Brexit versus productivity stagnation - what does the most damage
Brexit is on the horizon and economic growth is slowing down, but what’s doing the most damage. Brexit or productivity stagnation?
The economy, on the other hand, is not doing so well. Growth has slowed from around 3% in 2015 to 1.5%. Most of that slowdown is due to the effect of Brexit uncertainty on investment and, thanks to the inflation-boosting effects of a lower pound, a renewed squeeze on real wages and consumer spending. The Centre for European Reform suggests that the economy is 2.3%, or £17bn, smaller than it would have been in the absence of Brexit.
How do we square these two sets of data? The answer is productivity. Good employment growth alongside weaker economic growth means only one thing: disappointing productivity performance. And the UK’s productivity performance has certainly been disappointing.
The latest figures show that productivity measured by output per hour worked is rising at an annual rate of just 0.2%, continuing the stagnant pattern of recent years. Output per worker is rising at a 0.4% rate. In normal, pre-crisis times, productivity rises by 2% a year.
Productivity stagnation is nothing new, though it is disturbing. Had productivity over the past decade risen in line with its pre-crisis trend it would now be 22% higher than it is. And, while I am quick to recognise when talking about productivity that it is widely regarded as nerdy (you can almost see the eyes glaze over, or people confuse it with production or profitability), it is hard to think of many things that are more important.
Paul Krugman, the Nobel prize-winning US economist, once put it memorably, saying: “Productivity isn’t everything but, in the long run, it is almost everything.” It is the ultimate driver of prosperity, of living standards, of real wages and, yes, of profits.
Productivity has stagnated since the crisis for a number of reasons. In the aftermath of the crisis, lenders were happier to keep finance flowing to existing customers than to risk lending to high-productivity start-ups; the zombie firm problem. Business in general has been ultra-cautious about investing; the biggest reason for Britain’s internationally poor productivity record being that the UK is at the bottom of the Organisation for Economic Co-operation and Development investment league (investment as a percentage of GDP), a position that has been compounded since the crisis. There has also been a relative shift in the economy towards lower-productivity jobs.
Readers will also be interested to know that, perhaps because of the regulatory burden, financial services has contributed to the problem. Financial services productivity led the pack in the pre-crisis period, rising by 4 to 5% a year. Since the crisis, financial services productivity has been falling.
Brexit cannot be blamed for the productivity problem but has exacerbated it. This was a stage in the cycle when business investment was expected to rise strongly. Brexit uncertainty means it has not. A reduction in the supply of high-productivity EU migrants might also add to the problem.
Brexit or no Brexit, it is clear that if Britain could make up some of the shortfall in lost productivity, or even return to normal rates of productivity growth, it would have a transformative effect.
Could it happen? It requires investment, innovation, infrastructure and skills. Most pressingly, it requires more investment and better use of workers. The 10-year stagnation of productivity is highly unusual but history tells us that it should come to an end. It would be great news for the economy if it were to do so soon.
About the author
David Smith, economics editor, The Sunday Times.