Understanding the UK’s productivity problem

Few elements of macroeconomics better underscore the frustrating sluggishness of the recovery than productivity stagnation. A problem which applies the world over, but, in particular, appears to be stifling the UK.

To provide some meaningful insight into the depth of this ailment, OECD countries’ labour productivity generally grew at around 2 per cent in the decade up to 2006. The US fared somewhat better, averaging a growth rate of 2.5 per cent each year during this timeframe, while Germany managed 1.6 per cent. The UK’s equivalent figure fell halfway in between the two.

In the decade since, figures have slumped, with the US dropping to an average annual rate of productivity growth of 1 per cent, Germany 0.5 per cent, and the UK a shocking 0.2 per cent. According to the Office for National Statistics, the UK’s productivity per hour was 9 per cent below the OECD average in 2007, but this gap doubled to 18 per cent by 2015. As things stand, our output per hour is 35 per cent below Germany’s, while French workers produce more in 4 days than we do in a full working week.

What is productivity?

To put the above statistics into context, it is important to have a sound understanding of what exactly productivity refers to. In the case of economics, this is a measure of output per unit of input. Output is directly related to Gross Domestic Product (GDP), which comprises revenue generation, business inventories and other metrics. Inputs, on the other hand, refer to labour and capital.

The most simplistic slant on productivity - generally that which is referred to in the media – is the ratio of output (or GDP) to total hours worked. As such, the natural connotations for falling rates of productivity are things like laziness and inefficiency. While this may or may not be a relevant factor, the truth is that the overall picture is a bit more nuanced.

What has gone wrong in the UK?

The earthquake of the financial crisis has left an indelible mark on all major economies (and smaller ones too), but one of them is record-low interest rates, coupled with quantitative easing (QE). Many economists believe low rates have created an artificial landscape whereby ailing businesses, which in any other economic cycle would have ceased, have thus been able to survive – performing poorly and retaining employees in the process. In turn, the post-crisis credit crunch saw many innovative, tech-intensive startups fail to receive the requisite funding they needed in order to flourish. 

There are also a few other statistical skewers. For example, within financial services, far greater regulatory emphasis has been placed on compliance, meaning employees who are specialists in this realm have been hired en masse - ones who generally command high salaries, but who themselves are not revenue-generating for the firm. Another good example is energy, where many people are now employed within the renewable energy sector, given the greater global focus on conservation and the environment. However, these individuals produce far less quantities of fuel than their non-renewable counterparts.

The above exceptions aside, there appears to be a trade-off whereby the gains of higher employment – an area in which the UK has excelled recently – are offset by weaker productivity. This trade-off is one that the Bank of England has even acknowledged previously, but it is clearly their belief that, in this respect, higher employment trumps reduced productivity (along with the resultant consequences of QE such as poor wage growth, rising income inequality and derisory returns for savers) in terms of the overall impact on the wider economy.

An alternative school of thought

There are some who believe the figures for our current productivity are inaccurate – or at least exaggerated. For example, productivity in the services sector – which accounts for nearly 80 per cent of UK GDP – is notoriously difficult to measure. Not least of all high-tech sectors such as communications, whose exponential technological advancements do not appear to be adequately reflected in productivity figures.

To what extent this alternative view is applicable to the UK is open to debate. But what is not in doubt is that the key to boosting productivity growth lies in technological investment. Fintech firms such as Lending Works provide the clearest possible example in this respect. By using cutting-edge technologies as the driving force of its product offering, it has a streamlined business model which has the ability to produce unlimited output, with minimal input.

Conversely, established high-street behemoths like banks have inefficiencies at every turn, and while their volumes are presently considerably higher, this gap is already beginning to close, and with greater investment in online platforms such as ours – along with the effects of an inevitable shift towards the financial services mainstream - the end result will be a far higher ongoing rate of productivity.

Clearly, such logic is applicable to many other industries too. And while there may be fears of ensuing job losses as the old guard of underperforming brick and mortar gives way to more efficient, innovative, internet-based companies, one should also bear in mind that there is no statistically significant economic correlation between technological advancement and overall unemployment. On the contrary, higher productivity is a driver of job creation in itself, and is fundamental to delivering a high-growth, high-wage economy.

The UK’s potential is there. Now is the time for it to be unlocked.

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