Sunday, June 24, 2018
We don't need a new Bank target - but we do need to raise our game
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.

Just when you think there is nothing new to say about one of the defining problems of our age – stagnant productivity growth – somebody comes up with something new. A report commissioned by John McDonnell, Labour’s shadow chancellor, has called for the Bank of England to be set an additional target, that of achieving productivity growth of 3% a year.

Productivity, output per worker or, as it is more commonly measured, output per hour, has been the missing link in the economy in the period since the financial crisis. Had it made up the ground lost then, something that usually happens after recessions, we could be looking at gross domestic product (GDP) per worker 20% higher than it is. That was where the pre-crisis trend, if maintained, would have left us.

Most of that would have translated into a level of GDP a fifth larger than it is, alongside much better public finances; the budget deficit, 1.9% of GDP in 2017-18, would have long been eliminated and there would be no worries about how to fund the £20bn-plus boost to National Health Service spending.

Sustained growth in productivity of 3% a year would be transformative, converting Britain from the seven-stone weakling of the international productivity comparison tables to a country capable of kicking sand in anybody’s face. We could laugh in the face of Brexit and the uncertainties and prolonged drag on economic growth it brings.

To put it in perspective, the Office for National Statistics has data on GDP per hour worked going back to 1972. In that time, productivity growth has averaged 1.8% a year, so 3% would be an improvement of 1.2 percentage points, or more than 60%, on that long-term average.

By decade, productivity growth averaged 2.2% in the 1970s, 2.4% in the 1980s, 2.3% in the 1990s, 1.4% in the 2000s and just 0.5% since 2010. McDonnell’s Labour is sometimes accused of wanting to go back to the 1970s but in terms of its productivity ambitions it wants to go further.

It is not impossible; there have been 11 years in the past 45 when productivity has grown by 3% or more, years of strong economic growth or falling employment. But it is a long way from where we are now. The last 3%-plus productivity year was in 2000.

Much of the response to the report commissioned by the shadow chancellor, written by the consultancy GFC Economics and Clearpoint Advisors, has been that it reflects muddled thinking. Monetary policy and financial stability, the Bank’s responsibilities, have no direct links to productivity and adding to its targets merely makes it more likely that it will miss its central one, that of controlling inflation.

Where central banks have adopted so-called dual mandates, targeting employment as well as price stability, as in America, Australia and, currently, in New Zealand, there is a logic. Low inflation is a necessary condition of rising employment. But when it comes to productivity, some of the best years for its growth in Britain have been alongside high inflation, including the infamous Barber boom of the early 1970s.

Not only that but the idea of giving the Bank a target, and responsibility for raising productivity is the exact opposite of one of the motivations Gordon Brown had in giving the Bank independence 21 years ago. The Treasury, he said, had been too preoccupied with the short-term, and in particular the short-term question of when to raise or lower interest rates. Younger readers may need reminding that this used to be the preserve of chancellors of the exchequer.

Freed from that, he wanted to turn the Treasury into a fully-fledged economics ministry, with a focus on, among other things, raising productivity. A productivity agenda was an important part of new Labour’s economic programme, which included commissioning reports on Britain’s shortcoming from experts. Abolishing the dividend tax credit, the famous raid on pensions, was done with the aim of getting companies to invest more, rather than distributing all their profits to investors.

That Treasury tradition continues. Philip Hammond has his £31bn National Productivity Investment Fund, split between investment in the infrastructure and research and development. A separate £1bn artificial intelligence (AI) fund was anno0unced two months ago.

Tackling poor productivity is about addressing the three i’s – investment, infrastructure and innovation – as well as one ‘s’, skills, a subject I shall return to shortly. Investment, the lowest of any advanced economy from 1997 to 2017, tells quite a lot of the story.

What is lacking in the Treasury’s efforts is a sense of urgency. Brexit has weakened productivity directly, by choking off the expected strong recovery in business investment. It has also sucked the life out of everything else in policy terms. The urgent national task of raising productivity has been left to simmer gently on the back-burner.

That is why, while Labour is wrong to think the Bank needs another target, and that directing bank lending to “productive” investment is the right way to raise productivity, the party is right to focus on the issue. This is notwithstanding the fact that many of its policies in other areas, notably tax, are likely to reduce rather than raise productivity.

What should be done? A new study from the St Louis Fed, one of America’s regional federal reserve banks, suggests that innovation is one of the keys to productivity differences between countries. Given the productivity gap, Britain needs to do a lot more of it.

Recent work by the National Institute of Economic and Social Research, funded by the Joseph Rowntree Foundation, has also found that in low-wage, high-employment sectors of the economy, covering a range of mainly service sectors, Britain’s productivity is 20% to 30% below Germany, France, the Netherlands and America.

In retailing, Britain compares well with other European countries but is 40% behind America. In hospitality, productivity is 45% higher in France. There are traditional explanations for these differences, in lower levels of investment and labour quality, which brings us back to skills. They also feature in another part of the story, poor management quality and practices in Britain.

The good news about all these factors is that they lend themselves to solutions. Britain would be a lot more productive if we invested and innovated more, had better infrastructure and workforce skills, and improved management quality. All can be fixed though it will take time, even with greater urgency than now.

Improving Britain’s productivity is one for the long haul, not a short-term Bank target. But we should be doing more than we are.