Chronic yes, but hopefully not incurable

Rhys David looks at the UK’s persistently poor rate of productivity growth just a day after the Prime Minister unveiled her new industrial strategy.

It could almost be another riddle wrapped up in a mystery inside an enigma, the  description Churchill famously used for Russia in 1939. A puzzle, in this case, that has been exercising economists for decades. Why is Britain’s productivity record so much worse than that of other advanced economies?

At first sight it all seems rather paradoxical.  Britain, in many ways, seems a much more efficient country than our continental neighbours and, on occasions the US. We have led the way in many modern banking developments, including credit and debit card usage, and more recently in contactless payment – to the extent that some banks have now decided  to print bank statements on both sides  of the paper for the declining number of individuals requiring hard copies, such are the number of non-cash transactions these days. They are also threatening to cut the number of cash point machines, so many people are buying even a cup of coffee with a card and need less change.

Our transport ticketing systems, too, are often surprisingly far ahead of those in many other countries. Home ordering (and printing in some cases) of tickets is now routine for bus, rail and air journeys. Even suburban rural stations with relatively small numbers of passengers  boast machines that will enable you to buy a ticket for distant destinations, and across London the queues at underground stations are now for the ticket machines not the clerks’ windows. These changes, it can be argued, are merely transferring the cost of purchasing services from the operator, through reduced labour costs, to the user  purchasing a service at home. They are still improvements to the efficiency of the enterprise’s operations and hence productivity.

There are other examples. We were able to go into Prêt à Manger or one of its competitors and buy packaged sandwiches, paninis, wraps and salads  in multiple varieties when in New York the consumer still had to wait while the fillings were added. And who after coming from seven-day, sometimes 24-hour, shopping in Britain has not been frustrated to find that on certain days and times on the Continent retail has shut up shop? Why has the same apparent efficiency not happened as widely as we might hope, including where it perhaps matters most – in the things we make?

Many of the developments  described above merely reflect  that Britain is a very tech-savvy place, as the transformed area around Old Street in London demonstrates. Once among the grimmest of London’s thoroughfares, its crossroads with Moorgate  is towered over these days with crazily-shaped and coloured blocks housing the world’s internet giants. Amazon, Intel, Google and Cisco  are among those that have flocked to Silicon Roundabout  and surrounding East London to be part of a  community of more than 50,000 people in 3,000 companies. They have been  drawn from countries across the world by the opportunity to work  in this creative environment. Indeed, the proportion of the UK economy now accounted for by technology – 12.6 per cent – is more than twice that of the rest of the G7.

So, to return to the question. Why do we languish sixth out of seven among the G7 world’s richest countries in growing our output per person?  And, it might be asked, if Britain is growing faster than most of its neighbours (though not the US) does it matter?  The answer to the second point is key.  Britain’s growth is heavily dependent on consumer demand fuelled by debt, leading to a serious balance of payments deficit which perhaps vainly it is hoped the recent devaluation of sterling will help to rectify as our exports become less expensive to overseas buyers and imports are deterred by price. Our deficit itself has to be finance by overseas borrowings which can be secured at reasonable rates of interest only as long as lenders continue to have confidence in our ultimate ability to repay. Britain’s economy needs to shift from this paradigm sooner rather than later and this can only be achieved if the economy becomes more genuinely productive. More productive companies with faster-growing output can afford to pay higher wages, which in turn means higher tax revenues for Government and an improved capacity to pay for the social and other services now demanded.

So, what has been tried? Post-war efforts to raise UK productivity began seriously with Harold Wilson’s creation of industrial champions in electrical equipment (merger of English Electric/AEI/GEC), in motors (the 1968 BMC/Leyland merger), steel (the creation of the nationalised  British Steel Corporation   in 1967 with plans to expand production to 35m tonnes a year), and in aluminium (new smelters for RTZ/BICC/Kaiser, British Aluminium and Alcan).

Joining the European Community in 1974 was part of this same process but Britain as a whole continue to lag behind continental rivals in overall  productivity even as the City of London has roared ahead as Europe’s financial capital.  Even on the way out of the financial crash of 2008 the economy’s  recovery has been sluggish to the extent that it has only recently grown past the point it had reached  eight years earlier. Leaving the EU and concentrating on global markets is seen as another magic bullet but is it any more likely to  hit its  target than previous policy projectiles?

Productivity is to a greater or lesser extent a problem across most Western economies and, according to some economists, reflects a slowing pace of change over recent decades , in spite of all the apparent advances we see around us. On this analysis the western world went through a prolonged period of fast productivity growth from 1870-1970 brought about by changes from the late Victorian period which were much more fundamental than the IT revolution of the past 30 years. This was the period when the rail network was laid down, when plumbing and piped water reached homes, shops and factories, when electricity took over from less efficient means of power generation, when towns and cities brought industry and people together often to specialise in a particular form of commerce,  the telephone replaced the telegraph, and disease control reduced mortality. It was also the period when agriculture’s dominance of the economy – from 70 per cent in Victorian times to a figure of only around 1 per cent in Britain today occurred, releasing large quantities of labour to fill burgeoning factories. If this is so it explains the Solow computer paradox,  the remark by economist Robert Solow in 1987 that: “You can see the  computer age everywhere but in the productivity statistics”.

There are, of course, other explanation . Economists may be mis-measuring productivity – we are doing much better in Britain than we think and are understating productivity growth. The problem appears to have persisted for so long, however,  this  seems unlikely. The post-crash policy of the Government could be perpetuating the problems.  As Vince Cable, the former Liberal Democrat business secretary in the 2010 coalition admits, Government priority in the aftermath of the 2008 crisis was to ensure unemployment did not surge. Countries that have enjoyed the highest productivity growth in subsequent years are those where the greatest number of workers lost their jobs and now have very high unemployment, often among the youngest. Policies that have encouraged companies to hold on to and recruit low-cost labour (in many cases from outside the UK) have inevitably delayed or made unnecessary the introduction of new labour-saving technologies in the UK.

By keeping interest rates at very low levels for the longest period in history the necessary elimination from  the economy of “zombie” companies that would not otherwise survive, has also been thwarted. As a result their more successful rivals have not been able to grow as they might and secure the productivity gains that come when weaker competitors are removed. Or it could be the finance system itself is not working as well as it should, particularly when it comes to channelling resources to small and medium-sized businesses. Hence, the measures the Government has set in train to create new challenger banks and new financial institutions.

It is hard not to believe, however, that important as some of these factors have been, something more deep-rooted in the way in which British business operates  is at work. In the bigger companies too much of the surplus generated from activities is going into dividends (and executive salaries, which have now reached vast multiples of average earnings within the same companies). Investment  by manufacturing in new equipment and processes has long been neglected as a result, leaving far too many people doing low productivity work where they need more equipment at their elbows if they are to compete with rivals in other countries.

One consequence has been to accelerate the decline in the share of manufacturing in total gross domestic product – now down to only about 10 per cent compared with a figure of 33 per cent in 1970.. This has left an economy heavily skewed towards services where because of the nature of the work it can be very difficult to secure meaningful productivity gains. If a coffee chain reduces staff by 10 per cent it will save on its wage bill but it is unlikely to be able to find machines that will serve drinks and food as efficiently or clear tables, so customers will be lost. Nor can health care, personal care, education or tourism easily yield productivity gains and these are some of the staples in the British regions where productivity is the biggest problem.

The quality of management in much of business is not as good as in some of our competitor countries, a problem which the business education explosion that got under way in earnest in the 1970s has failed successfully to address.  Many of the institutions and courses that have been created since then dedicated to this purpose have now become dependent for survival on the provision of training for the future managers of our competitors in Asia and elsewhere.

The incentive schemes available within companies, particularly the largest ,may also be perverse in rewarding those nearest the top rather than those more at a more mundane level  on whom the implementation of changes in work practices will depend and who may think of useful innovations in the first place.  It may be, too, that the brightest and best-educated Britons are not finding their way into manufacturing or even some sections of the service economy. This may be the legacy of the long period of poor industrial relations that beset British manufacturing from the 1950s through to the 1980s. In this period it was still common for Britain’s big companies to trawl universities for the best graduates but the brightest since then have often chosen to go instead into service professions such as law, accountancy and management consultancy where the work may be hard but the headaches of dealing with what had become perceived to be difficult unions and labour relations do not exist.

Like the previous efforts to raise productivity Brexit will be seen as the latest opportunity to rebuild a new balance between the different parts of the economy and the different regions. It will not achieve this on its own, however.  And, neither will a greater emphasis on infrastructure, including  the digital economy, though this will be important too. The gap between the tech-savvy in Britain and the rest will need to be closed so that more individuals who can operate effectively within the modern labour market can be come forward.  There will need to be investment, too, in improving the skills of managers so that they are better able to carry forward projects that will enable their companies to grow organically and through acquiring other businesses. Large chunks of British industry have already passed into the ownership of multinational corporations outside Britain by business boards with limited interest in any other priority (salary and bonuses apart) than maximising returns to shareholders. Incentives need to be put in place to ensure Britain secures representation in many of those sectors that advanced  nations consider to be essential but which in Britain are now controlled from abroad.

It will not be easy. Britain will continue to need foreign direct investment even as it tries to rebuild some of its own domestically-owned manufacturing  strength. Overseas companies  bring with them new products, processes and ideas and play an important part in raising the standards of home-grown competitors, as Japanese, German, and US investors  have done over the past 50 years. Nor will it happen quickly.   Unless plans of this sort are embarked upon we are likely to be looking again before long for yet another solution to our industrial balance, productivity and balance or payments or chasing another hoped-for remedy. 

Rhys David is an Honorary Fellow of the IWA.

3 thoughts on “Chronic yes, but hopefully not incurable

  1. “So, what has been tried? Post-war efforts to raise UK productivity began seriously with Harold Wilson’s creation of industrial champions….”

    Congratulations on totally missing the elephant in the room! Most of these manufacturing conglomerates were destroyed by militant Trades Unions! Ludicrous wage demands, over-manning, restrictive practices and demarcation disputes, limits on permitted production with capped bonus schemes so people didn’t work too hard – I could go on and on. It was a standing joke in the steel industry around 1970 that every ton of steel produced was a triumph for management. And it was! Industry can’t invest in design and new plant AND pay rip-off wages for low productive labour. It was indeed the 1970s when the Unions trashed this country’s industrial base. Only the fittest and most specialised survived and they have mostly done OK since…

    I’m not saying management was blameless – a tendency to employ graduates with no direct experience and put them in charge of people who actually knew what they were doing, letting accountants run engineering and production instead of engineers, there was some asset-stripping, trying to compete with low-wage economies when they should have known they couldn’t so should have concentrated on high-end manufacturing instead,.. There were many reasons…

    Nor were the governments of both shades blameless – reducing general education standards from the 1960s, closing the old Technical Colleges and ending the vocational HND and HNC type of technical qualifications was a mistake and so was ending the old 3-year Teaching Certificate courses which arguably produced better primary school teachers than the PG route. The UK has ended up with a less skilled and less adaptable workforce in many areas than our competitors.

    More recently, energy intensive industries have been further trashed by unnecessary energy price hikes to pay for climate/carbon fraud and wealth redistribution from the developed economies – though this has adversely affected most of Europe since it is EU policy. This is policy we can soon abandon, and so will the USA, while the EU probably continues to destroy its productivity until it collapses. BREXIT buys us a window of opportunity.

    Because the UK is not cost effective to produce all that much we have also sold/licensed too much of our IP abroad and let them reap the benefits… Like the USA we need to repatriate some of this…

    It’s all fixable with the right government and it needn’t take very many years… But it won’t happen unless the Unions are controlled. They’re more realistic (less unrealistic!) now but they are once again being used as a political weapon and they must not be allowed to do the same level of damage they have clearly done in the recent past.

  2. Circular arguments can be made here. Are high wages and costs of employement a consequence of higher productivity or a spur to improve productivity. Low employment costs are hardly an incentive to invest in alternatives, which are more productive because they employ less people.

    Also on the finance and investment side of things there may be disincentives to invest in things which have a longer payback in terms of investment. I often ponder on whether simple accountancy conventions and tactics may drive production decisions than the more useful function of actually being employed to support good business decisions . It is advantageous in terms of Tax to depreciate things rapidly, which means that returns on investment have to be condensed into shorter timescales, because to a simplistic spreadheet reader, if something is fully depreciated then it is also probably defunct and in the real world the link is often not so clearcut.

    There are probably many disincentives to invest in things that will ensure longer term productivity objectives, because many companies may perhaps be using oversimplistic budgeting and financial models. Getting things off balance sheets can sometimes seem to be more important than making sensible business decisions.

    Just a few thoughts that those more knowledgable of these things than me can hopefully challenge and correct me on?

  3. JRW: Now here’s a funny thing. Germany has much higher productivity than the UK and is one of the world’s biggest exporters. How have they controlled their trades unions? By not treating them as the enemy within and giving them seats on company Boards! Do they have lower environmental standards? Er, no. It seems they don’t have to leave the EU to sells everal times as much to China as we do and they don’t have to ignorantly trash the climate either. Your points about British management and technical training, however, seem entirely correct to me. They are what distinguish the British and German cases.
    The US has higher productivity too but they do it by encouraging a brain drain of the world’s brightest people to their companies and universities. Don’t think that would work here.

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