Productivity, and changes in it, is a key element of the present conundrum about growth. In the second quarter of 2012, UK productivity dropped, with output per hour 2.6% below the year ago level and 3% below the pre-downturn peak. This measure may recover somewhat in the second half of the year. Nevertheless, heading into the fifth year of this downturn, it is unusual for productivity to be so low and still not growing.
The textbook economic cycle is: 1) the onset of recession causes output to drop more than labour input and productivity falls. 2) firms respond by laying off workers (often more than output) to defend profitability and, thereby, productivity starts to recover. 3) the recovery of productivity and profitability encourages firms to re-invest and re-start output growth. 4) with a lag, employment picks up, bolstering demand, and the downturn is over. The chart below shows that this was the case in the three previous UK recessions. (In this chart, the lines start at the pre-recession peak and are set at 100. The lines then track productivity by quarter thereafter. In the ‘normal, case, productivity is back to 100 quickly and continues to grow.)
Not this time … whilst productivity almost got back to 100 in early 2010 and briefly in 2011, it has failed to take off in the usual way for sustained recovery. As the chart shows, it has basically been flat throughout this downturn and, consequently, the incentive to invest, employ and grow has remained subdued. Official economists are keen to explain this pattern, particularly at the Bank of England where they are concerned to know why loose monetary policy has not stimulated the economy to date. In my mind, it is a combination of the unusual employment and demand effects as well as the highly uncertain global environment. What is clear, however, is that a boost to productivity is needed for recovery.