Philip Hammond must grapple with UK’s stalled productivity
BRITAIN’S productivity crisis is not going to come to an end any time soon.
That is the verdict of the Office for Budget Responsibility (OBR), the official watchdog of Britain’s government finances. Productivity is crucial to economic growth and to living standards – workers can be paid more and work less if they produce more output for every hour worked.
But since the financial crisis productivity has barely budged. Back in 2010 the OBR predicted productivity would resume its pre-crash trend, rising by about 15pc from 2009 to 2016. That did not happen. Each time the OBR made a forecast – at the Budget or Autumn Statement – it thought the strong old trend rate would pick up. But it did not. Productivity remained stubbornly low. After seven years of persisting with this, the OBR has thrown in the towel.
“As the period of historically weak productivity growth lengthens, it seems less plausible to assume that potential and actual productivity growth will recover over the medium term to the extent assumed in our most recent forecasts,” the watchdog said. “Over the past five years, growth in output per hour has averaged 0.2pc. This looks set to be a better guide to productivity growth in 2017 than our March forecast.”
That paints a gloomy picture for future economic growth, pay rises and government finances ahead of Philip Hammond’s Budget next month. The report notes that “some commentators have argued that advanced economies have entered an era of permanently subdued productivity growth for structural reasons”. However, the OBR does not quite go that far.
While it does “expect to lower our forecast for cumulative potential productivity growth significantly over the next five years”, it will do so “without going so far as to assume that there is no recovery at all from the very weak performance of recent years”.
Perhaps the most worrying section of the report looks at reasons why productivity growth has been so low. In particular, it examines the factors that were once thought to be behind the weak performance and have been fixed, only to find they were not to blame after all.
“In the immediate post-crisis period, labour hoarding in the face of temporarily weak demand was a plausible hypothesis,” the OBR said, as companies could keep on staff but work them less hard until demand recovered. “But that [theory] became less appropriate once firms began hiring again.”
Another plausible candidate was the banking system. Banks were in financial trouble and lending dived. Yet the sector has long since recovered, but productivity has not picked up.
“More recently, as the labour market has tightened, with the unemployment rate now at its lowest since the early Seventies, upward pressure on wage growth was expected to encourage firms to economise on labour and to
‘Moves by the Fed should test the idea that low interest rates are partly to blame for low productivity’
push through productivity improvements, but that has yet to happen,” the OBR said. Officials still have some potential candidates. Weak business investment could be to blame.
Capital investment levels have risen sharply since their low point in the financial crisis, though are still only around 5pc above pre-crash levels.
Alternatively there is the so-called “zombie firms” theory. “The abnormally low level of interest rates could also be weighing on productivity growth by allowing weak and highly indebted firms to survive for longer than they normally would, by alleviating the burden of servicing their debts,” the OBR said. Uncertainty following the Brexit vote could also have dented investment, though this problem existed long before June 2016.
The puzzle is a global one. Productivity growth has been disappointing across much of the developed world. At least the global nature of the problem allows for more “cures” to be attempted. The US is currently engaged in monetary tightening. Interest rates are rising and quantitative easing will soon start to be wound back.
The move by the Federal Reserve should begin to test the idea that low interest rates are in part to blame for low productivity.
At some point the theory around employment will surely have to be tested. Unemployment has fallen well below its pre-crisis levels, and the number of part-time workers who want more hours is on a downward trend. Eventually firms will be forced to boost pay or invest more if they want to grow, as they will not be able to find the workers they need.
At least ever-falling unemployment is not the most painful way to test the mysteries of the modern economy.