Productivity … further from the Holy Grail

The latest international comparisons on productivity show the UK’s relative position weakening in 2012.  Output per hour and output per worker were 16 and 19 percentage points respectively below the G7 average.  The ONS says the former was the largest gap since 1994.  Unlike most of its peers, UK productivity was lower in 2012 than in 2011.

In current prices, last year, UK output per hour was 29 points behind the USA and 24 points behind Germany and France.  In terms of GDP per worker, the equivalent gaps were 40 points and 10-11 points.  The large relative US differential between these measures (40-29) is explained by its longer working hours whereas the opposite is true in Europe (10-24).

In constant prices, UK productivity remained below its 2007 peak in 2012 and slipped back relative to its rivals and, significantly, compared with its own previous long term trend.  Here is the real cost of the UK downturn.  We are less competitive, buying a less negative employment impact at the price of poor productivity.  I am not saying this is right or wrong.  It just is.  In contrast, the USA and Canada in particular, have seen a more normal pattern of productivity and employment fall and rebound over the downturn.

Why does this matter?  It matters because productivity growth is the ‘holy grail’ of economic performance.  It is what underpins future living standards.  If our relative productivity performance is slipping and our absolute productivity is not increasing, relative living standards will fall over time and absolute, post-inflation, living standards will, at best, stagnate, and probably drop.  In turn, this means lower employment and real incomes, and higher unemployment down the line.

Many don’t get this.  “Surely,” they say, “productivity destroys jobs.  The easiest way to increase productivity is to sack people.  I think it’s better to have high employment than high productivity.”  This confuses the micro and the macro and the short and medium term.  For an individual firm, it may be that shedding labour will boost productivity – for a while.  In an upturn, this may be because new technology is adopted which raises output per hour/worker and less workers are needed to produce the same level of output.  In a downturn, this may be because demand has slumped and the current output level needs fewer staff.

But, in the first case, the new investment should make the company more profitable and more competitive.  It will be able to enter new markets, develop new products and increase its market share.  In the medium term, this growth will lead to a need for more staff as the company grows.  The chain is from productivity to growth to jobs.

In the second case too, shedding staff can turn things around by releasing resources that can be redeployed to better effect elsewhere in the economy and by turning round financial positions to the point where more positive trends can emerge.

In the medium term, productivity growth is a generator of jobs, especially at a macro level.  If everybody sacks workers to boost productivity, demand will fall and the economy will shrink and productivity will then drop again.  But, if everybody raises productivity, it will raise spending power, start to increase demand and hiring across the whole economy.

The bottom line here is that the UK recovery will not be sustained and secure until productivity starts to climb again, in absolute and relative terms.  In the short-term, this may restrict employment growth but, later, once we have got on to a productivity-led growth path, the increases in employment will come.

Politicians and commentators have been talking about rebalancing the UK economy to make it more internationally competitive for the long run.  My argument is that the crucial element is for it to be investment-led in a way that boosts productivity.  The latest productivity figures are awful and current policies are not really helping.  Let us pray that the UK political parties go into the 2015 election with productivity boosting policies at the ready.  Fundamentally, this probably means getting out of the way of entrepreneurial drive, innovation and skills acquisition.  The search for the ‘holy grail’ of productivity is paramount to a sustained upturn.  Unfortunately, right now, unlike our competitors, we are going in the wrong direction.  Until, we turn around, the recovery can only be weak and vulnerable to shocks.