Let’s get productive

Without key reforms wages will fail to rise

You eat what you kill: this was true when we were hunter-gatherers all those years ago, and it still applies to today’s workers. The more valuable our contribution, the more we tend to earn: that is why a lawyer whose firm is able to bill £200 per hour for their services earns more than somebody who is able to produce £20 of widgets an hour. The value is market-determined, rather than intrinsic.

This means that the only way to increase wages sustainably is to make sure that workers become more productive. One way to ensure this would be to encourage people to work longer hours, a somewhat crude solution. But while this may sometimes help, it can also come with diminishing returns and isn’t the real answer.

Far better is to encourage an economy where companies have an incentive to invest in new technologies and workers to train and upskill themselves. A better widgetmaking machine will reduce the number of workers employed in the factory, but will ensure that the remaining ones can make £40 worth of the stuff per hour. Soon enough, their wages will be bid up, especially in a tight labour market.

The connection between productivity and pay is one of the most basic rules of economics, and it is where the UK has a big problem. UK productivity, measured by GDP per hour worked, the best metric as it adjusts for differences in part-time work, is actually 12pc higher than Japan’s and 3.4pc better than Canada. But we lag Italy by 9pc and, more seriously, the US by 21.8pc, France by 22.3pc and Germany by 25.6pc. On average, our productivity per hour is 15.1pc lower than that of the G7. UK productivity is up by just 1.4pc in 10 years, a disastrous record: no wonder our wages are not going up. We have never recovered from the massive boom, bust and financial crisis.

It’s not all bad, however. Part of the productivity gap can be explained by a statistical distortion. There is an easy way to increase a country’s average productivity: ban all low productivity workers. That, in effect, is what countries like France have been doing for years: because the minimum wage there has been so high for so long, and the red tape so suffocating, the employment rate is lower than Britain’s. Low-productivity, low-skilled workers, including the young, secondary school dropouts and many immigrants, are locked out of France’s (and Italy’s) labour market, and therefore don’t drag down the average output per worker figures. By contrast, in the UK, where everybody has a job, including many in lower-paying service sector occupations, the average productivity numbers are weaker. Part of the productivity gap is therefore the flip side of the greatest British economic success story of the past few decades: the abolition of almost all unemployment.

Yet much of the gap still remains even after such statistical effects are ironed out. So what can be done? Here are three ideas, for starters. First, as the Adam Smith Institute points out, the Tories were right to slash corporation tax. But the simultaneous reduction in capital allowances means that the real decline in tax for many firms has been far too limited, which means that their incentive to invest more has only improved marginally.

At a time when the headline rate of corporation tax fell from 30pc to 20pc, the effective marginal tax rate on new investment rose from 20pc in 2007 to 23pc in 2010, before falling back to 17pc by 2016. It’s better, but not good enough, and a three-point drop was much less than the 10-point headline reduction. The Government needs to cut taxes much more savagely.

Next, property costs are deranged: the only solution is to drastically liberalise the planning system to boost supply. Over time this will facilitate the movement of labour, reduce corporate and other costs and allow tens of billions of pounds to be reallocated away from property towards factories, training, technology and other forms of investment.

Last but not least, transport: congestion is terrible and mobility too difficult. The private sector needs to be tapped to build new motorways, the dash towards self-driving cars accelerated, antiquated projects such as HS2 dumped, Crossrail 2 built and Heathrow accelerated.

This is only a partial programme. But these and many other reforms, including to education, are desperately needed if we want to break out of our productivity trap and start growing our wages again. allister.heath@telegraph.co.uk