Solving the UK’s productivity puzzle
28 August: Since 2009, the UK has struggled with a slowdown in the progress of productivity. ICAEW Insights examines the causes of this ‘productivity puzzle’ and looks at how the government could tackle this in its COVID-19 rebuilding programme.
Advances in technology, production and the accumulation of capital have meant that over time, an ‘average’ worker today produces in two weeks what a worker several centuries ago would have taken a whole year to create.
Such gains in output per hour worked are what enable societies to enjoy better standards of living or spend less time at work.
However, since 2009’s financial crisis, the UK has faced a “productivity puzzle”, described by Deloitte’s chief economist Ian Stewart as essentially a slowdown in the progress of productivity. Stewart argues that the “engine of growth would appear to have slowed, if not stalled altogether”.
To back his argument, he points to data that shows from 1971 to 2007, output per hour worked grew steadily, at an average annual rate of some 2.3%. Since productivity began to recover after the global financial crisis in 2009 up until 2019, output per hour worked grew, but by 0.5% each year.
Several possible causes for this reduced rate of growth have been suggested. Everything from austerity, Brexit and short-termism in the corporate sector, to low interest rates and mismeasurement, are possible explanations.
“Despite considerable study, no definite consensus on the cause or cure for this malady has emerged,” says Stewart. And while particularly acute in the UK, the problem is seen in most other advanced economies.
While productivity in the UK dipped in the first quarter of the year it is likely to fall further, as estimates suggest that the fall in output has been greater than the fall in hours worked, say Stewart. The outbreak of COVID-19 is extremely likely to bring further bad news on this front.
Vicky Pryce, chief economic adviser at the Centre for Economics and Business Research (CEBR) and a former joint head of the government’s economic service responsible for productivity, says there are several factors at play when it comes to the productivity dip.
“The UK had quite a substantial improvement in productivity up to just before the financial crisis,” says Pryce.
While this surge was led by the dominant financial sector, explains Pryce, the UK’s productivity performance was still “well below the output per hour compared to the Germans and even the French. We were not doing spectacularly well at all, but at least we felt like we were catching up gradually.”
Then came the 2009 global financial crisis, the financial sector collapse and what Lord Adair Turner, the then chairman of the Financial Services Authority (FSA) decried as a lot of “socially useless activity within it”.
Much of Adair’s ire was directed at complex financial instruments that he deemed had grown too big, like fixed income securities derivatives and trading.
The post-crisis fall in investment led to the UK’s current slowdown in productivity growth, a trend that has been further accentuated by Brexit and COVID-19, argues Pryce.
She cites other underlying issues causing a downward drag on UK productivity as an over-reliance on declining sectors such as oil and gas.
Promised you a miracle
In January this year, the Bank of England forecast the UK growth rate to be just 0.8% in 2020, rising to 1.2 to 1.4% over the ensuing parliamentary term of five years.
“We would need a serious productivity miracle to get growth going up, given we had very high employment,” says Pryce. “But with Brexit that productivity will suffer even more, particularly if we didn’t have a proper free trade agreement and relied on WTO rules in the future, because we wouldn’t be getting the foreign direct investment we would have got otherwise.”
Investment is key
“Productivity is crucially important for the longer-term sustainable growth of the economy, says Pryce. “Without it, you become uncompetitive in the world economy. If we are going to be relying on a ‘global Britain’ post-Brexit and sell to all those countries that produce things more cheaply than we do such as China, then you need to be hugely productive.
She cites IT, manufacturing, the green economy and ‘carefully selected’ infrastructure projects as key targets for the government.
Such sentiment chimes with Deloitte’s Ian Stewart, who says: “For an economy which ranks highly on measures of attractiveness to business, the UK does relatively poorly on infrastructure provision and vocational education. Underfunding plays a major role in both and only the government has the heft to make a major difference in these areas. Regardless of the progress of the virus, better infrastructure and vocational training would lay the foundation for a stronger, more productive recovery.”
Much more investment in regional economies, especially in further education and transport infrastructure, must follow, insists Pryce. “What I fear is the productivity differential in the regions. We know that London, the South East, and the East of England pay more into the Exchequer than they take out, while all other areas are net recipients and their productivity is the same.
“COVID-19 and Brexit are going to leave us with even greater inequality between the regions, so we need to invest in reducing those inequalities that exist,” Pryce continues.
Here to stay
Meanwhile, the trend for longer-term homeworking looks likely to stay.
New research from the Chartered Institute of Personnel and Development (CIPD) reveals employers expect that the proportion of their staff regularly working from home once the crisis is over to leap to 37% compared to 18% before the pandemic.
Employers also think the proportion of staff who work permanently from home will rise to 22% post-pandemic compared to 9% before lockdown.
Tellingly, the survey of 1,046 employers showed that they believe people working from home are as productive as other workers, with over a quarter (28%) believing the rise in homeworking has increased employee productivity or efficiency, compared to 28% of organisations that report the opposite. Just over a third, some 37% thought there had been no effect on productivity or efficiency.
Pryce remains sceptical about the tangible productivity benefits of home-working. “Anecdotally, home-working is unlikely to be a long-term boost as upskilling opportunities that would normally happen, won’t,” she suggests. However, Pryce is adamant that the greater flexibility engendered by homeworking produces a happier workforce.
Doors of perception
Debapratim De, a senior economist at Deloitte and author of the Big Four firm’s CFO Survey, reveals the firm’s research found some 55% of people working from home in the UK believe their colleagues are working either at or above their pre-lockdown productivity levels.
However, in the short term, De remains decidedly downbeat on UK productivity due to the factors that led to corporate short-termism and that an environment for low investment will persist.
De also points to the short-term displacement of activity, especially for places like the City, where the daily convergence of large volumes of people drove a micro-economy in the hospitality and ancillary sectors.
He is alert to the difficulties that policymakers will have in not supporting unproductive businesses while boosting others, together with the fact that prolonged and elevated levels of uncertainty, the risk of further unemployment, and potential bankruptcies do not provide the ideal environment to boost productivity.
However, on a more optimistic note, De also believes major technological change and creative destruction of the sort that we are likely to see as a result of this crisis should boost productivity and growth, and we should see a return to the levels of growth we’ve seen before.”
By long-term, De means 10 years, which is not an insignificant period in which to try and remain upbeat.
John Endacott, head of tax at PKF, said that despite being some four months on from lockdown, there was still a dearth of dedicated and meaningful data on productivity from government or any of the leading business schools.
Endacott suggests that a truer picture of productivity is gained when the number of unemployed people are included in calculations, otherwise, it gives a skewed representation of productivity.
Citing the plethora of ‘low value-add’ jobs currently being lost due to COVID-19, Endacott uses the UK hospitality sector as an example. “This generates around 5% of UK GDP, but employs about 10% of the workforce,” says Endacott. “You can begin to see where the mismatch is between where people work and potentially where the value is being generated.
“I think it’s conceivable in the way the maths works that when you get much higher unemployment and people say ‘great, our productivity is suddenly looking a lot better’, that this is just moving the deckchairs around because then you have a lot of unemployed people.”
And it is this wider lack of clear, published metrics that makes the accurate measurement of productivity so opaque. “For something that seems absolutely vital to the country, the quality of the data we’ve actually got to work on, doesn’t seem great to me,” says Endacott.
As Stewart is quick to highlight, Western governments can now borrow at almost negligible cost. The question remains, will they run up debt to invest deeply and widely – and if they do, will this be enough to consign the productivity puzzle to a minor footnote in history?