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Posts Tagged ‘output per hour’

The UK productivity puzzle

UK productivity growth remains well below levels recorded before the financial crisis, as Chart 1 illustrates. In fact, output per hour worked in 2016 Q3 was virtually the same as in 2007 Q4. What is more, as can be seen from Chart 2, UK productivity lags well behind its major competitors (except for Japan).

But why does UK productivity lag behind other countries and why has it grown so slowly since the financial crisis? In its July 2015 analysis, the ONS addressed this ‘productivity puzzle’.

Among the many reasons suggested are low levels of investment, the impact of the financial crisis on bank’s willingness to lend to new businesses, higher numbers of people working beyond normal retirement age as a result of population and pensions changes, and firms’ ability to retain staff because of low pay growth. While these and other factors may be relevant, they do not provide a complete explanation for the weakness in productivity.

The lack of investment in technology and lack of infrastructure investment have been key reasons for the sluggish growth in productivity. Many companies are prepared to continue using relatively labour-intensive techniques because wage growth has been so low and this reduces the incentive to invest in labour-saving technology.

Another factor has been long hours and, for many office workers, being constantly connected to their work, checking and responding to emails and messages away from the office. The Telegraph article below reports Ann Francke, chief executive of the Chartered Management Institute, as saying:

“This is having a deleterious effect on the health of managers, which has a direct impact on productivity. UK workers already have the longest hours in Europe and yet we’re less productive.”

Another problem has been ultra low interest rates, which have reduced the burden of debt for poor performing companies and has allowed them to survive. It may also have prevented finance from being reallocated to more dynamic companies which would like to develop new products and processes.

Another feature of UK productivity is the large differences between regions. This is illustrated in Chart 3. Productivity in London in 2015 (the latest full year for data) was 31.5% above the UK average, while that in Wales was 19.4% below.

This again reflects investment patterns and also the concentration of industries in particular locations. Thus London’s financial sector, a major part of London’s economy, has experienced relatively large increases in productivity and this has helped to push productivity growth in the capital well above other parts of the country.

Another factor, which again has a regional dimension, is the poor productivity performance of family-owned businesses, where ownership and management is passed down the generations within the family without bringing in external managerial expertise.

The government is very aware of the UK’s weak productivity performance. Its recently launched industrial policy is designed to address the problem. We look at that in a separate post.

Articles
UK productivity edges up but growth still flounders below pre-crisis levels The Telegraph, Julia Bradshaw (6/1/17)
Weak UK productivity spurs warnings of living standards squeeze The Guardian, Katie Allen (6/1/17)
Productivity gap yawns across the UK BBC News, Jonty Bloom (6/1/17)
The UK productivity puzzle Fund Strategy. John Redwood (26/1/17)
Productivity puzzle remains for economists despite UK growth in third quarter of 2016 City A.M., Jasper Jolly (6/1/17)

Portal site
Solve the Productivity Puzzle Unipart

Report
Productivity: no puzzle about it TUC (Feb 2015)

Data
Labour Productivity: Tables 1 to 10 and R1 ONS (6/1/17)
International comparisons of UK productivity (ICP) ONS (6/10/16)
Gross capital formation (% of GDP) The World Bank

Questions

  1. In measuring productivity, the ONS uses three indicators: output per worker, output per hour and output per job. Compare the relative usefulness of these three measures of productivity.
  2. How would you explain the marked difference in productivity between regions and cities within the UK?
  3. How do flexible labour markets impact on productivity?
  4. Why is investment as a percentage of GDP so low in the UK compared to that in most other developed countries (see)?
  5. Give some examples of industrial policy measures that could be adopted to increase productivity growth.
  6. Examine the extent to which very low interest rates and quantitative easing encourage productivity-enhancing investment.
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Productivity: should we be optimistic?

Productivity has been a bit of a problem for the UK economy for a number of years. Earlier posts from 2015 have discussed the trend in Tackling the UK’s poor productivity and The UK’s poor productivity record. Although the so-called ‘productivity gap’ has been targeted by the government, with George Osborne promising to take steps to encourage more long-term investment in infrastructure and create better incentives for businesses to improve productivity, the latest data suggest that the problem remains.

The ONS has found that the UK continues to lag behind the other members of the G7, but perhaps more concerning is that the gap has grown to its biggest since 1991. The data showed that output per hour worked was 20 percentage points lower in the UK than the average for the other G7 countries. The economic downturn did cause falls in productivity, but the UK has not recovered as much as other advanced nations. One of the reasons, according to the Howard Archer, chief UK economist at IHS Global Insight is that it ‘had been held back since the financial crisis by the creation of lots of low-skilled, low-paid jobs’. These are the jobs where productivity is lowest and this may be causing the productivity gap to expand. Other cited reasons include the lack of investment which Osborne is attempting to address, fewer innovations and problems of finance.

Despite these rather dis-heartening data, there are some signs that things have begun to turn around. In the first quarter of 2015, output per hour worked did increase at the fastest annual growth rate in 3 years and Howard Archer confirmed that this did show ‘clear sign that UK productivity is now seeing much-needed improvement.’ There are other signs that we should be optimistic, delivered by the Bank of England. Sir John Cunliffe, Deputy Governor for financial stability said:

“firms have a greater incentive to find efficiency gains and to switch away from more labour-intensive forms of production. This should boost productivity.”

The reason given for this optimism is the increase in the real cost of labour relative to the cost of investment. So, a bit of a mixed picture here. UK productivity remains a cause for concern and given its importance in improving living standards, the Conservative government will be keen to demonstrate that its policies are closing the productivity gap. The latest data is more promising, but that still leaves a long way to go. The following articles consider this data and news.

Articles
UK productivity shortfall at record high Financial Times, Emily Cadman (18/9/15)
UK productivity lags behind rest of 7 BBC News (17/9/15)
UK’s poor productivity figures show challenge for the government The Guardian, Katie Allen (18/9/15)
UK productivity lags G7 peers in 2014-ONS Reuters (18/9/15)
UK productivity second lowest in G7 Fresh Business Thinking, Jonathan Davies (18/9/15)
UK is 33% less productive than Germany Economia (18/9/15)
UK productivity is in the G7 ‘slow lane’ Sky News (18/9/15)

Data
AMECO Database European Commission, Economic and Financial Affairs
Labour Productivity, Q1 2015 ONS (1/7/15)
International Comparisons of Productivity, 2014 – First Estimates ONS (18/9/15)

Questions

  1. How could we measure productivity?
  2. Why should we be optimistic about productivity if the real cost of labour is rising?
  3. If jobs are being created at slower rate and the economy is still expanding, why does this suggest that productivity is rising? What does it suggest about pay?
  4. Why is a rise in productivity needed to improve living standards?
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Tackling the UK’s poor productivity

As we saw in the blog post The UK’s poor productivity record, the UK’s productivity, as measured by output per hour worked, has grown much slower than in other major developed countries since the financial crisis. In fact, output per hour is lower now than in 2008. In France and Germany it is around 3 per higher than in 2008; in Japan it is nearly 6% higher; in the USA it is over 8% higher; and in Ireland it is 12% higher.

The chart below shows international comparisons of labour productivity from 2000 to 2014. (Click here for a PowerPoint of the chart.)

And it is not just labour productivity that has fallen in the UK. Total factor productivity of labour and capital combined has also fallen. This reflects the fall in business investment after the financial crisis and, more recently, meeting the demand for extra output by employing more labour rather than by investing in extra capital.

In his first major speech since the election, the Chancellor of the Exchequer, George Osborne, told the CBI that the government was intent on tackling the problem of low and stagnant productivity. This would require investment in infrastructure, such as high-speed rail, better roads, superfast broadband and a new runway in the south east. It would require investment in education, training and research; it would involve cutting red tape for business; it would require making it easier for both parents in a family to work by cutting the cost of childcare. The details of the government’s policies would be made clear in the soon-to-be published Productivity Plan.

But how much difference can the government make? Are there intractable problems that will prove virtually impossible to overcome? How much, indeed, can a government do, however much it would like to? The articles explore the issues.

Articles
Will George Osborne’s productivity plan help make Britain a world-beater? The Guardian, Larry Elliott (24/5/15)
UK productivity has stayed stubbornly low for years. Dare we hope for better? The Guardian (24/5/15)
Joseph Stiglitz: ‘GDP per capita in the UK is lower than it was before the crisis. That is not a success’ The Observer, Anthony Andrew (24/5/15)
Osborne says low productivity key economic challenge BBC News (20/5/15)
Solving the productivity puzzle BBC News, Duncan Weldon (20/4/15)
Osborne faces up to productivity challenge BBC News, Robert Peston (20/5/15)
Osborne makes priority of boosting UK productivity Financial Times, George Parker (20/5/15)
The Bank of England is living in cloud-cuckoo land on wages Independent, David Blanchflower (18/5/14)
Cameron’s Plan Hasn’t Cracked Productivity Slump Flagged by BOE Bloomberg, Jill Ward (14/5/15)
To solve Britain’s productivity puzzle, try asking the workers The Conversation, Stephen Wood (29/6/15)

Report
Inflation Report: Chapter 3, Output and Supply Bank of England (May 2015)

Questions

  1. Define (a) labour productivity; (b) capital productivity; (c) total factor productivity.
  2. Why has the UK experienced lower productivity than other developed countries?
  3. Why may the UK’s lower unemployment than other countries in the post-recession period be the direct consequence of lower productivity growth?
  4. For what reasons might it be difficult for the government to achieve a significant increase in UK productivity?
  5. How might demand-side policy negatively impact on the supply-side policies that the government might adopt to increase productivity?
  6. How might the period up to and beyond the referendum in the UK on continuing EU membership impact on productivity?
  7. How might poor productivity be tackled?
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The UK’s poor productivity record

Real GDP depends on two things: output per hour worked and the number of hours worked. On the surface, the UK economy is currently doing relatively well, with growth in 2014 of 2.8%. After several years of poor economic growth following the financial crisis of 2007/8, growth of 2.8% represents a return to the long-run average for the 20 years prior to the crisis.

But growth since 2010 has been entirely due to an increase in hours worked. On the one hand, this is good, as it has meant an increase in employment. In this respect, the UK is doing better than other major economies. But productivity has not grown and on this front, the UK is doing worse than other countries.

The first chart shows UK output per hour worked (click here for a PowerPoint). It is based on figures released by the ONS on 1 April 2015. Average annual growth in output per hour worked was 2.3% from 2000 to 2008. Since then, productivity growth has stalled and output per hour is now lower than at the peak in 2008.

The green line projects from 2008 what output per hour would have been if its growth had remained at 2.3%. It shows that by the end of 2014 output per hour would have been nearly 18% higher if productivity growth had been maintained.

The second chart compares UK productivity growth with other countries (click here for a PowerPoint). Up to 2008, UK productivity was rising slightly faster than in the other five countries illustrated. Since then, it has performed worse than the other five countries, especially since 2011.

Productivity growth increases potential GDP. It also increases actual GDP if the productivity increase is not offset by a fall in hours worked. A rise in hours worked without a rise in productivity, however, even though it results in an increase in actual output, does not increase potential output. If real GDP growth is to be sustained over the long term, there must be an increase in productivity and not just in hours worked.

The articles below examines this poor productivity performance and looks at reasons why it has been so bad.

Articles
UK’s sluggish productivity worsened in late 2014 – ONS Reuters (1/4/15)
UK productivity growth is weakest since second world war, says ONS The Guardian, Larry Elliott (1/4/15)
UK productivity weakness worsening, says ONS Financial Times, Chris Giles (1/4/15)
Is the UK’s sluggish productivity a problem? Financial Times comment (1/4/15)
UK manufacturing hits eight-month high but productivity slump raises fears over sustainability of economic recovery This is Money, Camilla Canocchi (1/4/15)
Weak UK productivity unprecedented, ONS says BBC News (1/4/15)
Weep for falling productivity Robert Peston (1/4/15)
UK’s Falling Productivity Prevented A Massive Rise In Unemployment Forbes, Tim Worstall (2/4/15)

Data
Labour Productivity, Q4 2014 ONS (1/4/15)
AMECO database European Commission, Economic and Financial Affairs

Questions

  1. How can productivity be measured? What are the advantages and disadvantages of using specific measures?
  2. Draw a diagram to show the effects on equilibrium national income of (a) a productivity increase, but offset by a fall in the number of hours worked; (b) a productivity increase with hours worked remaining the same; (c) a rise in hours worked with no increase in productivity. Assume that actual output depends on aggregate demand.
  3. Is poor productivity growth good for employment? Explain.
  4. Why is productivity in the UK lower now than in 2008?
  5. What policies can be pursued to increase productivity in the UK?
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Good news and bad news on the labour market front

First the good news. Employment is rising and unemployment is falling. Both claimant count rates and Labour Force Survey rates are down. Compared with a year ago, employment is up 279,092 to 29,869,489; LFS unemployment is down from 7.87% to 7.69%; and the claimant count rate is down from 4.7% to 4.0%.

Now the bad news. Even though more people are in employment, real wages have fallen. In other words, nominal wages have risen less fast than prices. Since 2009, real wages have fallen by 7.6% and have continued to fall throughout this period. The first chart illustrates this. It shows average weekly wage rates in 2005 prices. (Click here for a PowerPoint of the chart.)

The fall in real wages is an average for the whole country. Many people, especially those on low incomes, have seen their real wages fall much faster than the average. For many there is a real ‘cost of living’ crisis.

But why have real wages fallen despite the rise in employment? The answer is that output per hour worked has declined. This is illustrated in the second chart, which compares UK output per worker with that of other G7 countries. UK productivity has fallen both absolutely and relative to other G7 countries, most of which have had higher rates of investment.

The falling productivity in the UK requires more people to be employed to produce the same level of output. Part of what seems to be happening is that many employers have been prepared to keep workers on in return for lower real wages, even if demand from their customers is falling. And many workers have been prepared to accept real wage cuts in return for keeping their jobs.

Another part of the explanation is that the jobs that have been created have been largely in low-skilled, low-wage sectors of the economy, such as retailing and other parts of the service sector.

But falling productivity is only part of the reason for falling real wages. The other part is rising prices. A number of factors have contributed to this. These include a depreciation of the exchange rate back in 2008, the effects of which took some time to filter through into higher prices in the shops; a large rise in various commodity prices; and a rise in VAT and various other administered prices.

So what is the answer to falling real wages? The articles below consider the problem and some of the possible policy alternatives.

Articles
Inflation, unemployment and UK ‘misery’ BBC News, Linda Yueh (16/10/13)
Employment is growing, but so are the wage slaves The Guardian, Larry Elliott (16/10/13)
Living standards – going down and, er, up BBC News, Nick Robinson (26/7/13)
Revealed: The cost of living is rising faster in the UK than anywhere in Europe, with soaring food and energy bills blamed Mail Online, Matt Chorley (16/10/13)
Cutting prices to raise living standards is just a waste of energy The Telegraph, Roger Bootle (6/10/13)
Downturn sees average real wages collapse to a record low Independent, Ben Chu (17/10/13)
Why living standards and public finances matter Financial Times, Gavin Kelly (29/9/13)
Social Mobility Tsar Alan Milburn Calls on Government to Boost Wages to End UK Child Poverty International Business Times, Ian Silvera (17/10/13)
Do incorrect employment growth figures explain low UK productivity? The Guardian, Katie Allen (23/10/13)

Data
Unemployment data ONS
Average Weekly Earnings dataset ONS
Consumer Prices Index ONS
International Comparison of Productivity ONS

Questions

  1. How are real wages measured?
  2. Why have real wage rates fallen in the UK since 2009?
  3. What factors should be included when measuring living standards?
  4. Why has employment risen and unemployment fallen over the past two years?
  5. What factors could lead to a rise in real wages in the future?
  6. What government policies could be adopted to raise real wages?
  7. Assess these policies in terms of their likely short-term success and long-term sustainability.
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