The productivity puzzle: is Britain stuck in a rut?

More oil off the coast of Scotland cannot just be magicked up
Growth in output per worker is vital to the wealth of nations. Since the financial crisis, Britain has consistently fallen behind on this score. Why? Stuart Watkins reports.
“Productivity isn’t everything, but in the long run it is almost everything. A country’s ability to improve its standard of living over time depends almost entirely on its ability to raise its output per worker.” So said Nobel laureate Paul Krugman, stating succinctly a view universally held among economists. Little wonder, then, that Britain’s productivity statistics cause so much hand-wringing. The latest official figures show that Britain has remained stuck in a rut that it first settled into just before the financial crisis of 2008. Output per hour, the most commonly used measure, fell 0.5% over the three months to June compared with the same quarter last year. In every quarter since the one ending in June 2018, the UK’s productivity growth has been flat at best. This continues a long losing streak. Productivity has grown by only 2.4% since the pre-crisis peak in 2007 and is about 20% below its pre-crisis trend; before the crisis, productivity grew at about 2% every year.

This is worrying. Producing more with less is the essence of economic growth and the basis for prosperity and improving living standards. In Britain, we are spinning our wheels and doing less with more. With the demographic constraints associated with an ageing population acting as a further long-term drag on our economy, that means Britain will in the future face difficult choices when it comes to national priorities, whether that’s spending on the environment and healthcare and other public services, or the ability to raise incomes or cut taxes.
Bringing the pieces together
This phenomenon is known as the “productivity puzzle”, an appropriate name given that the problem has many pieces and no one is really very clear about how they might fit together to produce a clear and coherent picture. Perhaps the slump has been caused by companies investing too little in productivity-enhancing machinery (they are still spending less than is typical following an economic slowdown, maybe because they remain nervous about the economic outlook). Perhaps record low interest rates have kept alive failing companies that should have been closed down, meaning highly unproductive zombies lumber on and drag us all down. Or perhaps it is simply a supply and demand issue: the plentiful supply of cheap workers, boosted by high net immigration, has made it more attractive for companies to hire them than to invest in labour-saving machinery. Furthermore, the tax credit system, where the government tops up the pay of low-paid workers, acts as a subsidy for employers, making unproductive part-time work more attractive. The puzzle is further complicated by the fact that the productivity slowdown is partly a global issue (it is crimping almost all advanced economies, including the US), partly a peculiarly British one (Britain lags the laggards) with regional and sectoral dimensions (some of our companies and towns and cities are not prospering and growing as they might).
There are other culprits: the fat cats. A new book by economist Andrew Smithers, Productivity and the Bonus Culture, says the cause lies in the perverse system of incentives that makes it more attractive for managers to line their pockets than invest in growth for the future. As a review of the book by Edward Chancellor on Breakingviews points out, you would expect the ultra-low interest rates and above-average corporate earnings of the past decade to have given investment a boost. That they clearly haven’t has been blamed variously on “secular stagnation” (this despite the UK and US enjoying strong growth in employment and consumption) and on a deleveraging private sector paying down its debt (in fact, debt has never grown more rapidly than during the decade since the collapse of Lehman Brothers). The real problem with our weak economies, says Smithers, lies not in insufficient demand, but on the supply side. Productivity growth is determined by how much is invested. If investment is too low, growth stagnates. Falling productivity accounts for the entire decline in trend growth in GDP in the UK, says Smithers, and falling tangible investment preceded the drop in productivity growth. The story is a similar one in the US.
Why, then, has investment fallen off?

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