London leads the way in solving productivity

The gloom of the Budget is largely down to regional disparities, which have steadily worsened

Where in Europe is productivity at its highest? Berlin, Munich? Or perhaps Paris, given supposedly superior levels of French productivity? Surprising though it may sound in view of the whacking great productivity downgrade unveiled in this week’s UK Budget, it is actually here on these shores – London and its immediate environs, to be precise.

Britain’s “problem” with productivity lies almost entirely outside the M25. If everywhere in Britain were as productive as London, our economic difficulties would be over, and with them the constraints of our present fiscal straitjacket. As it is, even the average UK region has a lower level of productivity than the most poorly performing region of any other major advanced economy.

These regional disparities have been growing steadily worse since the turn of the century, and accelerated further following the financial crisis. If the independent Office for Budget Responsibility (OBR) is to be believed, they are set to get worse still, extending one lost decade of wage growth into a second.

The OBR’S assessment is admittedly guesswork. In arriving at its gloomladen forecasts, it merely took the midpoint between the pre and (much worse) post-crisis trend in productivity growth – hardly a sophisticated approach – and filled in the numbers accordingly. Yet it could be right, or more worrying still, it may even be underestimating the scale of the collapse.

What made the Budget so depressing was that it had so little to offer beyond token gestures to address these deep-seated structural failings.

There are essentially two parallel problems at work here. The first lies in education and training. Relative to others, basic standards of literacy and education have fallen badly behind. Ironically, the capital city, once notorious for some of the worst schools in the country, now has some of the best. According to recent analysis by the OECD, over a quarter of workers in the UK are low skilled, holding back labour productivity and job quality.

There are no quick fixes to such a problem. Even accepting that education and training are now improving, it will take more than a generation for the existing deficiencies to wash through the system.

The second constraint is an even tougher nut to crack, for London’s success is in large measure a simple matter of geography and size. We’ve long known about the economies of scale that result from clustering large numbers of people together in a single space. Compact urban supply chains by their nature are likely to be more productive than more diffuse economic interaction. Yet in recent decades, a further advantage has established itself: cities are great places for the exchange and transfer of ideas. These “knowledge spillovers” create a virtuous circle of growth which attracts the cleverest and most skilled workers.

There are many reasons for superior US levels of productivity, but at least some part of the explanation lies in the fact that a greater proportion of American citizens are concentrated in large cities. As Europe’s only truly global metropolis, London enjoys some of the same advantages. It acts as a magnet, not just for the UK’S cleverest, but increasingly for Europe and the world. There is therefore some truth in the complaint that it sucks the lifeblood out of the rest of the nation.

In addressing the problem, the solution is not to punish London, but to encourage and empower the regions. The Northern Powerhouse is more than just a PR stunt; it is based on hard evidence that restricting the growth of cities ultimately makes us all poorer. Many of our second-tier cities are sub-scale. In a more brutal world they would be bulldozed, or otherwise turned into tourist attractions, forcing families into a smaller number of more successful cities. Zoning rules and planning restrictions stand obstinately in front of any such structural transformation.

I’m more optimistic than the OBR about prospects for improvement in the next five years. One of the primary reasons for poor post-crisis productivity is that we have also seen very strong growth in employment, together with easy access to low cost, low skilled foreign workers. This in turn has caused companies to choose labour expansion over capital investment. Full employment may be bringing this dynamic to an end.

Furthermore, by generating lots of jobs, Britain has avoided a condition known in economics as “hysteresis”, which broadly argues that the longer workers remain unemployed, the more they lose skills and thereby damage productive potential. Large parts of Continental Europe, with its very high levels of unemployment, will be paying the price of hysteresis for decades to come.

Be that as it may, fixing the productivity deficit is by far the biggest of Britain’s myriad economic challenges, much greater in truth than the all-absorbing business of Brexit. The solution, moreover, lies entirely in our own hands; it’s not going to be solved simply by leaving the EU. FOLLOW Jeremy Warner on Twitter @ Jeremywarneruk; READ MORE at telegraph.co.uk/opinion