Sunday, February 25, 2018
Productivity's up - but keep the champagne on ice
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.

Amid the flurry of economic news in recent days, one number stood out. This was that, after a strong rise in productivity in the third quarter of last year, there was another strong rise in the fourth. Taking the two together, productivity was rising at an annualised rate of about 3.5% in the second half of last year.

I am sure I do not need to tell you how much it would mean if it marks the start of a sustained revival in productivity. Productivity, the amount of value-added we produce for what we put in, is the ultimate driver of living standards. Without rising productivity there can be no increase in real wages.

It matters for competitiveness, and the huge productivity gap between Britain and our main competitors, in their favour. Closing that gap is important, and not just for national pride.

It is also important for the public finances. The Office for Budget Responsibility (OBR), which looks to have been too gloomy about the budget deficit again – it is likely to undershoot its November forecast by a significant margin – took a red pen to its productivity assumptions then, with important negative implications for the public finances over the medium-term. That productivity downgrade came amid the recent productivity revival. If it was premature in doing so, that would suggest Philip Hammond will have more room for manoeuvre in coming years than he feared.

It is worth putting the recent rise in productivity in perspective. Though it has been customary to talk of productivity stagnation, this is not quite accurate. What is true is that in the middle of last year, output per hour was no higher than at the end of 2007. Having fallen in the crisis, recovered, then falling again from 2011, productivity has been creeping higher in recent years, though creeping is the operative word. Its performance in the second half of last year represented a step change.

It is worth digging into that step change. The productivity numbers were based on a rise in gross domestic product rose of 0.4% in the third quarter and 0.5% in the fourth quarter of last year. The fourth quarter number was revised down to 0.4% after the release of the productivity figures. Revisions to earlier quarters cancelled each other out.

So how do you get to increases in output per hour of 0.9% and 0.8% respectively?

The answer is that in both quarters hours worked fell, by 0.6% and 0.3% respectively. This is, it should be said, a little odd. The job market is tight and full-time jobs have dominated the recent rise in employment, so why are people working fewer hours?

That is why, taking another measure of productivity, output per worker, there is little in the figures to get excited about. It rose by a reasonable 0.5% in the third quarter of last year, but by only 0.2% in the fourth, and at the end of 2017 was a mere 0.5% up on a year earlier (compared with 1.1% for the output per hour) measure. Adjust those figures for the downward revision to GDP and output per worker rose by only 0.1% in the fourth quarter and was just 0.4% higher than a year earlier.

So how do you get to increases in output per hour of 0.9% and 0.8% respectively?

The answer is that in both quarters hours worked fell, by 0.6% and 0.3% respectively. This is, it should be said, a little odd. The job market is tight and full-time jobs have dominated the recent rise in employment, so why are people working fewer hours?

That is why, taking another measure of productivity, output per worker, there is little in the figures to get excited about. It rose by a reasonable 0.5% in the third quarter of last year, but by only 0.2% in the fourth, and at the end of 2017 was a mere 0.5% up on a year earlier (compared with 1.1% for the output per hour) measure. Adjust those figures for the downward revision to GDP and output per worker rose by only 0.1% in the fourth quarter and was just 0.4% higher than a year earlier.

The big question is whether we are at a labour market turning point, and on the road to a future in which employment and hours worked do not rise very much but productivity does.

There were, on the face of it, turning point aspects in the latest numbers. Before the labour market figures were released last week, many analysts though the unemployment rate might drop to a new four-decade low of 4.2%. Instead unemployment rose by 46,000 in in the latest three months and the rate went up to 4.4%.

There was also a little bit of evidence of a firming of pay. Total pay rose by 2.5%, as in the previous month, but regular pay edged up to 2.5%. Pay and productivity are intimately linked, and an acceleration in pay is less concerning if accompanied by rising productivity. Surveys, including those by the Bank, point to stronger pay growth this year.

It is, however, too soon to call a turn in unemployment, despite the surprise rise in the latest figures. This is because there was a rise in employment, of 88,000, in the latest three months. That was smaller than expected but was nevertheless positive. It was possible for rising employment and unemployment to go hand in hand because of a drop in the economically inactive proportion of the population. Only when employment is falling and unemployment rising would you be confident that the job market has turned.

As for pay, there have been many occasions in recent years when it appeared to be on the brink of an acceleration, only to slip back. Regular pay growth picked up to 2.9% in the autumn of 2014, and was 2.7% in the autumn of 2016, both higher than now. The CIPD, the trade body for human resources professionals, says its survey shows a median expectation of pay rises of only 2% over the next 12 months. There are good reasons to expect stronger pay growth than that but the jury is still out.

It is also out on whether the tide has turned on productivity. The oddity in the latest numbers, a drop in hours worked, may resolve itself in coming months. Some of the things needed to drive sustained productivity improvements; significantly higher levels of business investment, improved skills and better infrastructure, are no different now than they were six months ago. We have yet to see how the reduced supply of generally high-productivity EU workers affects the numbers.

So, while we would all love to see the latest figures as the start of a sustained productivity revival, which would have a profound impact on Britain’s economic prospects, it is a little too soon to celebrate.