UK productivity, investment and economic performance

vdl-nedcar-production-lineProductivity in the UK lags substantially behind its competitors in the G7, according to the Office for National Statistics. It is now 18% down on the pre-recession trend, or nearly one fifth. This has become known as the ‘productivity puzzle’, as UK performance has persistently lagged behind the other major economies in recent years. It is productivity, or how much output workers produce over a given timeframe, that determines our standard of living. If productivity rises, then profits or wages (or both) can rise. Alternatively, it allows working hours to fall while wages remain constant, sustaining living standards while leisure time increases. Both these options are viewed as raising economic welfare.

Here in the UK, employment continued to rise even while growth was stagnant, producing falling productivity. The latter has picked up a bit in the last two years, but given that population growth has been fairly rapid, output per capita has grown more slowly. Wage growth has picked up in recent months, and given close to a zero rate of inflation, real wages (adjusted for changes in the cost of living) have seen their fastest growth in several years.

One could argue that the fact that the UK economy has created jobs even while growth was non-existent is a good thing. After all, it spreads the pain of economic stagnation more fairly than more rapid productivity growth and rising unemployment. The UK experience contrasts with that in the US, where unemployment peaked at a higher level during the recession while productivity performance was stronger.

Whatever one’s opinion on the distribution of the output produced in the UK, productivity growth needs to rise significantly if growth is to be sustained in the long run, or even if we simply want to maintain our standard of living but work less overall. Better performance in the US and in Germany and France throws the UK case into stark relief.

The political parties were noticeably silent on this issue in the run-up to the election. Labour did focus on the cost of living, but did not make the argument that wages can only rise in the long-run if productivity does the same. And productivity will only rise if firms and governments invest, in physical assets, and in people. If that happens, greater capacity and skills can contribute to improved economic performance.

Investment in infrastructure by the government is a no-brainer at the moment, given the very low cost of borrowing. Of course, the chancellor George Osborne has hemmed himself in somewhat by obsessing over the public sector deficit, although in practice he has been at least a little bit more pragmatic in reducing it than he sometimes makes out. But having attacked the Labour plan to borrow to invest in infrastructure, he has to make the case to carry out the latter without substantially increasing public borrowing. Given the current slowdown in the global economy, which is impacting on the UK’s export performance, and will either lead to a further rise in the current account deficit if domestic demand is sustained at its current growth rate, or to a slowdown, the chancellor may have to be even more flexible on fiscal policy than he has to date.

Investment in apprenticeships will help develop the UK’s skills base over the longer run, alongside the desirable rise in infrastructure spending mentioned above. To give the government some credit, they have recognized this and are doing something about it. These sorts of policies will have an effect, but if the investment is not funded out of borrowed funds, it will not boost aggregate demand in the short run and only improve growth in the medium and long run,. A slowdown in the UK is quite possible over the next few years, and this may be unavoidable, given the limits of further monetary easing by the Bank of England and the chancellor’s plans for further fiscal tightening which together prevent much of an offset to falling aggregate demand.

The new left-wing Labour leader, Jeremy Corbyn, has outlined a radical alternative to the current government’s plan: if it won power, it would create a national investment bank, funded through Quantitative Easing, to invest in infrastructure, housing and energy. If the economy did slow substantially, this idea has something to say for it, but if unemployment stays low, and growth continues at a reasonable pace, it could well fuel inflation if it creates excess demand in the economy. If the projects were carried out at a slow pace, and current growth performance is taken into account, they have the potential to boost productivity, if the projects were carefully targeted. If all they do is produce a spike in interest rates when investors lose confidence in the economy, the policy could crowd out private investment by raising the cost of borrowing. However, the need for infrastructure spending is there and it has the potential to crowd in private investment and support private sector growth. Whether Osborne’s policy will be enough remains to be seen.

One thing is clear: productivity performance in the UK must improve. Without it, the aspirations of the many will fail to be realized.

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