The UK’s recent productivity performance has been calamitous. True, the productivity slowdown has been a widespread phenomenon among high-income countries. But Britain’s slowdown is remarkably bad even by these standards. The question is why. Recent research sheds light on this vital economic question. Why is it vital? The answer is that if recent performance continued, the economy would no longer generate rising real incomes per head. That would change everything for the worse.
Since the financial crisis of 2007-08, the UK’s growth of labour productivity has been about the same as Italy’s, in the performance basement of the high-income countries. Yet the UK suffered much the largest deterioration in productivity growth of any of the large high-income countries since the crisis. Its productivity levels are also among the lowest of the high-income countries, which indicates room for fast catch-up growth. This makes recent performance even more disturbing.
Even I had not realised how bad performance has been until I read a recent speech on productivity by the Bank of England’s Andy Haldane. “For the past decade, average productivity growth has been negative,” he said, adding “you would have to go right back to the 18th century to see a similarly lengthy period of stagnant productivity.”
One reason why things might not be quite as bleak as this is laid out in a recent paper by Harvard’s Marty Feldstein. He argues that we tend to exaggerate inflation and so underestimate economic growth, because of growing difficulties in measuring quality improvements in the modern economy. In all probability, real incomes are rising more than statistics indicate. While plausible, this does not explain the virtually universal productivity slowdown. It certainly does not explain the UK’s exceptionally large slowdown.
Mr Haldane suggests another explanation: the huge lag between the productivity frontrunners and the laggards. He also shows that the dispersion in productivity performance is larger in the UK and has widened more than in other countries. Evidently, the UK economy contains many duff companies.
This analysis helps explain the UK’s low average level of productivity. But it does not appear to explain the sharp slowdown. Mr Haldane’s data show that the dispersion in productivity among British companies is exceptional, but not that it has grown faster since the crisis than before it. Indeed, he notes that “the tail of low-productivity companies today is, if anything, smaller than it was pre-crisis”. So that cannot explain the productivity slowdown.
Another hypothesis is that loose monetary policy explains the slowdown. But UK policy has not been exceptionally loose and so cannot explain its exceptional slowdown. Mr Haldane’s analysis does show that tighter monetary policy might have raised productivity levels by a modest 1-2 per cent, but at the cost of some 1.5m jobs. Inflicting that would have been grossly irresponsible.
There is another explanation. Research by my colleagues Chris Giles and Gemma Tetlow shows that the slowdown is mainly in banking, telecommunications, utilities, management consultancy and legal and accounting services. These sectors comprise 11 per cent of the economy, yet account for two-thirds of the slowdown. Many of these sectors were profoundly affected by the boom and bust of global finance. Indeed, one possibility is productivity growth has not so much slowed as never reached the heights estimated before the crisis. Surging real rewards might have been confused with booming output. If so, the slowdown is a return to normality.
It should be noted that none of these explanations is comforting. Eliminating the dispersion in productivity among companies would be desirable in itself and also raise productivity growth. But the question is why an economy that is open to the world, went though the Thatcher revolution and is among the least regulated of all the high-income countries, should show such a big dispersion in productivity. This suggests bad management is both rife and persistent. Again, while the Financial Times research clarifies where the slowdown has occurred, it does not explain why productivity growth is so pervasively low. One reason could be the exceptionally weak investment, by international standards. This would be another corporate governance failure.
Rectifying this disaster is the UK’s most important policy challenge, far more so than Brexit. The government should finance a high-level effort aimed at working out what has gone wrong, why and what (if anything) to do about it. The country’s very future is at stake.
