The UK productivity puzzle (cont'd)

Workers at a UK car factory How can the UK boost its productivity?

We found out this week that British workers, on average, were 20% less productive than the G7 average in 2011, and nearly 40% less productive than the average US worker.

That's the biggest gap since they started measuring it, in 1990.

We shouldn't be surprised by this number - and perhaps we shouldn't be too depressed by it, either (see below). But if we're entering a slightly calmer period for the UK economy, it is going to be very important for policy makers to work out what is driving this shortfall.

Ben Broadbent, from the Bank of England's Monetary Policy Committee, has a good go at this in his latest speech.

First, a bit of explanation. All that those productivity numbers are really telling us is that Britain has been better at creating jobs over the past five years than at raising national output.

If we're making less stuff, but employing more people to do it, our productivity - output per head - has to have gone down. It's a simple matter of arithmetic.

'Jobs-free growth'

Of course, we'd rather that jobs, productivity and output were all going up, as they usually do. But if you're stuck, as we have been, with the slowest economic recovery in modern memory, most people would probably say it was better for the long-term health of the country to have more people working, less productively, than to have rising productivity but also higher unemployment.

In effect, that is what you have had in the US, where output per worker has jumped by five percentage points since 2007, at the same time as national output (GDP) has risen by only one percentage point. That has only been possible because the number of people in work has fallen by four percentage points in that time, the number of hours worked has fallen even more.

By contrast, British GDP fell 2.4 percentage points between 2007 and 2011, while employment actually rose, by 0.3%. Amazingly, the UK created almost as many jobs as the US did in the three months to July, even though America's economy is seven times larger.

I suspect many Americans would be happy to swap their higher productivity for a few more jobs.

On the campaign trail both the main US presidential candidates are under pressure to say how they would create more employment. As far as I know, President Obama does NOT go round telling voters that high unemployment is a "small price to pay" for a historic rise in productivity.

But, even if we prefer "growth-free jobs" to the other available alternatives, it's important for the Bank of England to understand why employment has grown recently, while output has not.

Why? Because, in the end, we can only get richer - raise our national income per head - if we can create more economic value with the same number of workers. That, too, is a matter of basic arithmetic.

It matters, therefore, whether this is a short-term blip - due to labour-hoarding by employers, for example, coupled with a shortage of demand - or whether something more fundamental has been happening to the "supply side" of our economy, which is systematically preventing us from growing out of the crisis as quickly as we had hoped.

I went through some of the possible explanations in a blog last month. But Ben Broadbent thinks it is increasingly hard to put it all down to a shortage of demand. Something bad must also have happened to our productive potential.

This gets some support, as it happens, from the new figures on international productivity levels which I cited at the start.

When you measure productivity in terms of output per hour worked, instead of output per worker, these ONS numbers show that our productivity growth has not been very different from other European countries. Even though countries like France and Germany have had stronger recoveries than us and a different set of government policies. (See chart below from Credit Suisse).

Output per hour in major economies

So - whatever has been hurting Britain's productivity, it seems to have hit the likes of France and Germany as well. Put it another way, they have had "surprising" growth in employment as well. (Though the output per worker comparison shows you they haven't had quite the puzzle that we have had.)

What might that shock be? Ben Broadbent's explanation is worth reading in full. But in essence he thinks that you can explain quite a lot of what has happened if you assume (a) that some parts of the economy have been much worse affected by the crisis than others, and (b) our damaged financial system has not been doing a good job of pulling capital out of the poorly performing sectors and channelling it to the growing ones.

Put those two together, you get companies in the fast-growing sectors taking on workers to meet rising demand, because they can't get a loan from the bank, and companies in the hard-hit companies holding on to workers, hoping something will turn up. Employment goes up, even if overall output is flat.

In more normal times, the slow-growth companies might go bust - and produce a lot of job losses in the process. But in an environment of super-low interest rates, it's possible that a lot of them have been able to stagger on, and some lenders, at least, have been unwilling to pull the plug.

In its Financial Stability Report last December, the Financial Services Authority reported that a third of commercial property loans were in "forbearance".

How does this explanation fit the facts? The debate will run and run. But Mr Broadbent pulls together some striking evidence in support, including this wild and wacky chart (below) which looks like an electrical experiment gone wrong, but actually shows the movement of output across 81 sectors of the economy since the late 1990s. Each of the coloured lines represents the output of one sector.

Output across economic sectors

What this chart shows is that the various parts of the economy grew at broadly similar rates for most of the first years of the 21st Century, but since the start of the crisis they've sharply diverged. Some parts of the economy really are doing a LOT better than others.

He also points out that the rate of both corporate failures and start-ups has remained relatively low - far lower, for example, than in the late 1980s or early 1990s. That also backs up the idea that new companies are being held back by a lack of finance while quite a lot of failing companies are somehow surviving, despite very weak demand.

The fact that there is a lot more variation than usual in the rate of return you can earn investing in different parts of the economy also backs up his case. With a well-functioning financial system, you would expect those differences to get ironed out, because people would be getting out of the low-return sectors to invest in the more lucrative ones.

Employment focus

So far, so interesting. If Mr Broadbent's story is true, what does it mean for the future?

Eventually, he thinks things will have to get back to normal, and productivity will start to grow at a decent rate again. If that comes mainly from the high-growth sectors finally getting capital, employment could carry on growing, or at least remain stable.

But if it's from money finally being sucked out of the weak sectors, that's going to show up in lost jobs and even slower economic growth. In that case, the Bank might need to unleash yet another round of quantitative easing.

Whatever happens, Mr Broadbent thinks the Bank of England's Monetary Policy Committee should focus more on employment, which does have a reliable link to inflation, and a bit less on short-term changes in GDP.

That sounds sensible. Politically attractive, even. But politicians might not like the practical consequences.

In effect, Mr Broadbent is suggesting that the MPC should tighten policy if employment growth continues to be strong, in order to meet the inflation target - even if the pace of the recovery is still weak.

Stephanie Flanders Article written by Stephanie Flanders Stephanie Flanders Former economics editor

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  • rate this

    Comment number 182.

    153, 155

    JfH: Yes, stable exchange rates would be wonderfull, but not at the cost of a collapsing economy and society.

    Nautonier: EU contributions may be costing me a fortune, but the same goes for my competitors..

  • rate this

    Comment number 181.

    Appart from the delta between UK, france and italy - the huge gap in productivity is between USA and EU. Massive gap that EU policy makers have been going on about for decades.

  • rate this

    Comment number 180.

    Possible explanation, at least for the dozen or so people I employ.

    Growth is flat, possibility of bonuses is remote, so there's no incentive to put in unpaid overtime. Low growth means we couldn't afford our customary annual pay rises this year, so instead we cut the working week & kept salaries level.

    Others doing similar e.g. extra leave in lieu of pay rises to keep costs down & staff happy.

  • Comment number 179.

    All this user's posts have been removed.Why?

  • rate this

    Comment number 178.

    "the least while maintaining the status quo for those whose models have blatantly failed"

    And ho do you work this out? It is the middle calsses and savers who are getting nailed; not the lower echelons. Welfare budgets have been hardly touched.

    Ring fencing foreign aid just plane stupid.

    Want to fix tax avoidance broaden base & lower rates

    What models are you talkign about?

  • rate this

    Comment number 177.

    I am afraid these guys are doing this on the back of a fag packet, look where they are looking for the money?
    Those who have the least while maintaining the status quo for those whose models have blatantly failed.
    Welfare and social costs and the saving they have gained are a drop in the ocean compared to dealing with tax avoidance and ring fencing foriegn aid etc.

  • rate this

    Comment number 176.

    "I love it when people who know nothing use words like "average"..."

    Earthman at 172 where do you spot these people who know nothing and how do you know they know nothing? Do you really mean nothing? Or do you mean they don't know as much as you about economics and numbers?

    I love it when people try to put others down but mess it up and end up looking silly.

  • rate this

    Comment number 175.

    174. Well as the cuase of the problem sit significantly at the feet of the last govt they have justification. As for solvign the problem they should be cutting more deeply than they are whilst making necessary supply side reforms to free up the economy. West govts need to realise quickly that the social democratic party is over.

  • rate this

    Comment number 174.

    This parliment has failed and its mocking of New Liemore beggars belief.
    Where's the press?
    Gideon couldn't organise a childrens tea party unless he spent a couple of £m on consultancy to help him.

  • rate this

    Comment number 173.

    "even with the cuts our debt remains static"

    No it's goign up. By 2015 gvot debt etsimates are circa £1.5 trl. Govt is merely slowing the rate of increase; not cutting at all.

  • rate this

    Comment number 172.

    I love it when people who know nothing use words like "average" and "normal", both meaningless words in economics, coupled with spurious choices, like, employment or productivity which do you want?

    we need both actually . . . those in currently in power have absolutely no idea about how to achieve it.

  • Comment number 171.

    All this user's posts have been removed.Why?

  • rate this

    Comment number 170.

    Mr KIng has shown himself to be the whipping boy of those who got us into this mess, with a nod and a wink from Gideon and Little Lord fauntleroy the farce continues.
    Don't worry though its only our pensions and future incomes on the line, even with the cuts our debt remains static ,pain without gain should be our leaders clarion call.
    QE is theft, about time we hit 0.25% on the BR.

  • Comment number 169.

    This comment was removed because the moderators found it broke the house rules. Explain.

  • rate this

    Comment number 168.

    167 nature most productive bio diversity proof never has famine been less wide spread tell that the fish birds and bees,mono culture for soya,etropa for fuel,corn for syrup worldpalm oiletc eco system collapsing,qoute 6bn fron 2002 bbc lecture,ty for update if worlds pop falls lets give quallity a go not quantity and preplanned obselesence

  • rate this

    Comment number 167.

    166. Its at 7 bn now and world population growth is slowing significantly -popn now growing at 1 % pa, down from 2% in 1960s. World easily has capacity to fed many more. Never before have we looked less likely to starve. Never has famine been less widespread. Thsoe it perpetually promote doom & gloom really are very tiresome reactionaries.

  • rate this

    Comment number 166.

    falling tp thank you,man adaptabilty
    dickens days the world's population was 500m, yet today we have the capacity to feed 6bn people, showing that food shortages and starvation are driven by political not agricultural failure.
    The worry now is with the world's population set to rise by 50% to 9bn in the next 30-40 years, Malthus will come back into his the ghost of xmas past

  • rate this

    Comment number 165.

    Or even Thomas Malthus?

    162. Another day another posting promoting the great deregulation myth as the curse that is upon us. You should really look a little more widely.

  • rate this

    Comment number 164.

    money goes to money as always,
    take everything you can,
    give nothing back
    ,old money,land grabs still same old game,
    still till they get what there hearts desire,
    we live on the trickle down and closer to food source fresher it will be
    cap was to keep family farms on the go originaly comes to uk FOODALISM ,charlie and co,is growth good and compatible with world eco systems?

  • rate this

    Comment number 163.

    And if man hadn't walked out of the Rift Valley? And what if if and buts were saucepans?

    Est that globally nearly 50% of food spoils before it reaches consumers. Blame rests mainly with govts who impose stupid internal levies, fail to apply rule of law of to provide transport infrastructure whilst imposes taxes & other barriers to entry.

    You are Thomas Maulthus no?


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