Britain’s productivity puzzle solved

Why is it that UK productivity growth is so much lower than that of other developed nations? Most countries have lower than expected productivity and various explanations have been produced for this but the fact that the UK is performing uniquely badly is something no one seems to understand. It's a "puzzle." Or so we keep being told.

But it hasn't ever seemed like much of a puzzle to us. Surely, we have written many times over the last decade, if you provide an economy with an almost endless supply of cheap labour as the UK government has, employers will use it instead of investing in any kind of productivity raising automation?

The UK has seen high net immigration since the 1998 (the new Labour government was keen) and exceptionally high net immigration since 2004 when the UK was one of the very few EU countries to give instant freedom of movement to all of the new east bloc members. Think a net of about 275,000 a year (the numbers post-2008 were pushed up again by the arrival of southern Europeans desperate for work post financial crisis).

Cheap labour has hampered productivity growth

The official view against what Charles Dumas in his book Populism and Economics calls "the obvious economic reality that increased supply depresses the price of any commodity" has been to produce studies showing that any impact of the arrival of the new workers was "small and confined to low income jobs." However, the lack of consideration for those in low income jobs already aside, you can argue (as a footnote in one of the most cited studies does) that "there is a weaker adoption of advanced technology which is complementary to skilled labour in the presence of large numbers of the unskilled." Well quite.

The problem with the studies into the matter is that they do not cannot (how can you put a number on it?) take account of the perfectly reasonable tendency of employers to hire cheap labour when it is available rather than to invest in all the things that raise productivity and, of course, real wages. The existence of workers who will take low wages effectively create low wage jobs.

It's worth noting as we have before that in the UK this isn't just about cheap EU workers. Their arrival came hot on the heels of Gordon Brown's tax credit expansion which effectively incentivised people to work part time, however low the wage, in order to be topped up by the credit system.

But add it all up and you will see why it probably is that the UK lags behind most other developed countries in, for example, robotics and automated farm equipment (check out how they do farming in the Netherlands).

This matters. Governments may be interested in overall GDP numbers, but the rest of us don't care about that. We care about individuals about GDP per head. To us, progress is not lots of new people arriving, being paid a little and bumping up UK GDP. It is prosperity rising for everyone GDP per head going up.

Things are changing as labour shortages bite

Good news then, that as much as the Bank of England, likes to talk about the productivity puzzle, some of their staff seem to agree with us on at least part of its cause. In a blog post here, Will Holman and Tim Pike note that "a common thread in the post-crisis period had been that, when looking to expand their productive resources, companies chose recruitment over business investment. This included both direct' (eg shopfloor) and indirect' (sales, marketing, R&D) employees. In part that reflected a change in the relative costs of labour and capital. Strong growth of labour availability was associated with low real wages growth."

They also observed that as a result of the "large inward migration of employees from Eastern Europe...the composition of the economy and workforce pivoted towards lower value-added services and jobs, resulting in downward pressure on average wages and productivity levels" (there's another blog post from them here on this) .

So far, so perfectly obvious (to us anyway). However, things are now changing. The Bank's regional offices report that, as labour shortages begin to bite and pay pressure rises "increasingly, the focus of many companies is turning to investment in labour-saving plant and machinery to raise productivity and alleviate resource bottlenecks. This recent pivot towards business investment to overcome greater labour scarcity is being aided by some major advances in technology, which are increasing the returns from investment relative to those from recruitment. Robotic technologies in particular are being deployed in a mix of manufacturing and service industries, at relatively low cost and often with payback periods of less than five years. Usually, the working life of the equipment being deployed is greater than five years, making the investment extremely attractive."

So there you have it. When the supply of labour rises and that labour is cheap, employers create low paid, low productivity jobs. When the supply is tight and the price of labour rises, they go for productivity instead. Part of the puzzle solved and with a bit of luck part of the problem also solved.