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Does the UK have a productivity problem?

What’s going on and how does the UK compare to other markets?

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Something appears to have gone badly wrong in the UK economy. Today, the average French worker can leave work on a Thursday, having already achieved more than their British counterpart will in a week. And France is not alone - the output of British workers is around 16% lower than the G7 average. For example, a German worker adds $70 to the nation’s GDP per hour worked, compared to $55 for the UK.

It wasn’t always like this. In the 1950s, Britain had the highest productivity - that is output per hour worked - in Europe. In the 1960s, the UK slipped behind to become “the sick man of Europe.” Most of that lost ground was recovered between 1980 and 2008, but since the global financial crisis, Britain has slipped down the rankings once again.

“Productivity isn’t everything, but in the long run it is almost everything,” says Nobel Prize-winning economist Paul Krugman. “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 why is our productivity so poor? How can it be resolved? And what might that mean for business?

The productivity conundrum

Productivity growth has stalled just about everywhere in the developed world since the financial crisis hit, but Britain’s slowdown has been among the most pronounced. Had the pre-financial crisis trend remained intact, UK productivity would be a good 25% above where it is today. And there’s little sign of a turnaround - in the second quarter of this year, productivity in the UK fell at its fastest pace in five years.

The slowdown has been especially apparent in the computer programming, energy, finance, mining, pharmaceuticals and telecoms industries. Combined, these make up about 20% of the UK economy, but account for 60% of the productivity decline. Some regions fare worse than others, too - Bristol and Southeast England have a greater share of high productivity businesses than Northeast England, for example.

However, the weakness is widespread. The most productive companies have lost momentum. They are, notes economist Patrick Schneider in a Bank of England research paper, “failing to improve on each other at the same rate as their predecessors did.” Meanwhile, at the other end of the scale, notes Bank of England chief economist, Andy Haldane, lies a “long tail” of companies with poor levels of output per hour. “The UK’s international productivity gap is, to a large degree, a long tail problem,” he says - the top is failing to drag up the bottom.

The roots of the productivity problem

No single issue lies behind the slowdown, and economists disagree as to the importance of each factor. The financial crisis affected the ability and the willingness of banks to lend, which made it harder for innovative small businesses to raise funds. At the same time, the collapse in interest rates (and thus, debt-servicing costs) meant that businesses that might otherwise have died, or at least been forced to radically restructure, have been able to limp along, crowding out new competitors. These are often known as “zombie companies.”

Persistent, deep skills shortages in key industries are another factor. You will often hear UK employers complain that too many UK workers have inadequate skills. In 2016 the OECD wealthy country think tank found that England had one of the largest proportions of low-skilled young workers among advanced economies. Almost 30% of 16-24 year olds in the UK have low levels of literacy and numeracy, compared to an OECD average of around 18%, and less than 10% in Japan, Holland and South Korea.

On the political front, uncertainty over Brexit has not helped - volatility in the pound and political uncertainty has led many to delay investment until outcomes become more clear. More generally, the fact that wages have remained low in the post-crisis period has encouraged companies to favour “recruitment over business investment,” as Will Holman and Tim Pike pointed out in a piece for the Bank of England last year. In other words, as long as there is a ready supply of relatively cheap labour, then many companies will favour the flexibility of taking on more staff to cope with increased workloads, rather than invest in more costly technology that promises to enhance productivity in the longer term.

Bridging the productivity gap

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    Are we just measuring the wrong thing?

    The risk, of course, is that this becomes a self-fulfilling prophecy. Low productivity deters companies from investing, which in turn damages productivity further, and so on. That said, there is a more optimistic point of view - that Britain’s lack of productivity is simply overstated, and that behind the weak headline figures, companies continue to improve.

    Sebastian Chambers, managing partner at CIL Management Consultants, makes two key points. Firstly, productivity prior to the financial crisis was arguably overstated, he says. Much City activity that appeared at the time “to be very productive and very tax generative, turned out to be the mis-recording of profits” when the crash came. For example, the mis-selling of Payment Protection Insurance (PPI) to customers by the banks might have appeared extremely productive at the time, but it has since turned out to be extremely costly.

    Then there is the North Sea. As Chambers points out, in the lead up to 2008, the oil industry was very productive. “But we are now producing less oil and gas, and oil and gas prices have both fallen.” As a result, since the financial crisis, the City and the oil industry’s relative importance have declined, and there has been considerable employment growth in areas that are inherently less productive, because staffing costs are higher relative to turnover.

    “In manufacturing, you might get £100 of revenue from 8p or 10p spent on labour. In the restaurant industry, 20p of labour might only get you £1 of revenue. Running a care home, or a school or a university, the number of people you employ relative to the turnover might be 50%,” he says. “But that doesn’t mean that individual firms aren’t improving their productivity. I work with so many different companies and my experience is that everyone is trying to get more productive.” Indeed, Chambers is convinced that the UK is leading the world in the service industry and that what has happened here will happen elsewhere.

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