Britain’s ‘productivity puzzle’ bugs economy

Towards the end of last year, there was some good news on productivity, that perennial bugbear for the UK economy. 

The Organisation for Economic Co-operation and Development (OECD), the club of rich countries that seeks to promote economic growth, published figures revealing that the productivity gap between Britain and other advanced economies, including the United States, Germany and France, was not as big as had been previously assumed.

The average British worker, the OECD revealed, was only 8% less efficient than the average American worker, instead of being 16% less efficient.

The average British worker was now only 11% less efficient than the average French worker, down from the previous 19%. And, compared with the typical German worker, the typical British worker was now only 14% less efficient rather than the previous 22%.

All of which was very encouraging and particularly for the Treasury. Perhaps the UK’s dreadful record on productivity – economic output per hour worked – was not as bad as previously assumed?

Today, though, the Office for National Statistics has brought everyone back down to earth. It reports, in its latest assessment, that productivity from July to September last year was just 0.2% higher than during the same three months in 2017.

It represents the slowest rate of growth in productivity in two years.

On a quarter-on-quarter basis, productivity was actually down 0.4% on the previous three monthly period between April and June, during which it had bounced back from the snow-affected first three months of last year.

Productivity in the public sector, meanwhile, has fallen in each of the last four quarters on which the ONS has reported. Productivity in public services is now back where it was in 2013 as a result.

To put these numbers into context, prior to the financial crisis, productivity was growing at around 2% per year.

So what’s behind these latest numbers? Part of the problem appears to lie in the services sector, which accounts for more than three-quarters of UK GDP. In the latest quarter, output per hour in the services sector rose by just 0.1%, with output rising only slightly faster than the number of hours worked.

By contrast, in the manufacturing sector, productivity rose by 1.7% – with the number of hours worked falling while output still increased.

As Howard Archer, chief economic adviser to the EY ITEM Club, put it: “The relapse in the third quarter of 2018 reinforces concerns over the UK’s overall poor productivity record since the deep 2008-09 recession.”

They certainly will.

A country’s ability to raise its living standards – to pay its workers more – ultimately depends, in the long term, on its ability to raise its output per worker. Britain’s lacklustre record has long been a source of frustration in the Treasury.

There are a number of possible explanations for why productivity growth remains so sluggish.

One is that, while unemployment is at levels not seen since the end of 1974 and the beginning of 1975, many of the jobs created since the crisis have been low-skilled.

Another is that, with wages growth low, many employers have had comparatively little to gain by laying off their less productive workers. Weak business investment, itself reflecting the uncertainty currently hanging over the economy, has undoubtedly been another factor.

And, with interest rates still at close to their all-time low, many ‘zombie companies’ stagger on, able to meet their interest payments but never to reduce their debts, stifling growth.

In previous recessions, such businesses would have gone to the wall, freeing up employees and other resources, such as capital, to be deployed in more efficient competitors. The continued existence of such zombie companies stifles growth.

That is not to say that a solution cannot be found.

Tony Danker, chief executive of Be The Business – the business-led campaign group that seeks to close the productivity gap – argues that, with the labour market continuing to be tight, companies will have no option but to invest.

He said: “With employment levels continuing at historical highs, business owners will increasingly struggle to hire their way to growth. Our business community must see this as an opportunity to tighten processes and invest to close the gap with more productive competition from overseas.”

Another cause for concern is that, while productivity growth remains sluggish, earnings have finally started to pick up.

The ONS also reported today that unit labour costs, a measurement of how much it costs employers to produce a certain level of output, rose at an annual rate of 2.8%. This was the fastest in 18 months but comfortably below the average growth rate of 4% that was seen before the financial crisis.

However, unit labour costs are a key indication of inflationary pressures, while the Bank of England, in its most recent forecasts in November, said it was expecting them to grow by 1.75% for the whole of 2018.

So the fact they are rising by more than expected might, under normal circumstances, persuade some on the Bank’s Monetary Policy Committee to think harder about raising interest rates.

The ‘productivity puzzle’, as it has been dubbed, remains as vexing as ever.

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