UK: Some Thoughts On The Productivity Paradox

Last Updated: 9 June 2015
Article by Ian Stewart

There is a lot of talk in the media and among policymakers these days about Britain's poor productivity record. It is a vital subject. Productivity, or increased efficiency of production, is the big driver of human welfare. As Paul Krugman, the Nobel laureate and New York Times columnist famously said, "Productivity isn't everything but in the long run it is almost everything".

But before examining why productivity has stalled it is worth thinking about this puzzle in another way. Productivity measures output per worker. During the financial crisis output slumped. But instead of the mass redundancies that were expected, companies hung onto employees.

Unemployment rose, but nowhere near as high as in the milder recessions of the early 1980s and early 1990s. The flip side of Britain's productivity problem is that more people have stayed in work through the biggest downturn since the 1930s. In terms of human welfare this is surely preferable to sustaining productivity by pushing hundreds of thousands into unemployment. The "productivity crisis" and Britain's success in preserving and growing employment are two sides of the same coin.

Keeping people in work through the downturn has helped maintain skills, experience and contact with the world of work. Indeed, it was this reason that many employers avoided mass lay-offs during the recession. In this way, at least, the standstill in productivity of the last few years may actually contribute to future growth in productivity.

Weak productivity during the downturn had a silver lining, in terms of job preservation. But the downturn has long since ended and productivity growth remains weak. This is a global phenomenon, but the UK has done especially poorly.

Before the downturn, output per worker in the UK rose year in, year out, by about 1.8%. Since 2008 output per worker has stopped growing. The Bank of England estimates that if the pre-crisis trend had continued productivity would be 16 percentage points higher today.

According to analysis carried out by the Financial Times around three quarters of the fall in productivity is due to four previously high productivity sectors – the professions, telecommunications, manufacturing and banking.

So what's gone wrong?

One comforting theory is that output has been underestimated in recent years and, as a result, we are underestimating productivity growth. Certainly GDP numbers are choppy and prone to revision, often years after the event. If GDP gets revised up – and it often does – the UK's productivity performance will look better. Another angle on this theme is that technology is raising welfare in ways that are not being picked up in conventional measures of economic activity – so, for instance, people getting free music and videos via You Tube or using the services of Google Maps.

But for us a leading suspect in this story is that the financial crisis made credit hard to come by, companies became risk averse and investment and innovation collapsed. 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 will, in time, reboot productivity. 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. At the same time, rising demand will mean more work for existing employees – who during the downturn might have been involved in internal projects, marketing and bidding – and this will reinforce the recovery in productivity.

But some of the weakness in productivity may well prove more deep rooted. Richer countries are shifting to services where the scope for raising productivity is far lower than in manufacturing. (As the US economist William Baumol has noted, it takes the same number of musicians to play a Beethoven string quartet today as in the nineteenth century; the productivity of classical music performance has not increased). Emerging economies may be approaching the end of a period of rapid economic catch-up based on using Western innovations, techniques and technology.

The gloomiest argument in this debate is that today's technologies are less productivity-enhancing than those of the past. Its proponents argue that we have banked the big inventions – everything from antibiotics, the internal combustion engine and indoor plumbing – and we are in an era of less revolutionary technological advance.

We are optimists on the long-term effects of technology on growth. History suggests that it takes a long time for technology to have its full effect on production and that it works in an unpredictable fashion. We are reminded of the probably apocryphal statement attributed to Thomas Watson, CEO of IBM, in 1943, "I think there is a world market for maybe five computers".

And we tend to the view that more time and more investment will help revive productivity growth. If we are wrong the world is moving into an era of slower growth, and slower growth in living standards.

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.

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