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The UK’s productivity puzzle

January 24, 2014

This was originally published on the NEF blog at: http://www.neweconomics.org/blog/entry/the-uks-productivity-puzzle

You might have missed the ONS’ latest estimates for UK productivity – they crept out late last year on Christmas Eve. They tell a familiar but not especially pretty story: output per hour worked fell by 0.3% over the middle part of 2013. In production industries, it’s down 1.2%. This means whatever economic growth occurred over the last year was not the result of people working better, or more efficiently. It was the result of an increase in the total number of hours worked. Productivity, over the whole year, barely improved.

Productivity matters hugely to the kind of economy we live in. Competition amongst firms creates an imperative to growth. Each firm has to grow to survive. For government, charged with overseeing the process, GDP becomes their number one economic target. When GDP goes up, it means an economy is expanding. And when the economy is expanding, it should mean there is more wealth available for everyone in it. Of course, that wealth can be distributed extremely unevenly: over the last two decades or so, the fruits of economic growth have very largely gone to the already wealthy.

Driving that growth means either mobilising more resources, or making existing resources work more effectively. Until recently, China has been a spectacular example of how mobilising dormant productive resources can drive growth. Up to 340 million Chinese have migrated from the countryside and into towns and cities since 1979 – the largest population movement in human history. This immense increase in the urban workforce, combined with huge capital investment, delivered China’s extraordinary economic growth for the last three decades.

Britain does not have an immense rural population, and hasn’t had for centuries. There is no readily-available stock of cheap, low-productivity labour waiting to move into more productive occupations. Like other developed countries, if growth occurs here it has to be intensive, rather than extensive: making existing resources work more effectively. In the decades since the Second World War, that has been more-or-less what happened. Year in, year out, the economy delivered increasing productivity. Over time, each hour worked produced more output. As the economy became more efficient, it could keep growing. Recessions interrupted this trend, but did not break it.

After the crash

Something different has happened since the crash. The graph below plots productivity, as measured by output per hour worked, after each of the four major recessions since 1970. It is shown relative to its pre-recession peak, marked here as 100 for each. For every recession until now, productivity had returned to its pre-recession peak no later than 18 months after the initial crash. After that initial drop, productivity returned to its trend growth. For the recession beginning in 2008, however, productivity fell – and then never really picked up again. It’s as if it has hit an invisible ceiling.

productivity_recessions[1]

Source: ONS

There are competing explanations for this productivity puzzle – that even as output is increasing, productivity is not. The most immediate is that our “flexible” labour markets have been proved to be very effective in delivering part-time and temporary work, at low cost to employers. The rise of zero-hour contracts is testament to that – one survey suggests that up to 5.5m people are now working on a zero hours basis. Meanwhile, underemployment – those who would like to work more hours, but cannot –is at record levels. When faced with collapsing markets in the recession, employers – rather than reducing the number of people in work – effectively cut wages and hours of those working.

The puzzle has huge consequences. It means  there is very little scope for the economy to deliver increases in real earnings. With productivity remaining low, there is huge pressure on firms to also keep their costs low – and that means holding down wages and salaries. If productivity does not pick up, wages and salaries will not pick up either; at least, not without a fight. Those pressures will worsen as time goes on. To the extent that British firms seek to operate globally, they face competitive pressure. Other countries have lower costs than here, or are more productive – or indeed both.

Productivity growth has been slowing across the developed world over the last decade – and, indeed, arguably for far longer, the technology boom of the 1990s providing only a temporary improvement. But the UK is unusually badly affected by this general slowdown, and, worse, already significantly less productive than close competitors like France, Germany, or the US.The typical hour worked in the UK produces just 76%, by value, of the typical hour worked in the US.

Solving the puzzle

There are three sets of solutions to this. The first is to insist on still greater sacrifices from those in work, and from those looking for work. If productivity is not improving, it may be possible to cut labour costs per hour. That means cutting hourly pay. This is a real race to the bottom, with workers here pushed to match the lowest competing wages elsewhere in the world. When George Osborne warns about the need for “Western democracies to… rise to the challenge” or risk being “outworked”, it is this race that he has in mind.

The second is to try and seek out ways to boost productivity. Increased investment would mean installing newer, more efficient equipment and improving infrastructure. Both would be expected to boost productivity. Research spending, too, might lead to gains over time. Neither is guaranteed to deliver, however, and, as things stand, British companies are not inclined to invest. Their spending on new fell by a quarter in the recession, and has not fully recovered. It is lower now, as a share of GDP, than it was a decade ago. These firms could, undoubtedly, be compelled to do much more; or government could simply invest the money itself.

The third, and most dramatic, is to refuse to play the game. Rising productivity has transformed how we live and work. But if those improvements in productivity are pulled along by the dull compulsion of economic growth – of chasing GDP – their advantages dwindle. The potential for liberation that growing productivity could represent – of freedom from backbreaking work, of hugely increased possibilities for free time – is crushed. Better, instead, to think about how we can organise an economy that sets itself meaningful, human goals, ahead of growth at any price.

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