UK: Deloitte Monday Briefing: The UK’s Productivity Puzzle - Producing Less With More People

The Monday Briefing, written by Ian Stewart, Deloitte's Chief Economist in the UK, gives a personal view on topical financial and economic issues.

• One of the bright spots of the UK's economic performance in recent years has been the strength of the labour market. Output has slumped, but the number of people in work has risen. This has softened the human cost of the UK's deepest recession since the 1930s. But with more people producing less, the result has been a sharp decline in productivity.
• In the last five years the total output of the UK economy has fallen by 2.9% and employment has risen by 0.7%. As a result, productivity, or the volume of goods and services produced by each working person, has fallen by 3.6%.
• US productivity has soared through the downturn but the UK can, perhaps, take some comfort from the fact that productivity growth in Italy, France and even Germany has been weak in the last few years.
• Declining productivity hits competitiveness and makes it harder for the UK to export its way back to growth. Poor productivity helps explain why, despite the large, 30% devaluation in the pound in 2007-08, the UK's export performance has been so poor.
• If low productivity is here to stay the UK has a long term growth problem. Understanding the causes of the productivity conundrum is vital to gauging the UK's growth potential.
• Some argue that the growth in labour intensive, lower productivity services and the decline in manufacturing have hit UK productivity growth. Yet manufacturing has been declining as a share of the economy for more than 30 years and this hardly seems a plausible explanation of the UK's recent productivity performance.
• Another potential explanation is that when the recession hit employers hung onto surplus workers in the hope of a quick rebound in growth. The aim was to avoid the cost of laying off staff and then having to rehire them as growth returned. This may explain the resilience of employment in 2008-09. But it does not explain why, four years later, and against a backdrop of a weak and uncertain growth, employers have continued to hire.
• But there is an alternative labour market explanation which, to us, seems more plausible. The willingness in this cycle of employees to accept lower real wages and changed terms of work has enabled business to squeeze wage costs and hold on to more workers. A lower marginal cost of labour seems may well have resulted in a lower marginal return to labour. Yet this effect seems likely to reverse as the economy, and wages, start to rise.
• Some observers believe low UK productivity may be a function of the rise in the number of "zombie companies" – weak and inefficient companies which are able to survive thanks to low interest rates and a supposedly more tolerant attitude to corporate borrowers by banks.
• This may explain some of the UK's poor productivity performance. However, the point of low interest rates is to keep companies that have a viable long-term future in business while demand is temporarily weak. As the demand recovers many of these "zombie" companies are likely to revive.
• For us an obvious explanation for low productivity is that this recession has hit finance, a high productivity sector, very hard. As a result the economy has been more dependent on low productivity sectors, such as the public sector, and this has slowed whole-economy productivity. If the global financial crisis has caused a lasting shrinkage in the UK financial services sector this would represent a permanent loss of productivity to the economy. This strikes us as a serious risk.
• But for us the most likely principal cause of the UK's poor productivity performance is that companies have been investing less. The resulting deterioration in the UK's stock of tangible and intangible assets – from machinery and buildings to highly trained workers and research and development – has made employees less productive.
• If this is the case then a revival in capital spending would reboot productivity. It is, perhaps, no coincidence that US productivity and investment have held up well in recent years. Collectively UK companies have ample reserves of cash. The largest businesses, which are the main drivers of capital spending, have good access to credit. The corporate sector probably has the means to invest and, with existing capital assets wearing out, they have a growing need to do so. Our hunch is that the next few years are likely to see stronger capital spending which will give a fillip to productivity.
• So we think that, on balance, the UK's dire productivity performance is likely to reverse as growth comes back. If we are wrong the economy is in a much bigger hole than most people think.

MARKETS & NEWS

UK's FTSE 100 ended the week up 2.2%.

Here are some recent news stories that caught our eye as reflecting key economic themes:

KEY THEMES

• The UK economy grew by a better-than-expected quarterly rate of 0.3% in the Q1 2013
• The US economy grew at a slower-than-expected annualised rate of 2.5% in the Q1 2013, although consumer spending was stronger-than-expected
• Measured US output will rise by as much as 3% in July due to a revision in how GDP is calculated with 'intangible assets' such as spending on research and development and film royalties included in capital spending for the first time
• The decade between 2001 and 2011 saw the first fall in the proportion of British people owning their homes since 1918, with 64% of people owning their homes in 2011 compared to 69% in 2001, according to data from the ONS
• Italian benchmark bond yields fell below 4%, their lowest level since November 2010
• Spanish banking group Bankia, which required a bailout last year, announced profits of €74m in the first quarter of 2013
• Spanish unemployment rose above 6 million for the first time, with 27% of the workforce unemployed
• Russian tycoon Alisher Usmanov, who owns almost a third of Arsenal football club, has been named as the UK's richest man, displacing Indian steel magnate Lakshmi Mittal at the top of the Sunday Times Rich List
• Reuters reported that Japanese banks are hiring Spanish-speaking bankers to win new business in Latin America as they search for higher returns abroad
• Bill Gross, manager of the world's largest bond fund for Pimco, criticised European austerity by claiming that "the UK and almost all of Europe have erred in terms of believing that austerity, fiscal austerity in the short term, is the way to produce real growth"
• The UK government confirmed that it would be putting its one-third stake in the uranium enrichment company Urenco up for sale in the 2013-14 financial year, potentially raising up to £3bn
• Online gambling group Betfair rejected a £910m indicative proposal from CVC Capital Partners
• The planned sale of 610 branches of Lloyds Banking Group to the Co-operative Group fell through, with the Co-op citing the worsened economic outlook and increased regulatory environment
• Apple reported its first quarterly fall in profits in a decade, with net profits of $9.5bn in Q1 2013, down from $11.6bn in Q4 2012
• Korean firm Samsung Electronics announced record first quarter profits, with net profits having risen 42% compared to a year earlier, driven by strong smartphone sales
• Spending on beauty and personal care products has increased by 11% per person since the start of the credit crisis in 2007, according to the latest British Lifestyles report from Mintel
• Racecourse owner the Jockey Club has launched the first retail bond in British sport, where investors can invest between £2,000 and £100,000 in the Racecourse Bond, paying the equivalent of 7.75% interest a year before tax
• Sandwich chain Pret a Manger revealed that the most popular item on their menu is the banana, selling around 75,000 of the fruits every week – Pret a Peel

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.