A British sugar factory in York. © Ken Crosby

Productivity is Britain's biggest problem

All the parties have failed to address the UK's dismal productivity. Here's what they should do.
April 22, 2015

What is this election really about? “The economy, stupid.” Bill Clinton’s famous answer about what motivated voters in the United States in 1992 rings equally true for Britain in 2015. Yet when it comes to specific economic policies, the key differences between the parties can be reduced to meaningless long-range deficit projections or to relatively trivial issues such as mansion taxes and small tweaks to labour and banking legislation that could not conceivably have much impact, whether for better or worse.

Meanwhile the most important change in Britain’s economic performance has gone almost unremarked. The truly extraordinary and unexpected problem that has afflicted Britain has been the unprecedented stagnation of labour productivity and real wages, which are roughly 15 per cent lower than implied by trends before the 2008 crisis—a shortfall of about £4,000 annually for every man, woman and child. While falling living standards and productivity, which are two sides of the same coin, have certainly figured in the election campaign, there has been very little serious discussion about what dismal productivity statistics really mean.

There are three distinct and partly contradictory interpretations of stagnant Gross Domestic Product per head (the best measure of long-term trends in both productivity and living standards) since 2008, a stagnation never previously recorded in modern British history, even in the 1930s. These conflicting explanations imply very different policy conclusions for the next parliament.

The first interpretation sees the productivity standstill as evidence of some catastrophic change in Britain’s economic structure since 2008—a sudden loss of work ethic or business acumen or ability to compete. This is the pessimistic view officially adopted by the Office for Budget Responsibility two years ago, and now accepted as the only responsible assumption by most of Britain’s political and media establishment. It was summarised with characteristic acuity by the Economist’s Emma Duncan on a BBC election programme: “Productivity is the big issue that no politician talks about. Britain’s workers are so unproductive that the French could take every Friday off and still produce more. Our country is badly educated. Our R&D is terrible. Our infrastructure is lousy.”

The policy implication is clear and is now  accepted by all three main parties. Until Britain’s education, technology and infrastructure dramatically improve, the country must learn to live within its newly-straitened condition. How to share out the suffering between public sector austerity and private belt-tightening is the only political choice.

But this fashionable pessimism, which blames productivity failure on the economy’s sclerotic “supply side,” offers no plausible explanation of why British workers, schools, business managers and infrastructure suddenly turned so dysfunctional in 2008. Education, infrastructure and technology may all be sub-standard, but what exactly happened in 2008 to make them so much worse? After all, Britain enjoyed the strongest productivity growth in the G7 from 1992 to 2007.

One answer from supply-side pessimists is that productivity before the crisis was simply a mirage. But why believe the accuracy of the 0.1 per cent annualised growth in GDP per head from 2008 to 2014, while dismissing as an illusion the 17 years of 2.5 per cent growth from 1991 to 2007, not to mention the 40 years before that, when productivity grew by an average of 2.4 per cent a year?

Strangely enough only one powerful institution has seriously confronted this question: the Bank of England. Governor Mark Carney, along with many academic economists, such as Jonathan Portes and Simon Wren-Lewis, has attributed productivity stagnation mainly to weak demand, rather than a sudden and unexplained collapse of productive potential. The combination of post-crisis credit crunch and fiscal austerity has reduced wages, consumption and business investment. These, in turn, have damaged productivity by encouraging substitution of cheap labour for modern machines.

The demand-side diagnosis suggests an opposite prescription for Britain’s productivity malaise from the conventional supply-side analysis. Instead of tightening austerity, the next government should spur demand with lower taxes, more public spending and bigger deficits. There is, moreover, a third possible view which reinforces this less pessimistic analysis. The productivity “crisis” may be largely a statistical illusion. Rapid technological and structural changes in the economy have diverted consumption and employment growth into many activities that did not exist in earlier periods and others that are organised in totally new ways. Consider email, now an unpaid service that eludes statistical measurement and has largely replaced conventional post. Or online ventures such as Twitter and Skype which generate little revenue but employ thousands of staff on good salaries, financed mainly by raising capital from investors. Or businesses such as Amazon, which are organised to minimise the value-added they show to the taxman and therefore also to government statisticians.

The optimistic statistical explanation of the productivity slowdown assumes that technological change has accelerated since the 2008 crisis instead of slowing, which is what supply-side pessimism implies. This seems quite plausible, given the obvious evidence of accelerating technology all around us, as well as the fact that the countries supposedly suffering the biggest productivity slowdown have been those with the biggest service sectors experiencing technological disruption—not just Britain, but also the US.

Which explanation should we believe? No doubt there is some measure of truth in all three, but the first story about a deteriorating supply-side seems the least important aspect of the productivity conundrum. There is no evidence that technological progress has decelerated since 2008, or that educational standards have precipitously fallen, or infrastructure suddenly collapsed. Yet ironically, the supply-side explanation of the productivity and growth slowdown, and the associated policy prescriptions—austerity and deficit reduction—have become semi-official dogma in British politics, embraced by all the main parties. If you believe this story then the choice in the election is simple: vote Tory if you want more public spending cuts, Labour if you prefer lower personal living standards or Liberal if your sado-masochism extends to both public and private spending. If, on the other hand, you can see no reason to believe that British businesses and workers have suddenly and inexplicably lost their ability to innovate, create, adapt and compete, then you may well decide that none of our defeatist politicians deserves your vote.

Anatole Kaletsky will be speaking at How the Light Gets In, the world’s largest philosophy and music festival, running from 21st May to 31st May in association with Prospect Magazine.