Sunday, February 17, 2013
Close the productivity gap, or we get even poorer
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

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My regular column is available to subscribers on www.thesundaytimes.co.uk This is an excerpt.

Why is Britain's productivity - the amount we produce per worker - in such a bad way? Why, relative to other countries, is it going backwards?

Official figures showed that in 2011, output per hour in Britain was 16 percentage points below the average for the rest of the G7 (America, Japan, Germany, France, Italy and Canada). The productivity gap, on this basis, has not been wider for two decades, since 1993.

Every hour worked in America produces 27% more output than in Britain; 26% more in France, 22% in Germany and even 3% more in Italy.

The gap when measured by output per worker was even larger, 21 percentage points. The rest of the G7, in other words, is roughly a fifth more productive than Britain. America, on this basis, is 39% more productive than Britain.

Should we be bothered? Yes. In another release, unusually, the Office for National Statistics(ONS) quoted Paul Krugman, the Nobel laureate turned New York Times columnist, and his observation that: “A country’s ability to improve its standard of living over time depends almost entirely on its ability to raise output per worker.”

Krugman’s slightly snappier version is that “productivity isn’t everything, but in the long run it is almost everything”.

The weakness of productivity is directly linked to another phenomenon highlighted by the ONS: falling real wages. Adjusted for inflation, average earnings in Britain have been falling since 2009 and are now back at the levels of 2002-3. For the self-employed, the picture is even grimmer: real incomes are a fifth lower than they were a decade ago.

As far as the growth in real pay is concerned, it is almost as if the period between the Queen’s golden and diamond jubilees never happened. Worse, with inflation still running more than a percentage point above average earnings, the fall in real wages is not yet over.

I had always thought that the drop in real wages was a function of what we must now call the Bank of England’s “flexible” inflation targeting regime, as elaborated on by Sir Mervyn King in presenting his penultimate inflation report.

The Bank, in other words, is prepared to tolerate years of above-target inflation because it thinks the alternative would be worse. But that above-target inflation, as often noted here, stands in the way of meaningful consumer spending recovery.

The productivity numbers, however, suggest another explanation, which is that real wages are so weak because we are falling behind on productivity. It is not quite “pay peanuts and you get monkeys” but it does suggest employers have little choice but to hold down pay because productivity is so poor.

Britain, is seems, is turning into a low wage/low productivity economy or even a falling wage/falling productivity economy. It is particularly galling because only a couple of weeks ago I quoted figures showing that, starting in about 1980, Britain had reversed her long-term relative productivity decline. The good work, it seems, is being undone.

So how worried should we be? Are we condemned to falling living standards and never trading our way out trouble? If you have ever wondered why Britain’s exports are not doing better, a chart in the Bank’s inflation report provided an explanation.

Wages have been weak, but productivity even more so. Combining the two gives unit labour costs and Britain’s relative unit labour costs, what the Bank calls the real effective exchange rate, is up by between 15% and 20% over the past four years.

The question is how permanent is the poor productivity performance. Here, there are one or two grounds for optimism. Weak productivity since the financial crisis hit has been a European phenomenon, experienced by Germany, which we do not think of as busted flush, as well as Britain.

Countries that have done well in maintaining jobs, such as Germany and Britain, have done much worse on productivity. America, in contrast, had a much bigger drop in employment (and still suffers from higher unemployment than Britain) but has done better on on productivity. That is the way the arithmetic, always of course subject to statistical revision, works.

Second, most economists believe that Britain’s productivity weakness is temporary and will recover. History suggests it is is rare for economies to hit a brick wall.

Even the Bank’s monetary policy committee, which has been accused of productivity pessimism, is basing its new forecasts on what it describes as “a gradual revival in productivity growth” and allows for the the possibility that it could recover more rapidly than expected.

Finally, we should look at the particular causes of the productivity problem in recent years, over and above the need for more investment (the more capital per worker, the higher the labour productivity) and higher skills.

ONS research shows that plunging North Sea output, without a matching drop in the number of workers, has hit productivity hard in recent years. Without this, measured productivity would have grown by 1% a year more. Though North Sea output appears to have stopped slumping, we may have to wait for shale gas for a sustained productivity boost from energy.

The other important sector is financial services. Before the financial crisis iits productivity growth rate was more than 4% a year. Since it, productivity has been falling by nearly 3% a year.

That is not the only consequence of a smaller and neutered financial services sector. The Bank governor lamented the drop in Britain’s financial services exports, another reason why the current account deficit has remained stubbornly large.

The North Sea will never get back to its glory days and, whether glorious or not, the City will struggle to regain its former highs. That leaves the onus on the rest of the economy, particularly the wider service sector where productivity is below levels at the depths of the recession, to raise its game, partly by adopting better and more efficient ways of doing things. The alternative is declining living standards.

We do not have to be productivity pessimists. But we do need to work at generating higher productivity.