Sunday, June 16, 2013
Don't write off Britain's productivity yet
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


My regular column is available to subscribers on This is an excerpt.

The news on pay and productivity has been bleak. Britain, it seems, has become a lower-paid, faling-productivity economy, a land of squeezed incomes, low investment and declining ambition.

For those tempted to switch off now, stay with me for a while. Let me start some of those gloomy numbers. The Institute for Fiscal Studies (IFS), in a series of studies, reported that real wages at the end of last year were 6% lower than on the eve of the recession in early 2008.

Real wages have fallen more over the past five years than in any comparable period, the IFS noted, with large numbers of workers subject to pay freezes (at a time of rising prices) and cuts.

Nor, according to another IFS analysis, have households been making up this wage squeeze elsewhere. Depending on which measure of inflation you use, but based on official Department of Work and Pensions data, it demonstrated that median real incomes dropped by between 4% and 6% between 2009-10 and 2011-12.

The IFS was not the only organisation to highlight what has been happening to pay. The Trades Union Congress reported that total pay in 2012 was £52bn lower, in 2012 prices, than in 2007, a 7.5% fall. In some regions, according to the TUC, the fall was close to or in some cases exceeded 10%: worst hit were the north-west, the wesd midland, the south-west and Scotland.

This is, of course, very unusual, “unprecedented” according to the IFS. The forces of supply and demand are conspiring to keep wages down. Though a record number of people are in work, nearly 30m, demand is barely keeping up with supply, so unemployment remains close to 2.5m.

That supply is partly the result of immigration but mainly a consequence of the fact that many older workers are no longer retiring gracefully (a record 1m over-65s workers are in employment). Also, partly as a result of government policy, many more single parents have stayed in the labour market.

It is also the case that declining union representation has made it easier for employers to freeze or reduce wages. Had the unions retained their power base and influence of, say, the 1960s, there would have been less of a fall in real wages for those who stayed in work, though almost certainly at the price of much higher unemployment. Fact 1, however, is that we have seen a big drop in real wages.

Fact 2 is that alongside that there has been a big fall in productivity. The latest official figures show that output per hour, across the whole economy, is still below its level in 2009, the recession’s low point. Output per worker and output per job are up, but only fractionally.

This, so far, is the recovery lacking productivity growth. Output per hour worked is more than 4% below its pre-crisis peak, a break with the past. As Paul Johnson, director of the IFS, noted: “The difference is remarkable. Output per hour worked started rising at a healthy pace very soon after the start of each of the last two recessions and within five years of the start of the recession had reached a level 15% above its starting point.”

All very gloomy. How can I possibly extract anything even remotely optimistic from all that? It is difficult but when it comes to pay - average earnings - it is clear that recently at least there have been some distorting factors at work.

Earnings growth has been particularly subdued for most of the past year but at least some of that, and I would not want to overstate it, has been the result of higher earners avoiding the 50% top rate of tax.

So private sector total earnings in March were down by 0.9% on a year earlier, while in April they were up 4.2%. That jump was driven by an explosion on bonus pay in April, up 47.5% in the private sector on a year earlier, and including sectors such as construction and manufacturing as well as financial services. Even the public sector joined in: its bonus payments in April were 32% up on a year earlier.

A bigger reason for hope is on productivity. Have we turned ionto a low-productivity economy in which low, or even falling real wages are fully justified? I do not think so.

The most interesting bit of IFS research, for me, was on this point. It showed that productivity and wages have held up relatively well in large firms but fallen among medium-sized businesses, those with 50-249 employees, and even more for small firms, with fewer than 50 workers.

Why have productivity and wages fallen among smaller firms? They have been credit-constrained, so have not been able to invest in productivity-enhancing equipment. They have been able to call on their workers to make pay sacrifices, without falling foul of the unions; most smaller firms are non-unionised and not subject to national pay agreements. And they have been keener to hold on to staff even in a time of subdued growth, because of the cost of recruiting and retraining.

But the IFS found that these firms are not instrinsically low-productivity businesses. Most had good rates of productivity before the crisis, suggesting that productivity can and will bounce back as the recovery gathers pace. We should not write it off yet.

That is my view and it is also the view of the CityUK’s independent economist group, chaired by the former monetary policy committee member Andrew Sentance. One of the biggest falls in productivity has been in financial services.

It thinks that this, along with the wider weakness of productivity, is more likely to be cyclical and thus temporary, rather than structural and therefore permanent. Solving the productivity puzzle will take time, But solved it will be and with a return to more normal rates of productivity growth. Let us hope so anyway.