More on UK Productivity

This is from the Deloitte Monday Morning Briefing, so some of you (all?) should have looked at this. Even if there is no direct question on productivity in the exam (strong chance there will be, it is a very testing question that will give the examiners good visibility on wider understanding), you can bring material in for other questions - policy, inflation, inequality...

A personal view from Ian Stewart, Deloitte's Chief Economist in the UK. Subscribe to & view previous editions at: https://urlsand.esvalabs.com/?u=http%3A%2F%2Fblogs.deloitte.co.uk%2Fmondaybriefing%2F&e=5b966a0a&h=87ec49bf&f=n&p=y

* It’s official, the UK growth outlook has taken a turn for the worse. By far the biggest news in last week’s budget was the downgrade in the Office of Budget Responsibility’s (OBR) forecast for UK productivity growth over the next four years, from an average of 1.6% to 0.9% a year.

* There is no consensus about why UK productivity growth has been so weak in recent years. But with the under-performance running into its sixth year, and other countries struggling with similar problems, the OBR has thrown in the towel and accepted that the days of rapid productivity growth are over.

* The OBR downgrade points to much weaker growth ahead.  Just two years ago the OBR thought that the UK economy might be able to grow by 2.5% a year. Today that figure stands at 1.5%. 

* At the risk of piling on the pessimism the OBR’s new growth numbers do not take account of the all the effects of Brexit.

* As Paul Johnson, director of the Institute of Fiscal Studies said last week, these new forecasts, “suggest that GDP per capita will be 3.5% smaller in 2021 than was forecast less than two years ago, in March 2016. That’s a loss of £65 billion to the economy. Average earnings look like they will be nearly £1,400 a year lower than forecast back then, still below their 2008 level. We are in danger of losing not just one, but getting on for two, decades of earnings growth”.

* To put it mildly, this is gloomy stuff.

* The downgrade to the OBR’s view of UK productivity is understandable. For the last few years its forecasts have erred on the side of being too optimistic. But is there a chance that the OBR has become too pessimistic?

* Here are some things which might, just, go right for the UK in coming years.

* One likely culprit for the UK’s productivity problem is the way in which sluggish wages and a plentiful supply of workers have encouraged firms to build capacity using employees rather than through investing. Far from machines taking peoples’ job, the amount of capital deployed per employee has fallen in recent years. That helped push employment to record highs but has almost certainly dampened productivity. Today, with unemployment at a 45 year low and Brexit on the horizon the era of easily available labour may be coming to an end. Added to this is the way in which policies introduced in recent years, such as pensions auto-enrolment, the apprenticeship levy and the National Living Wage, are adding to the cost of labour. The incentives for companies to make productivity-enhancing investments are likely to sharpen as labour becomes scarcer and more expensive.

* A tighter labour market also strengthens the hand of workers and, by increasing the rate of job changing, speeds the diffusion of knowledge across the economy. Meanwhile gradual rises in interest rates will put pressure on lower productivity businesses to up their game or quit the field. 

* There is a lot of gloom about the capacity of new technologies to raise productivity. Yet history shows that the effects of technological improvements on growth come it fits and starts, often with long lags. Despite rapid developments in IT productivity growth disappointed in the 1970s and 1980s, prompting the quip from the US economist Robert Solow that, “you see the computer age everywhere but in the productivity statistics”. By the 1990s the productivity and growth numbers had caught up and the general view was that we had entered a new area of faster, technology driven growth.

* We may be in a Solow moment today. We see technology at work at all around and, through innovations such as AI, driverless cars and Blockchain, more is to come. But, as in the 1970s and 1980s, we don’t yet see it in the productivity data.  

* Productivity growth is not something we have to live with, determined, like the weather or the tides, by forces entirely beyond human control. Much lies in the hands of management, something which is underscored by the varying profit and share price performance of different businesses. Recent research by the UK’s Office for National Statistics shows that foreign owned firms operating in the UK are 74% more productive in terms of the value of output per worker per hour than equivalent UK firms. The implication is that the application of new techniques and ideas across sectors, particularly from larger to smaller firms and from foreign to UK businesses, could raise productivity.

* Nor is government powerless. Zimbabwe and Venezuela shows what happens to growth when governments get things badly wrong, but careful reform, pursued over years, can reboot growth. Thus Mrs Thatcher’s reforms in the 1980s helped arrest the alarming decline in the UK’s growth rate. Chancellor Schroder’s shake up of German labour market rules in the early 2000s helped turned Germany from a high to a low unemployment nation. 

* After years of disappointments optimism about UK productivity is low. Yet history shows that productivity growth comes in waves. In the 1930s in the wake of the Great Depression the US economist, Alvin Hansen, argued that technology and population-driven growth was played out and the US had entered a new era of low growth. Three decades of unprecedented growth followed.

* Economic forecasts, especially long term ones, are fallible. Productivity growth is not predestined. Business and government should view the OBR’s forecasts as numbers to be beaten – not a self-fulfilling counsel of despair.