The Productivity Puzzle: Lacking in labour

Machines productivity factory 2
By Michelle Perry, CA magazine

21 August 2018

Economics tells us that the solution to one problem may itself be the cause of the next problem. As such, the UK’s success in apparently tackling the issue of unemployment could be contributing to another long-term challenge - productivity.

The “productivity puzzle” hitting the UK refers to the economy's inability to substantially boost productivity since the 2008 global recession, compared with other developed nations such as France, Germany and the US.

Hopes of an imminent improvement endured further setbacks in the early summer of this year with the impact of several escalating issues:

  • some of Europe’s biggest industrial companies warned they would not invest in Britain while uncertainty remained over the terms of its exit from the EU;
  • the CEO of HMRC said business could face up to £20bn in extra costs as a result of Brexit;
  • and major parts of the UK train network, particularly in the north of England, crumbled into near-chaos following the introduction of a new timetable.

Vital ingredients to improving productivity include business investment, an efficient transport infrastructure, a robust training and education system, the dissemination of best business practice and a skilled workforce.

I don’t think anyone knows why UK productivity has been so bad. - Howard Archer

Many economists acknowledge that given the complexity of productivity no one truly knows how to fix it – otherwise the puzzle would surely have been solved by now.

Howard Archer, Chief Economic Adviser, EY ITEM Club, commented: “I don’t think anyone knows why UK productivity has been so bad. There are lots of different factors put forward - some structural and some cyclical.”

Why is productivity so important?

Productivity ultimately determines the wealth we have as a nation and therefore our standard of living. At present, productivity is particularly vital because Britain is at a point where the supply of labour in many sectors is failing to meet demand. This is why the UK’s employment rate is so high, despite weaker economic growth compared to other developed nations such as France or Germany.

The UK’s departure from the EU will make the UK’s resources even tighter because of the immigration restrictions likely to be introduced. “Which is all the more reason why we need better productivity so that we can produce more with even fewer people in the UK,” stated Yael Selfin, Chief Economist with KPMG.

In January the Office for National Statistics (ONS) reported that UK employment hit 75.6%, the highest level since records began in 1971.

In the UK, growth in output per hour worked plummeted after the 2008 recession and has never fully recovered

France’s employment rate is currently 65.7%, while Germany’s is around 68%; both of these economies are, however, growing marginally faster than the UK’s and both have higher productivity levels.

In the UK, growth in output per hour worked - the most popular measurement - plummeted after the 2008 recession and has never fully recovered. According to the ONS, productivity in Q4 2017 was 16.4% below its pre-downturn trend - or, equivalently, productivity would have been 19.6% higher had it followed [its] pre-downturn trend”.

Yael said: “It’s not only that the productivity level in the UK is low. It’s also increasing by less, which means that the gap is getting wider in terms of performance, which is not good news.”

A much-needed sharp pick-up in productivity in the second half of 2017 was swiftly followed by a disappointing and marked decline in the first quarter of 2018.

According to the statistics office, output per hour fell 0.5% quarter-on-quarter in Q1 2018 - the sharpest fall since Q4 2015. Conversely, productivity had gained 0.7% quarter-on-quarter in Q4 2017 and 1% quarter-on-quarter in Q3 2017.

So what is the UK’s problem?

One of the biggest issues in terms of productivity is the labour market. Given the high level of uncertainty since the global financial crisis, companies have retained and hired more staff as a way of producing more, rather than investing in new technology and/or developing their workforce.

“What we’ve seen in the last 10 years is businesses increasing their output by hiring more workers, rather than being more efficient, because they haven’t made the necessary investments,” explained Tej Parikh, Senior Economist at the Institute of Directors.

He added that this current level of underinvestment is compounded by the fact “the UK has a legacy of underinvestment from both the private and public sector”, which is probably explained by the abundant availability of cheap labour in the past few decades.

“It’s always lagged behind in terms of R&D investment as a portion of GDP,” Tej concluded.

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