Stability is the missing piece in Britain’s productivity puzzle

Thursday was not a good day for optimism about the public finances. Since the start of the year, a little bit of Tigger had crept in to nudge aside Eeyore. Yes, the national debt was high as a percentage of gross domestic product, but it had been worse before and the economy was showing some unexpected signs of life. If we kept up the improvement in growth reported in the first six months, maybe Rachel Reeves would turn out to be a lucky chancellor.
First, the Tiggers got a whack across the belly with a wet flounder in Lord Darzi’s report on the state of the National Health Service, which posted a big and persistent demand for cash through No 11’s letterbox. A few hours later came the Office for Budget Responsibility’s look at the long-term trends in public finances, which found that, if we go on as we are, the ratio of national debt to GDP could grow from the present 100 per cent to 270 per cent or more.
One thread linked Darzi’s findings to the OBR’s projections. Both talk about the potential transformative power of productivity improvements. Darzi highlighted the puzzle of the NHS’s sudden drop in efficiency.
Productivity had improved steadily over much of the previous two decades, but went backwards after the pandemic. It is now worse than it was in 2019. If that could be reversed, the bill to repair the NHS would be much less. It is the same story on a much larger scale for the public finances as a whole. The OBR said that if productivity could be increased by one percentage point, the same as returning to the productivity growth rates achieved before the financial crisis 17 years ago, it could keep debt below 100 per cent of GDP for the next 50 years.
• UK debt could soar to 300% of GDP, warns OBR
Unfortunately, Britain’s recent record on productivity is poor. Since the crisis the OBR alluded to, we have lagged behind most of our big trading partners, particularly the United States. This is worrying, and not just because of the knock-on effects on the NHS and the public finances. It is saying goodbye to our chances of improving our relative standard of living. As Paul Krugman, the Nobel prize-winning economist put it: “Productivity is not everything, but in the long run, it’s almost everything.”
This fall in efficiency has always made me slightly suspicious. Can it really be true that British workers, and the capital and machines they use, are much worse than those elsewhere? It didn’t tally with what bosses often told me. Japanese car company executives were happy (with a few exceptions) about the relative performance of their UK plants, while pharmaceuticals and aerospace companies love the UK. Maybe something else was skewing the figures, something to do with the make-up of the British economy, perhaps, or the way different countries measured their performance.
To try to gain some illumination, I spoke on Times Radio last week to Professor Dame Diane Coyle, Britain’s productivity guru, who is the Bennett professor of public policy at Cambridge (as well as being a director of the Productivity Institute, a former vice-chairwoman of the BBC and a former member of the Competition Commission). She said the UK was lagging, but pointed out a few wrinkles and had one simple idea that might guide future policies.
First, when economists like Coyle talk about productivity, they are usually not talking about the plain English meaning of productivity, that is how many hours a worker takes to complete a task. If you measure only the hours worked, you come up with a number for labour productivity, taking into account only one factor of production (as an aside, that simple measure throws up some interesting ideas: if I pay a professional bricklayer to put up a wall, it might take her or him a day; if I do it, it will take a week; but if I don’t pay myself, am I actually more productive? In terms of wage cost to my household, my productivity is infinite. What you decide to measure makes a big difference).
Leaving my amateur economics to one side, what Coyle and her peers focus on is total factor productivity, a measure that takes into account all the inputs into an enterprise. This is complicated and there are difficulties in working out (or estimating) all the different things that might influence the final number. Inflation is one obvious problem. The value of output might go up, but that might be because prices are going up rather than because the underlying activity has become more productive.
In general, it was easier, Coyle said, to measure productivity in manufacturing rather than services. It might not be too difficult to work out which of two car factories is more productive. But what about two film production companies or two songwriters? This is particularly relevant in Britain, where last week’s GDP numbers revealed that manufacturing now comprised only 9.2 per cent of GDP, a record low.
Having noted those caveats, Coyle said she was “pretty confident” that the UK was lagging behind, for one obvious reason. Its capital investment was lower and, as she put it, a builder with a digger will always be more productive than one using a spade.
The UK will struggle to compete unless businesses and the public sector buy more capital goods that will help workers to produce more. This is something that governments can encourage with tax reliefs and the Conservatives’ decision to allow full expensing of capital investment was, in Coyle’s view, a step in the right direction.
She also pointed to something that had been missing. Stability. There had been so much “churn” in corporation tax (which, it is worth remembering, has gone from 30 per cent in 2007 down to 19 per cent in 2017 and is now back up to 25 per cent) and other industry tax regimes (consider the yo-yoing of tax and reliefs in the North Sea) that companies were nervous of big investment decisions.
When in opposition, Reeves talked endlessly about the need to restore productivity growth to the UK’s economy. With her first budget a mere six weeks away, will she take Coyle’s advice and learn to leave things alone? Or will she, like most chancellors before her, be overwhelmed by the urge to tinker?
Dominic O’Connell is business presenter for Times Radio