UK Economy: Time to Talk About Productivity

The UK’s 2014 budget, due to be released on March 19, will be the latest in a very long line. I say that with enthusiasm even though I have covered enough to last a lifetime.

And were I to say how many of them were genuinely memorable, the answer would be a rather small number. I’m struggling, as I write, to remember much about George Osborne’s 2013 budget, and that was only a year ago.

My list of memorable budgets would probably include Sir Geoffrey Howe in 1979 and 1981, Nigel Lawson in 1984 and 1988, Norman Lamont in 1991 and again, with Kenneth Clarke, in the two tax-raising budgets of 1993.

Gordon Brown would make it with his 1997 budget and, possibly, 2002, when he raised National Insurance to pay for health spending, Alistair Darling’s 2009 budget, the one that included the new top rate of 50%, squeezes in.

Osborne’s memorable one was his June 2010 “emergency” budget, which set the parameters for the parliament and raised Vat to 20%, though his 2012 “omnishambles” sticks in the memory.

Just as budgets quickly fade in the memory, so it is important not to overstate their impact. Though there are exceptions, 1981 and 1988 particularly, economic policy is usually incremental. The chancellor as conjuror, waving a wand to transform the economy, is appealing but usually wrong.

There is, however, a central issue hanging over Wednesday’s budget. It is not, for once, the question of whether the economy is growing or the budget deficit coming down. As discussed last week, unless Osborne has a rush of blood to the head and is tempted into unaffordable giveaways, the public finances will slowly continue to mend.

No, the issue is productivity. Britain’s productivity, whichever way it is measured – the economic output produced by each worker, or each job, or each hour worked – is notoriously weak.

So, compared with its level in 2010, latest figures show that output per job across the whole economy is up just 0.5%, while output per hour is down 1.1%. This weakness is true of manufacturing, unusually, and it is true of services. Stronger economic growth has boosted the number of people in work but it has not yet boosted productivity.

Weak productivity matters because it matters. The only line I am likely to quote from the American economist Paul Krugman these days is “productivity isn’t everything but in the long run it is almost everything”. Raising productivity is the key to prosperity.

It matters too because the weaker productivity is, the sooner the Bank of England will decide spare capacity in the economy – 1% to 1.5% of gross domestic product – is used up. At that point, or before, interest rates will start to rise.

And it matters particularly for the public finances. Nearly three years ago, accompanying Osborne’s 2011 autumn statement, the Office for Budget Responsibility (OBR), taking a gloomier view of the economy’s supply potential, revised up its estimate of the underlying – or structural – budget deficit.

This is the deficit that will not permanently disappear even as the economy recovers and has to be dealt with by spending cuts and tax hikes.

The result was to kill the chancellor’s ambitions of “dealing with the deficit” in this parliament, forcing him to extend austerity beyond the election.

Some fear history is about to repeat itself. In December, in the economic and fiscal outlook published alongside the 2013 autumn statement, the OBR was quick to say that the upturn was cyclical, rather than reflecting any underlying improvement in growth potential.

It also noted that, because the weakness of productivity was unexpected, it was hard to say when, or if, it would return to past rates of growth.

Whether or not the OBR takes an even gloomier view now, with serious implications for the public finances, there is an imperative for the chancellor to try to do more to boost productivity.

What could it be? Some things being done, shifting people from traditionally low-productivity public services to the higher-productivity private sector should be helping more than it is.

There is talk of measures to boost business investment, perhaps through more generous capital allowances, building on the recovery we have seen.

One explanation for productivity weakness is that firms have preferred to recruit workers, who can be unrecruited if demand falls short, rather than make the bigger and less reversible commitment to new investment.

Britain’s low productivity in relation to Germany and France – where output per hour is 31% and 32% higher respectively – is in large part due to lower levels of investment in this country.

Another budget theme is expected to be boosting exports, perhaps via better-focused export credit. Again, this is a promising route to lifting productivity.

Export sectors tend to have higher productivity than sectors supplying only to the domestic economy, with Japan the most dramatic example of this.

There is much more. Another reason for weak productivity has been the lack of “creative destruction” in recent years – too few bad businesses going under and being replaced by dynamic, high-productivity start-ups.

That reflects what has been happening in parts of the banking system: keeping too many zombie firms alive while starving new ventures of the finance they need. That is changing, but it needs to change faster. The Funding for Lending scheme has been refocused towards small and medium-sized firms but lending to that key sector has yet to turn round.

Achieving high productivity requires more than pulling a few budget levers. It means changing the culture. But the budget must make a start. George, we have to talk about productivity.

This piece is cross-posted from with permission.