The great productivity puzzle

Tony Ward

October 9, 2017

Tony Ward is chief executive of Clayton Euro Risk

With all last week’s political shenanigans, it’s been easy to take our eye off the ball as to what really matters.

What’s been keeping me up at night is our ability – or lack of it – to maintain strong productivity growth in the UK.

Our great housing problem

I raised concerns back in July when the Office for National Statistics (ONS) reported that hourly output had fallen 0.5% in the first three months of the year.

Now, things seem to be going from bad to worse.

Last week, the ONS once again reported that productivity fell through the first half of 2017.

Output per hour fell by 0.1% from the first quarter of the year to the second, and is now 0.3% below its level at the end of 2007.

It said the figures represented a continuation of the so-called productivity puzzle – the unexplained phenomenon of sluggish productivity growth since the financial crisis.

Why so important? Well, as argued before, I believe that productivity is the foundation for strong economic growth and is a key factor in improving living standards; the fall in output per hour in both of the first two quarters of this year is a depressing indicator.

That means productivity is now 20% lower than it was expected to be, if the pre-crisis rate of growth had been maintained.

Economist Howard Archer at the EY Item Club said: “Given the uncertain economic and political outlook, some businesses may also be trying to meet demand by taking on labour rather than commit to investment. The relatively low cost of labour relative to capital certainly supports employment over investment.”

This view supports what’s happening in the wider economy, in which employment has risen to a record high while unemployment is at a 42-year low, but has been accompanied by weak investment and sluggish pay growth.

Mr Archer added that a large number of jobs are being created in relatively low skilled, low paid sectors.

And there may also be an impact from so-called zombie companies – those which are inefficient and unproductive but are kept alive by low interest rates, allowing the problem to persist.

Worryingly, the UK’s productivity continues to lag behind all major trading partners.

Productivity growth is weak compared with other countries, and output per hour worked in the UK is now 15.1% below the average among the other G7 countries.

That really is a frightening statistic.

Analysts at Bank of America Merrill Lynch believe this poor productivity growth will turn into weak long-term economic growth.

“The quid pro quo to the UK’s labour market producing jobs ‘like there is no tomorrow’ is that there has been ‘no tomorrow’ for productivity and real wages,” said economist Rob Wood.

Mr Wood believes this could lead to higher interest rates and less money for the government to spend.

“Weak trend means real wages will not rise at traditional rates after inflation drops back, which will deliver a weak growth outlook,” he said.

Brexit could make productivity progress worse if it slows the arrival of skilled workers or deters capital investment by businesses.

“A major risk is that the prolonged uncertainty and concerns over the UK’s economic outlook end up weighing down markedly on business investment and damages productivity,” Mr Archer said. “Prolonged difficult Brexit negotiations would increase this risk.”

All rather grim. But what’s to be done?

Well a swift and decisive resolution to Brexit negotiations would help but that isn’t likely to happen any time soon, although a breakthrough in the talks this week that allows both sides to move on to considering the future relationship would be a start.

This may bring back some much-needed confidence and, in turn, lead to a greater spend on investment.

Also, a more substantial infrastructure pledge is required by government although this seems unlikely as the Chancellor has little room to manoeuvre in the budget next month.

It may seem therefore that more radical thinking is required.

Andy Haldane, Bank of England’s chief economist, has suggested before that links should be established between managers of weaker companies with those from more successful firms.

This makes sense.

Joined-up thinking is needed – certainly with a focus on investment, education and training.

We can’t let muddled Brexit negotiations get in the way of addressing this problem.

The implications of doing nothing will affect us all.

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