Productivity is described as output per unit of input. In other words, it measures the efficiency of the factors of production used in the production process. UK productivity growth has been markedly sluggish ever since the 2008 Financial Crash[i] and much lower than other developed nations such as Germany and France. The Office for National Statistics reported output per hour in Q1 of 2023 was just 0.6% above the 2019 average.
Why is productivity so important?
“Productivity isn’t everything, but in the long run it is almost everything,” - Paul Krugman, American Economist and Nobel Prize winner in Economic Sciences.
High productivity is a crucial factor in economic growth[ii] as it helps improve living standards and wages. Higher productivity is likely to result in a greater supply of goods and services as firms unlock economies of scale[iii], causing prices to fall as their average cost of production falls, thus keeping inflation low. Consequently, consumers benefit from more purchasing power and an increase in their material living standards.
Workers can earn higher wages as businesses generally pay more productive workers higher wages as their marginal revenue product[iv] is high.
Firms will make more profit as their average costs fall and demand for their products increases. These can be reinvested back into the economy, helping create more jobs in the manufacturing of capital. Subsequently, the government would receive a fiscal dividend whereby tax revenues increase meaning more funds are available to develop infrastructure or improve public services like healthcare and education.
Higher productivity also makes export industries more competitive. Therefore, businesses have access to a broader market allowing more international trade and export led growth.
Why has UK productivity growth been so stagnant?
A persistent productivity gap has been ongoing since the 2008 Financial Crash. Had the pre-crisis trend growth rate continued, productivity levels in the UK would have likely risen by 20% and the UK economy would be approximately £300 billion larger. A major reason behind the stagnation is low levels of capital investment. The credit crunch of 2008 meant that many businesses could not take out loans to fund their expansion despite record low interest rates.
Low confidence and economic uncertainty have also hampered investment efforts. Huw Pill, the Bank of England’s chief economist wrote that the UK had also “experienced three major waves of uncertainty”, in the form of the global financial crisis, the EU referendum and the pandemic, which would have made companies cautious about investing and innovating. The Resolution Foundation, a UK based economic thinktank, claimed in a recent report, “If UK business investment had matched the average of France, Germany and the US since 2008 ... our GDP would be nearly 4 per cent higher today, enough to raise average wages by around £1,250 a year,”.
In addition, the UK spends less on research and development (R&D) than many other countries, such as Germany and South Korea. In 2019, the UK spent 1.7% of its GDP on R&D, compared to 2.9% in Germany and 4.6% in South Korea. Infrastructure investment is also low. In the World Economic Forum's Competitiveness Report 2021, the UK ranks only 36th in terms of infrastructure quality.
Slow wage growth can also lead to firms preferring to employ labour instead of expensive capital. This makes production processes slower and more labour-intensive. Labour markets become more flexible keeping labour costs down and thus encouraging some firms to choose labour over capital.
The Financial Crash also deeply affected the financial sector within the UK. As the UK is highly specialised in financial services, the crisis had a major impact on labour productivity not only within the sector but also nationwide.
Some economists believe that record-low interest rates reduced borrowing costs for firms, allowing highly unproductive so called “zombie” companies to avoid going insolvent.
The UK has a relatively low proportion of highly skilled workers and managers compared to other developed countries. This inhibits innovation and may lead to a wastage of resources. There are also skills shortages in many sectors such as teaching and engineering. As a result of scarcity, hiring skilled workers is more expensive leading firms to substitute them with more unskilled and cheaper workers, thus reducing productivity.
How can the Government revive UK productivity?
The government is well aware that raising productivity is a priority to reinvigorate the economy. As such, the government should foster a positive investment environment government by ensuring the country has the modern infrastructure it needs and a financial system that encourages investment.
Creating a favourable tax system and providing tax relief can stimulate more investment as firms have retain more of their profits. However, corporation tax has actually been increased from 19% to 25% and the super-deduction Capital Allowance scheme was ended in March 2023.
Mega infrastructure projects like HS2 and Crossrail are predicted to encourage business investment and facilitate more production. These schemes incur vast expenses and are also built over a large time scale but are likely to increase UK productivity over time.
The government has also implemented an Apprenticeship Levy. This requires employers with an annual payroll of more than £3 million to help fund apprenticeships across the country. The aim is to increase the number of apprenticeships available and improve the skills of the UK workforce. However, it has been found that half of all young people signing up for apprenticeships quit them. The quality of many lower levelled apprenticeship has been called into question as some accuse employers of failing to properly train their apprentices. Exploitation has been a problem with the Low Pay Commission reports that apprentices are more than ten times more likely than the average worker to get less than the legal minimum wage.
A Skilled Worker Visa Programme has also been introduced. This is designed to deal with skilled labour shortages in specified industries and occupations by inviting foreign skilled workers to move to the UK.
Footnotes:
[i] Financial Crash - a severe would wide economics crisis that occurred in 2008 as a result of excessive risk tagging by financial institutions.
[ii] Economic Growth - Growth in a country’s real gross domestic product over time.
[iii] Economies of scale - cost advantages a firm can gain by increasing their scale of production, leading to a fall in average cost of production.
[iv] Marginal revenue product - the additional revenue created by employing an extra unit of labour.
Bibliography:
If the UK is high tech, why is productivity growth slow? Economists weigh in | LSE Business Review
Britain's Productivity Problem : Planet Money : NPR
Eleven Reasons For The UK's Poor Productivity | HuffPost UK News (huffingtonpost.co.uk)
