Despite growing at its fastest pace in six years, UK productivity is still sluggish and disrupting healthy economic growth. It’s likely to be high on Chancellor Philip Hammond’s list of priorities in next week’s Autumn Budget.
Productivity rose by 0.9% in the three months to September, but this follows some of the UK’s worst productivity performance since 2012.
Ever since the financial crisis, global productivity has struggled to recover. The UK has suffered more than most and the hard work is far from over.
How does productivity impact inflation?
Economic growth is driven by consumer spending, business investment and government spending, as well as the difference between imports and exports. Productivity is a crucial cog in this wheel.
In a growing economy, consumers spend on goods and services, businesses reinvest the profit and create more jobs, and the government spends the money from increased tax revenue on new initiatives.
If consumer demand for goods and services increases faster than capacity, this economic growth is likely to cause inflation. Improve productivity and the demand supply dynamic should rebalance.
Now, it’s worth remembering that inflation can be good for the economy – low levels can encourage investment by promoting economic stability and confidence. This investment drives long-term economic growth. Overall deflation, on the other hand, can damage an economy.
However, the current acceleration behind the consumer squeeze forced the Bank of England to lower its forecasts on how much the UK economy can expand without triggering inflation, and raise interest rates for the first time in a decade.
What’s causing low productivity?
It’s not easy to attribute blame for the UK’s productivity woes – when it comes to my children’s lack of homework efficiency it’s usually because they would rather be running around the house.
Labour productivity is measured by dividing the gross domestic product (GDP) by the total number of hours worked. Sounds easy enough – although it’s not.
Challenges to the way GDP is measured, especially in the UK, can downplay productivity measurements. This is heightened by the shift away from traditional industries towards services and the sharing economy.
There are other more traditional market dynamics that weigh on productivity, like unemployment, sector exposure and the corporate backdrop.
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Whilst unemployment tends to suppress productivity, some industries are hit more than others.
A slowdown in the financial sector, for example, has left the UK rather bruised. Annual productivity growth across the EU financial sector fell from an average of 2.4% in the run up to the financial crisis, to just 0.4% in the seven years after. Manufacturing has also suffered, with growth in output per hour worked halving to around 1.5%.
Companies have also been tight with the purse strings since the financial crisis, which means there’s been a lack of investment in new machines and technology to accelerate production – thus driving productivity.
This is despite a monetary policy backdrop that encourages spending. The low interest rate environment may have also contributed, as companies that perhaps should have folded during the recession were attached to the life support of cheap money and quantitative easing.
What should the Budget focus on?
Calls for a ‘big, bold Budget’ may go unanswered in next week’s Budget as Hammond tackles downgraded economic growth forecasts amid Brexit uncertainty, sluggish productivity, and the squeeze on household Budgets.
The Chancellor won’t have much room for any big giveaways, especially on the tax front.
Signing a cheque to develop infrastructure in the UK, or finding ways to encourage businesses to spend on driving efficiencies are obvious answers to the productivity crisis – whether they will work this time round remains to be seen.
The government needs to work hard to align the south-east of England with the rest of the UK – which will include building the Northern Powerhouse. Investing in the rest of the UK should drive productivity levels, which will support long-term economic growth.
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