Sunday, September 18, 2016
Hammond needs to get Britain's productivity mojo back
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.

One of the challenges Philip Hammond has set himself for his autumn statement on November 23, among many others, is to boost Britain’s productivity. In this, the new chancellor is very much following in the footsteps of his predecessors.

Gordon Brown had his productivity agenda – even at a time when productivity (output per hour worked) was growing at a rate we would give our eye teeth for now – while George Osborne had his productivity plan. Every occupant of 11 Downing Street has sought to raise Britain’s productivity game both in absolute terms and in relation to other countries. Most have struggled to make any discernible difference.

The issue is more pressing for Hammond. The productivity performance he inherits is a particularly feeble one. Though there has been a modest improvement since the depths of the crisis in 2009, output per hour across the whole economy at the end of last year was lower than at the end of 2007. Nor is there any sign of improvement. The latest labour market statistics showed a rise of 2% in the number of hours worked over the past year, roughly in line with the growth in the economy.

Eight years without any growth in productivity is extraordinary. In the previous eight years, when Brown was trying to improve it, it rose by 19%, and in the eight years before that by 20%. Something has snapped and the new chancellor’s task is to try and fix it.

Most countries have experienced weaker growth in productivity since the crisis but Britain’s performance is particularly stark. GDP (gross domestic product) per hour worked is 36% higher in Germany, 31% higher in France and 30% higher in America than in Britain. Even Italy is 11% more productive.

The weakness of productivity is not just a statistical curiosity or a matter of international bragging rights. Most people know the American economist Paul Krugman’s famous remark that “productivity isn’t everything but in the long run it is almost everything”. Productivity – getting more output out of a given input – is the key to prosperity; to living standards.

It also matters hugely for the public finances. You may remember that Osborne’s final autumn statement a year ago was notable for the £27bn that the Office for Budget Responsibility (OBR) discovered down the back of the fiscal sofa, thanks to changed assumptions about tax receipts and the interest on government debt. Less well remembered, because other things dominated the headlines, is that the OBR took away roughly double that £27bn in Osborne’s final budget in March, because it took a gloomier view about productivity after the publication of poor official data.

Even its gloomier view assumed a significant pick-up in productivity growth, to 2% by 2019, not far from its long-run average. Without that, the prospects for growth, living standards and the public finances would have been notably worse.
Hammond is a fiscal conservative and will not let rip with the public finances. He also knows, because he mentioned it in giving evidence to the House of Lords, that there are huge regional variations in productivity in Britain. Put simply, if the rest of the UK matched London’s productivity performance, which is 30% above the national average (measured by gross value added per hour worked) this country would be near the top of the international comparisons rather than languishing near the bottom.

This tells us, for a start, that anything that seriously damages the London economy over the next few years would hurt the economy as a whole. Undermine your highest-productivity region and the country’s ability to improve living standards and fund public services would suffer. The aim must be to lift the rest of the economy up to London’s high value-added, high productivity levels, not drag the capital down. George Osborne, who on Friday launched his Northern Powerhouse Partnership think tank, understood this very well.

Can Britain become a high-productivity economy? Everything these days has to be seen through the prism of the Brexit vote, and it could go either way. To the extent that employers have found it too easy to find labour as a result of immigration, and have chosen employment over investment, there could be a positive effect on productivity. After all, one reason why French productivity is so much higher than in Britain is because of its inflexible labour market. French businesses choose to invest rather than recruit, though high unemployment is the unfortunate side-effect.

A new system of controlled immigration, prioritising skilled migrants, could help to boost productivity, partly because of their direct contribution and partly because a reduction in the numbers of unskilled migrants would force employers to more aggressively seek productivity improvements.

Against this there are factors which could push Britain towards even lower productivity. One is the threat to the London economy, and particularly the financial services sector, from leaving the single market. London will still be the financial capital of Europe, indefinitely, but it could retain that position even if it lost 20% or 30% of its activity. Any such loss would, however, be negative for the economy.

The other is the outlook for business investment, including foreign direct investment. Foreign investment has been an important driver of productivity improvements in Britain. On average, foreign-owned businesses demand and achieve higher levels of productivity than their domestic competitors.

When business investment – both domestic and foreign – boomed in the 1980s, the talk was of a British productivity miracle under Margaret Thatcher. When it did so again, in the 1990s, the healthy productivity numbers described above were the result. But it is a long time since business investment has boomed, and bodies such as the British Chambers of Commerce and Institute of Chartered Accounts have warned that it is likely to fall over the next couple of years.

Productivity could go either way in this new era. As a first step on the road to improving productivity, Hammond will need to come up with measures that encourage business investment in an uncertain environment and provide reassurance to a City of London that fears land grabs from the rest of Europe and the rest of the world. Can it be done? Nobody told him that his new job was going to be easy.