Productivity growth: is the OBR being too optimistic?

Brexiteers have criticised the organisation—but may have it the wrong way round

November 25, 2016
Office for Budget Responsibility (OBR) chairman Robert Chote ©Lewis Whyld/PA Archive/PA Images
Office for Budget Responsibility (OBR) chairman Robert Chote ©Lewis Whyld/PA Archive/PA Images

The Office for Budget Responsibility has found itself under attack from Brexit supporters this week, charged with being too pessimistic on the impact of leaving the EU on the UK economy. Its new forecasts—released at the Autumn Statement—show an additional cumulative £120bn of new borrowing by 2021, with around half of that directly related to June’s referendum result. But in one vitally important way, the OBR may actually still be being too optimistic.

Since its creation in 2010 the OBR, and indeed most other forecasters, have been too upbeat on the UK’s productivity numbers. In its central scenario, the scenario around which most of the public debate has been based, it is once again predicting a gradual productivity recovery. But the process of Brexit may make that even less likely.

To recap, productivity growth is, in the long run, perhaps the most important driver of an economy. The ability to get more economic output from the same number of workers is what drives GDP per capita, wages and ultimately living standards higher. In the absence of decent productivity growth, inflationary pressures are higher and wage rises mean falling profit margins and more intensive distributional battles.

In the three and half decades to 2008, output per work hour rose at an annual rate of around 2.5 per cent but since then it has been broadly flat. After outright falls in 2008 and 2009, the average annual growth rate has fallen below 0.5 per cent in the last five years. The OBR now expects (hopes) that it recovers to 1.8 per cent a year by 2020. That compares to a forecast of 2.2 per cent (still below the trend of the last few decades) this time last year and an estimate of 2 per cent a year at the Budget in March. As the OBR itself noted in its report, “the long-awaited return of sustained productivity growth is the most important judgement underpinning our forecast.”

The OBR has helpfully provided forecast of a “weak productivity scenario” and it is important to be clear that this is a scenario in which productivity growth fails to accelerate from its current growth rates rather than one in which that growth falls further. In that weak scenario, rather than public sector borrowing coming in at £17bn in 2020/21 it would still be running at closer to £60bn. Government net debt to GDP rather than being 81 per cent would still be around 90 per cent.

Weak productivity growth has been a global trend over the past decade but the UK has been especially hard hit. In fact, the UK in many ways has a double productivity problem—not only is it being hit by a global slowdown in the growth rate of productivity but there is also a gap in the level of productivity between the UK and its advanced economy peers. Hence all the talk of German workers taking four days to produce what takes a UK worker 5 days and the endless procession of productivity plans from governments over the last two decades.

Economists have been debating the productivity slowdown intensively over the past few years and no clear answer has emerged. Instead of a single explanation there are multiple competing theories as to what factors are at play. In reality, the seemingly never ending debate probably reflects the fact that there is not a single culprit.

But it is very likely that weak business investment is one of the larger drivers in recent times. Simply put, the more capital per worker then the higher output per worker should be. Despite a welcome boost in government investment announced in the Autumn Statement, the OBR now expects much weaker growth in business investment than it did before the referendum. The end result is that overall investment is now forecast to be 8 percentage points lower in 2020 than the OBR expected at the Budget.

For the next few years firms will be facing great uncertainty over the outlook for the UK economy, which is not an ideal environment for an investment-led productivity rebound. It is perfectly possible to believe that some of the global pessimism on productivity prospects—best encapsulated by the work of Robert Gordon—has been overdone, whilst also worrying that the UK in the run-up to Brexit is not on the verge of a productivity rebound.

Productivity growth matters for the long run. In the short run, the very welcome upside of weak productivity has been strong growth in UK employment. It has been very easy for the last few years to ignore the dire long run warnings and concentrate on the sort run side effects. The silver lining has obscured the cloud. But sadly the long run has a habit of eventually arriving and if Brexit delays a productivity recovery then the government will have a whole host of short run problems to deal with.