Why productivity won’t recover to pre-crisis levels

A few weeks ago we speculated here that one of the main reasons for Britain’s falling productivity was the decline in the number of people employed in the financial sector.

Whether you approve of its particular brand of productivity or not, we said, people who work in the City are, statistically speaking at least, highly productive. In plain GDP terms, one investment banker operating in a good environment is many times as productive as, say, a car plant worker.

At the moment, City activity is, on some measures at least, at a ten-year low. Look at it like that, and it makes sense that productivity is also low – we are employing more people, but they are producing less.

When we wrote this we didn’t have any evidence for it – it just seemed like a reasonable explanation. So it was good to see City AM’s Allister Heath referring to a new paper out from Douglas McWilliams of the CEBR in his editor’s letter. You can read the whole paper here: We should not get so worried about the productivity shortfall.

The key point (to me at least) is that “in some sectors, especially financial services, measured productivity in 2007/8 gave a misleadingly high estimate for productivity since it reflected an unsustainable position (often for example including as output profits that subsequently not only had to be written off but had to be offset by huge provisions).”

So a “significant” part of the explanation for the apparent fall in productivity growth is that the fast growth from 1997 to 2007/8 (2.2% a year) was too good to be true. It reflected not real sustainable GDP growth but froth; froth that is now being “squeezed out” as we deleverage and the City normalises.

The good news? Economists can now stop fretting about why productivity is falling – McWilliams appears to have nailed it. The bad? We can’t expect an automatic “bounce back” to 2008 levels of productivity to make everything ok.