What's behind Britain’s fall in productivity?

What's the issue?

The British economy continues to stagnate. GDP contracted by 0.3% in the last quarter and hasn't reached its pre-crisis peak for over five years, making this the longest slump in modern British history. Yet unemployment in the three months to the end of November fell to 7.7%, the lowest level for nearly two years. The number of people in work has also risen to the highest levels since records began in 1971.

The government has welcomed these "very positive figures". But they mask a worrying trend: according to the Office for National Statistics (ONS), output per hour worked continued to increase throughout the 1973, 1979 and 1990 recessions. However, this time it continues to languish below 2008 levels. Is Britain facing a productivity crisis?

Can we trust the data?

The contrast between the weak GDP figures and relatively strong employment data has led many, including the British Chamber of Commerce, to question the reliability of the GDP figures. Allister Heath notes in City AM that GDP figures are "spuriously accurate" and often "subject to shockingly large revisions", long after the initial figures come out. However, such concerns are hardly new and don't explain why it has taken so long for the economy to recover this time.

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Others have queried the employment statistics. The Institute of Public Policy Research (IPPR) claims that "hidden unemployment" is a serious problem. The IPPR argues that the figures are being artificially boosted by "the self-employed, unpaid family members and people on government work schemes". However, the evidence for this is weak (see below).

How can firms keep hiring in a weak economy?

The most obvious reason is because wages have been stagnating, or even falling. According to the ONS, average weekly earnings growth was 1.3% in November, compared with the same time last year, well below the rate of inflation of 2.7%.

Even sectors with faster-growing wage rates, such as the public sector, which grew by 1.9%, and retailing, hotels and restaurants, which went up by 2.3%, are experiencing real (post-inflation) wage cuts, while nominal (pre-inflation) wages continued to fall in construction and finance.

According to the National Institute for Economics and Social Research (NIESR), in many workplaces managers have responded with changes in their staffing practices, with a third (33%) of employees seeing their wages frozen or cut. More than 25% of workers have also had to work longer hours for the same pay.

So why the productivity drop?

Stewart Lansley of Bristol University, writing in The Guardian, thinks the major reason for the slow increase in output has been a lack of investment, with firms holding too much cash. He thinks they should be forced to "use this hoarded money to finance a desperately needed investment boom".

But Ben Broadbent, an external member of the Bank of England's Monetary Policy Committee, points out that the investment rate is still above 10% of GDP, suggesting that underinvestment isn't the problem. Instead, he blames the misallocation of capital by banks and capital markets.

Dearer energy and depressed domestic demand should have resulted in more lending to the energy-efficient and export-orientated sectors. Instead, banks have used cheap funds generated largely by low interest rates and quantitative easing to prop up troubled firms, particularly in the consumer sector.

This has protected jobs and encouraged capital-starved firms to hire more workers rather than buy new equipment. But it's also meant that capital investment has been in areas with low returns, hence the relatively low productivity. Evidence of capital being misallocated in this way comes from the fact that, while rates of corporate failure and start-ups surged above 20% in the early 1990s, this time they are both less than 15%.

Will unemployment remain low?

That seems unlikely. The Daily Mail's Becky Barrow notes that, even if restrained wage growth has succeeded in preserving jobs, the reduced purchasing power "is fuelling the crisis on the high street". Economist Spencer Thompson writes on Leftfoodforward.org, a blog, that if the same problems that have seen several high-profile retailers go bust were to spread to smaller firms, "the potential effect could be serious".

Deloitte, a consultancy firm, reports the number of retail bankruptcies went up 6% last year and is 18% higher than in 2010. It claims "2013 is likely to be marked by further closure programmes within and outside of formal insolvency processes". That can only be bad news for jobs.

Is the way we work really changing?

The IPPR think tank claims that employment figures are being flattered by changing work patterns. But is that right? It notes that the number of self-employed people has gone up by 10% since 2008, yet there hasn't been a large rise in the proportion of working people who are self-employed, or a big shift from full-time to part-time work. In the three months up to last November, 85% of people in work were employees of a firm, compared with 86% for the same period in 2007. Similarly, the proportion of part-time workers has only risen from 25% to 27%.

Although they say the proportion of temporary and part-time workers who can't find a full-time job has risen from 25.7% and 9.5% respectively in 2007 to 39.7% and 17.5%, they only represent a fraction of the workforce. In summary, we are employed in much the same way as we were five years ago.