to systematically over-estimate labour input and, so, under-estimate labour productivity. In short, the UK’s productivity shortfall may not be as large as the data suggest.
The second factor is the UK’s relatively flexible labour market. This may have allowed the UK to settle into a ‘low wage – low productivity – high employment equilibrium’, where it has been more attractive for firms to employ people at relatively low wages, and even keep them on when they might otherwise have been let go, rather than invest in more capital. This is good for jobs, but potentially bad for productivity.
However, this equilibrium is not necessarily permanent. The flipside is that as the UK approaches full employment and the supply of cheap labour dries up, firms will have to invest more and productivity is likely to recover of its own accord. The rollout of Universal Credit, despite its faults, should also reward progression to more productive jobs by reducing the rate at which benefits are withdrawn.
This is surely preferable to the situation in less flexible economies, such as France, which are suffering from structurally high unemployment, and where only the most productive people have jobs. This means that France might report a higher average level of productivity than the UK, but people in comparable jobs in these two countries might still be equally productive.
The third factor is the actions of the government. Here I’m firmly in the camp that the problem is too much intervention, not too little. The UK’s poor performance can partly be explained by declines in sectors where productivity has traditionally been highest, notably finance & insurance and oil & gas. This has actually been exacerbated by increased regulation and the particular way in which green energy has been promoted in this country. With a grim inevitability, politicians now seem to be turning their attention to other cutting-edge sectors, notably the digital and gig economies.
Of course, there will always be some who insist that low rates of investment in the UK are largely the fault of austerity in the public sector and of short-sighted managers in the private sector, and that the answer is therefore more public investment and more state intervention. However, it is heroic to believe that politicians and officials are any better at making investment decisions than the private sector (just think HS2, or Hinkley Point). Market-oriented solutions are likely to be more effective.
An alternative approach would therefore focus on lowering barriers to investment, whether public or private, including by further reform of corporation tax and investment allowances, reductions in energy costs and liberalisation of planning laws – from fracking to housebuilding. A reduction in Brexit uncertainty should help too, but the vote to leave the EU is not yet a key part of the productivity puzzle.
CapX depends on the generosity of its readers. If you value what we do, please consider making a donation.