21 November 2017

Hammond is feeling the productivity pressure


We all know that UK productivity has been the big disappointment of the decade. Hourly productivity is now a staggering 20 per cent below its pre-crisis trend, having effectively flat-lined since 2011. Inevitably, there have been consequences for UK workers. Stagnant productivity growth has squeezed living standards and people are feeling the pinch.

There is, of course, a consolation. Forecasters have persistently overestimated productivity gains, but at the same time they have underestimated employment growth. The UK’s buoyant labour market has largely offset the potential impact on the public finances, leading to a successful reduction in government borrowing.

Now, however, we are at a critical turning point for the UK economy. With an unemployment rate of only 4.3 per cent, there is limited scope to increase economic activity from higher employment levels. Productivity is now the only game in town.

Be in no doubt that the stakes are high. In the short-term, if productivity levels continue on their current trend, the UK’s structural borrowing would rise to over 3 per cent of GDP by 2021 and leave the Chancellor’s fiscal rule in tatters, according to the Institute of Fiscal Studies. And the longer-term consequences could be dire. The Office for Budget Responsibility estimates that growth of GDP at just 0.1 percentage points more slowly than projected over the next 50 years would increase Britain’s debt-to-GDP ratio by 50 percentage points.

These projections do not even take account of the possibility of a recession in the next few years. Since 1970, no decade has passed without a downturn, so statistically speaking there is a reasonable chance of this happening in the medium-term, which only adds to the urgency of increasing output per capita.

To be fair to the Government, most of the reasons lying behind Britain’s productivity problems have been beyond their control. The healthy employment market has led to employers prioritising labour over capital. Ultra-loose monetary policy has sustained zombie firms. And the problems of the financial system, inherited from the previous government, initially prevented a re-allocation of resources from weaker to strong firms.

But it is now more urgent than ever that the Government sets the conditions for booming productivity. Philip Hammond has little wiggle-room in fiscal terms at the Budget, with Government plans already implying that a budget surplus will only be achieved by 2025. So, a focus on spending commitments cannot be a solution.

There are other measures that would help, however. Planning reform, review of the greenbelt and ensuring public bodies utilise land efficiently would help spur on the UK’s housing market. A speedy decision on airport expansion would shore up the confidence of investors. Promoting more competition in Britain’s energy, water, rail and broadband industries would yield huge benefits. And embracing mechanisation to boost the UK’s lagging capital-labour ratio would help directly boost wages.

On Sunday, the Chancellor made the case for this Budget to be “balanced”. From a productivity perspective, Hammond’s “balanced” budget will likely be mixed news. His wholehearted support for Britain being at the forefront of the fourth industrial revolution is welcome. But at the same time there are obvious concerns. The UK’s housing market will no doubt be constrained by Hammond’s continued persistence on having the greenbelt remain sacrosanct, and there may not be much movement on liberalising planning restrictions. Moreover, we are likely to see ill-advised additional complexity in areas such as stamp duty reform.

The specifics of this Budget will face heavy scrutiny. But it is the overall picture that will be critical. Hammond is facing considerable pressure from his own side to loosen the purse strings in pursuit of better productivity. This temptation will prove difficult to resist. But there are many measures that could be taken requiring little, if no, short-term fiscal costs that could help push forward a much needed productivity turbo-charge . This is where the efforts of the Chancellor must be focused at this Budget.

The Great Productivity Squeeze” is published by the Centre for Policy Studies

Daniel Mahoney is Deputy Director and Head of Economic Research at the Centre for Policy Studies