Sunday, 5 November 2017

The great productivity debate remains unresolved

Over the course of the last week I have listened to presentations from three of the UK’s most influential forecasting institutions (the Institute for Fiscal Studies, National Institute of Economic and Social Research and BoE) in which the common factor was the weakness – indeed lack – of productivity growth. The ONS measures productivity using three main metrics – output per worker, per job and per hour. In the nine years since the great recession, these have grown by 0.8%, 1.0% and -0.2% respectively. For the avoidance of any doubt, these reflect the absolute changes across a nine year span, not the annual average – in other words, output per hour has declined in absolute terms by 0.2% since Q4 2007 (do you feel as though you are working less?).

To put this into context, annual growth over the period 1980 to 2008 averaged 2% for output per worker; 1.3% per job and 1.4% per hour which means that output per worker is currently almost 13% below its pre-crisis trend (chart). You really have to go back a long way to see a sustained period of sluggish productivity as poor as this in the UK during peacetime – probably back to pre-industrial revolution times, if the BoE’s excellent long-run historical dataset is any guide.


On the assumption that real wages grow in line with productivity, this means that real wages today are a similar amount below where they would otherwise be. But what makes matters worse is that, miserable though productivity growth has been, UK real wages have lagged even further behind. Average weekly earnings deflated by the CPI are currently 4.6% below their end-2007 levels. In other words, productivity growth has been flat but real wages have fallen. This goes to highlight the claim made by Paul Krugman that productivity may not be everything, but in the long run it is almost everything. It is undoubtedly one of the reasons why we all feel so much worse off than we did prior to the recession.

None of this is exactly news, as it has been a mounting cause for concern in recent years. Indeed, I recall looking at the problem as long ago as 2013. But the fact that productivity has remained stubbornly weak, and not recovered in line with expectations (and indeed, historical experience) clearly points to something wrong. It might be partly the result of measurement error in an increasingly digital economy; labour hoarding in a service driven economy; a lack of investment or simply an ageing demographic profile. It is, of course, not just a UK problem: It is a problem across all industrialised economies although the UK seems to have been hit relatively hard. Nonetheless it is an issue which governments have tended to downplay up to now.

Each of the three UK institutions noted above sees different aspects of the problem, reflecting their particular speciality. For the NIESR, it will contribute to weak growth and thus an ongoing squeeze on living standards. As far as the IFS is concerned, whose focus is fiscal policy, the resultant weakness of growth will put pressure on the economy’s ability to generate sufficient revenue to eliminate the budget deficit. Indeed, the Office for Budget Responsibility last month noted that it is likely to “significantly” reduce its “assumption for potential productivity growth over the next five years“ in its November forecast which accompanies the Autumn budget statement. Meanwhile, the BoE is concerned that weak productivity growth will hold back potential output growth with the result that the economy is more likely to run into capacity constraints which will generate inflation.

So far, we seem to have escaped the worst aspects of sluggish productivity growth. Inflation has only picked up because of a sterling-induced crash, not because of any underlying rise in domestic cost pressure. Public finances have improved significantly, with public borrowing declining by two-thirds between 2010 and 2017. Arguably the squeeze on living standards has been the worst aspect, and may well have contributed to the Brexit vote last year. But the sunny uplands to which politicians promise we will soon return will remain unattainable without a recovery in productivity. And the longer productivity remains weak, the more of a struggle economic recovery will be. Like a Facebook relationship status, the productivity puzzle is complicated but it is one we need to get a handle on – and fast.

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