One of the biggest headaches for Britain's new government is
raising productivity. Productivity, or the efficiency of
production, is the main driver of human welfare. Raising it is the
Holy Grail of economic policy. As Paul Krugman, the economist and
Nobel laureate put it, "Productivity isn't everything but
in the long run it is almost everything".
UK's productivity performance since the Financial Crisis has
been dismal. Unlike previous downturns there has been no bounce in
productivity since the recession. Among the major industrialised
nations only Italy has done worse than the UK in raising
productivity since 2007.
If the UK's pre-2007 trend had continued, productivity today
would be more than 16% higher. Wages and the standard of living
would be significantly higher than today.
The gap looks even worse measured in terms of absolute levels of
productivity. Output per hour in the UK is 25% lower than in
Germany, the US and France.
Something seems to have gone badly wrong. As with so many other
economic issues, there is no agreement on what. But there are
plenty of theories.
The most comforting is that the UK's productivity crisis is
a statistical illusion. Productivity is calculated by divided
output by hours worked. If output is underestimated so is
productivity. GDP numbers are prone to revision, often years after
the event. If GDP gets revised up – and it often does –
the UK's productivity performance will improve. 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 Google Maps. It may be that
mismeasurement is part of the story, but I doubt it explains much
of the productivity gap.
The gloomiest explanation for weak productivity is that
today's technologies are doing less to enhance efficiency than
those of the past. Its proponents argue that we have banked the big
inventions – everything from antibiotics, the internal
combustion engine and electricity – and we are in an era of
less revolutionary technological advance.
The most influential advocate of this view is the US economist,
Robert Gordon. Gordon invites us to choose between one of
today's ubiquitous technologies – the iPhone – and
one of the nineteenth century's great inventions, the flushing
toilet. His point is that today's innovations are not changing
lives in the profound way that the technologies of the nineteenth
and twentieth century did.
But this doesn't work as an explanation for the UK's
recent performance. Why would UK productivity have stood still when
other countries have seen gains? And why, suddenly, in 2007, would
technology cease driving productivity after years of good
A more plausible theory is that the shrinkage and disruption in
the financial sector has taken a chunk out of UK productivity
growth. Tougher regulation and an end to the pre-crisis financial
boom which artificially raised financial sector productivity have
taken a toll. The Economist magazine estimates that productivity in
finance and insurance is 10% lower than in 2009.
There are two other suspects.
The first is a shortfall in investment. The risks attached to
investment have risen since the crisis and the opportunities have
dwindled. Companies have tended to hang on to cash and squeezed
investment. The deterioration in the UK's stock of assets
– from machinery and buildings to highly trained workers and
research and development – has made employees less
The second suspect is, strangely, too many jobs. On this
argument the financial crisis has squeezed pay and made the labour
market more flexible (think, for instance, of the growth of part
time work and zero hours contracts). Jobs are preserved and
unemployment stays low. But, because labour is cheap, flexible and
plentiful, it removes an incentive for employers to undertake
productivity-enhancing investments. The "productivity
crisis" and Britain's success in preserving and growing
employment are two sides of the same coin.
The exact reason for the standstill in UK productivity may never
be known. That does not mean the UK is stuck with it forever. There
are proven ways to raise productivity - improving regulation and
state bureaucracy; raising the UK's mediocre record on
secondary education and investing in infrastructure. Mrs Thatcher
economic reforms of the 1980s are widely credited with having
boosted productivity. Between 1991 and 2007 UK productivity rose by
41%, faster than in any other major industrialised nation.
To paraphrase Marx, the challenge is not to interpret
productivity growth, but to raise it.
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