Britain’s productivity puzzle

Growth in output per worker is slowing globally, but the issue is acute in Britain, where low-paid and part-time work is on the rise. Why, and what can be done? Simon Wilson reports.

What's the issue?

Ten years after the global financial crisis, labour productivity growth remains weak in many countries, and the UK in particular. This matters: weak growth in productivity ie, output per hour worked is a major drag on "real" (after-inflation) wage growth (if workers do not produce more per hour, companies can't afford to raise pay) and economic growth. That in turn means lower tax receipts and weaker public finances. As economist Paul Krugman put it in 1994: "A country's ability to improve its standard of living over time depends almost entirely on its ability to raise its output per worker". But while economists all agree that productivity is key, they are not sure on what exactly is behind its apparent stagnation.

What are the figures?

UK productivity rose sharply in the third quarter of 2017, but it has grown by just 0.6% over the past 12 months, according to the Office for National Statistics. Prior to the financial crisis, it grew at 2% a year. Global productivity growth has been low since the 1980s, but the issue is especially acute in the UK, where output per worker per hour is below the likes of Ireland, the US, Austria, Germany (36% lower), and even France (29% lower).

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But at least unemployment is low?

Britain's jobless rate is at its lowest since the 1970s, in part because firms have invested in people, rather than technology, helped over the past decade by the UK's attractiveness to lower-wage migrant workers. Unemployment also rose less severely in the wake of 2008 than in several EU countries. But many of these jobs are low paid or part time. Since 1999, Britain has been good at raising its minimum wage without incurring job losses. But it means that far more workers today are in low-wage jobs, in low-productivity sectors such as hospitality and retail, than before.

How many more?

In 1999, 3.4% of jobs paid the minimum wage. Last year, it was 7.1%. This bulge at the bottom of the income scale makes it harder for people to climb up, damaging both social mobility and productivity. Then there's our convoluted tax credit system, which MoneyWeek has long argued disincentivises productive investment by allowing firms to pay less than they would otherwise have to. It also encourages part-time work; another factor that may hit productivity.

Is it all just a measurement issue?

"The idea that there is a global productivity crisis that real wealth is not increasing is nuts," says Hamish McRae on ThisIsMoney. Innovations such as smartphones have increased productivity greatly, but in ways that are hard to measure, compared with factory output, say. For example, between 2010 and 2015, UK data usage rose ninefold, but because the cost of delivery had plunged, the official figures suggested the output of the telecoms industry had fallen by 4%. Yes, the UK still has to use its people more efficiently, says McRae. But "I suspect that we are not laggingas badly... as the experts think". The Bank of England has estimated that mismeasurement may account for about a quarter of the productivity shortfall.

What other explanations are there?

Some argue that low interest rates have allowed unproductive "zombie" firms to stay afloat, buoyed by cheap borrowing. Others blame the cost of innovation: breakthrough technologies are becoming more costly and labour-intensive to develop. Still others focus on slower rates of "diffusion" of innovation and good practice from "frontier" companies to the laggards. For example, the Bank of England's chief economist Andy Haldane argues that Britain has an unusually "long tail" of low-productivity firms (which may not even be aware of the fact that they are underperformers), where even tiny improvements across the board would add up to a big national boost.

Any other suggestions?

These arguments all have something to them, but the fundamental issue, argues economist Andrew Smithers, is soaring executive pay. As Smithers notes, weak productivity is ultimately due to a lack of investment, which makes companies less efficient and less competitive over the long run. This in turn is driven by skewed incentives at board level, where pay has ballooned over roughly the same period as productivity has weakened.

A CEO can make so much money in such a short space of time that the managers who run today's listed corporations are less worried about the long-term problems caused by low investment, than they are about hitting short-term profit targets to secure their bonuses. So it's always safer and easier for them to cut or neglect investment, in favour of boosting profit margins temporarily. This inefficiency also drives up prices for consumers. In a letter to the FT in August, Smithers called for government intervention, arguing that "the bonus culture discourages investment; its impact is similar to a decline in competition. Both benefit shareholders at the expensive of the economy".