Britain’s productivity crisis: beware all the usual simplistic solutions
Too few economists seem prepared to accept that at least some of the UK’s productivity shortfall was a good thing
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9:37PM BST 21 Apr 2015
81 Comments
We keep being told, with some justification, that Britain’s greatest economic weakness is its poor productivity. The average worker doesn’t produce enough output for every hour that they work; given that our pay is directly connected to the marketable value of the output we generate, this helps to explain why wage growth has been sluggish over the past few years.
The numbers certainly make grim reading. The latest release from the Office for National Statistics reveals that output per hour fell by 0.2pc in the fourth quarter of 2014 compared with the previous quarter. For last year taken as a whole, labour productivity remained at roughly the same level as it was in 2013; depressingly, this was slightly below the level seen in 2007, prior to the recession and financial crisis.
Research by the Conference Board for the Financial Times showed a similar pattern. Total factor productivity – which includes not just the contribution of workers but also of capital and management – fell by 0.1pc in 2014, by 0.4pc in 2013 and by 1.5pc in 2012. This was the first time since 1992 that the UK has suffered three consecutive annual falls on this measure. The situation is almost as bad in France and Germany, which registered a much bigger drop of 0.6pc and 0.3pc last year but which have done better than the UK since 2010.
I agree, as a general point, with the view that the UK’s productivity growth has been far too weak. But there is one big caveat that is too rarely made. Too few economists seem prepared to accept that at least some of the UK’s productivity shortfall was a good thing. It happened because a large number of low productivity workers found work in the UK, dragging down the average. Similar workers have not been able to get jobs in other countries.
To see why this matters, consider the following thought experiment: imagine two countries with identical economic characteristics and where the bottom 10pc of workers contribute 5pc of output. In the first country, a new law is passed banning them from working. They all lose their jobs, GDP drops by 5pc – but productivity shoots up by 5.5pc. Now imagine that all these workers move to the second country and immediately find work. That economy’s GDP goes up by 5pc, but because the number of workers rises even faster, average productivity falls by 4.5pc.
What country would you prefer to live in? The one being cheered by economists for its buoyant productivity and high-wage model, or the one with booming employment, where migrants, the young and labour market outsiders all find work? I would plump for the second without a second’s hesitation. I’m exaggerating, of course, but the UK has behaved a lot like the second kind of country in recent years, and countries like France or Italy like the first kind.
I’m not for a second claiming that we don’t have also have a genuine and extremely large productivity problem, merely that it has been exaggerated by the astonishing private sector jobs miracle of the past few years.
It is vital, as the election campaign enters its final weeks, that the politicians’ proposed solutions tackle the real issues. For a start, anything that reduces the labour market flexibility that has created so many jobs should be resisted. It is also time for a proper investigation into the role of in-work benefits: do they push down wages in a meaningful way, and are therefore a subsidy to firms, or do they subsidise people who otherwise wouldn’t work (because what they could earn is too low to sustain them)? If the second, as I suspect, what supply-side solutions could be used to make sure that they are able to earn more and require fewer subsidies? Clearly, these will need to involve dramatically improved vocational training and, for the long-term good of the economy, much better education.
Improving and enhancing the UK’s infrastructure ought to be good for productivity, but only if done in the right way. Building useless government-financed projects with costs greater than their benefits isn’t the answer, which is why I’m sceptical of those who blame cuts to the Government’s capital expenditure budget since the crisis for the slowdown in output per worker. The UK government has been short-termist for decades now, privileging current expenditure over capital spending, which is a good reason why as many important decisions as possible need to be depoliticised; but some of the figures that are often cited as proof of this exaggerate the trend by failing to control for the impact of the privatisation of industry, utilities and housing.
Some government capital projects that have been cancelled since the crisis would have boosted productivity; many merely represent a form of disguised consumption. The HS2 high-speed rail project would be a waste of money. By contrast, allowing the private sector to expand London’s airport capacity would add a vast amount of value.
The UK has a problem with mobility: it takes too long to travel. Pricing road use properly, rather than hitting motorists randomly through fuel duties and other taxes, makes sense – but it would be a terrible error merely to seek to suppress demand, rather than trying to bolster capacity. The UK must tap into the private sector’s appetite for financing long-term infrastructure projects.
HS2 high-speed rail project
Infrastructure spending should not be seen to be synonymous with government spending, and especially not with the variety focused on buying votes in marginal constituencies. Like in the 19th and early 20th century, we need to unleash the forces of entrepreneurship and competition on all kinds of capital projects, from transport to energy.
Insurers need to match long-term liabilities with predictable, long-term cash flows; contrary to the received wisdom, this allows them to think in a longer-term way than politicians and to finance multi-decade capital projects.
Excessive regulations are also a major barrier to productivity. Vast amounts of time and resources are diverted to economically useless activities. Perhaps the single most pernicious regulations in the UK today are those surrounding land use: they have pushed up property prices by at least a quarter, imposing huge costs on families and companies.
Last but not least, the public sector itself needs to embrace technology to improve its own efficiency. Britain faces a massive productivity challenge, for all of the caveats I mentioned at the start of this article. But governments of all stripes must ensure they make the problem better, rather than worse.
allister.heath@telegraph.co.uk
