Issue 113:2017 07 13:Zombie Nation (Frank O’Nomics)

13 July 2017

Zombie Nation

Does low UK productivity matter?

by Frank O’Nomics

“Productivity isn’t everything, but in the long run it is almost everything”.  Nobel laureate Paul Krugman wrote this in 1994, but given the latest data from the ONS his view is topically disconcerting for the UK.  For the last 10 years our productivity, defined as output divided by the number of hours worked, has not progressed at all.  A number of quarters of positive growth were reversed in Q1 of this year, due to a fall in hourly output of 0.5%.  On the face of it this is very worrying.  If the economy is not creating wealth, tax receipts will not grow and the governments ability to spend on infrastructure, or increase public sector pay, will be severely constrained.  In short the end of austerity is not nigh and living standards in the UK are in danger of falling further.

A recent review of productivity in twenty developed nations showed the UK ranked 16th, equal with Italy and only above Portugal, Japan and South Korea.  Our output per hour was only 76% of that in the US, 78% of France and 79% of Germany according to 2015 data, and the latest fall will not have improved that position.  What is perhaps worse is that the scope to increase employment to help rectify low productivity is more limited in the UK – only in Germany are more 16-64 year olds currently in work.

In looking at why UK productivity is so low, the obvious starting point is the chronic level of underinvestment over a number of decades.  If plant, machinery and general infrastructure are not improved it is very hard to become more productive. The UK only invests 1.7% of its GDP in public and private research and development, a level well behind the average in the OECD.  Constraints on government spending leave prospects looking bleak and, although there are signs that business investment is starting to pick-up, this is from a very low level and may not continue given the second lowest recording of business confidence in the last 6 years. The second factor is that the level of skills in the UK is not developing, particularly in some regions.  Overall we have not, and are not, investing in physical and human capital.  The other element, which has not helped, is the low level of interest rates. The rate of business failures in the UK has been very low for some time as poorly performing businesses have been able to survive due to low debt service burdens. Interest rate policy has perpetuated zombie companies to produce our zombie economy. The issue with this argument is that other countries have had similar interest rate policies and yet manage better levels of productivity.

There are some who would argue that UK productivity is not properly recorded, and that, given high levels of employment, low productivity does not matter. The UK economy is largely service based , focussed on an area in which it is difficult to calculate productivity levels.  If I write 2 articles this week rather than one, my productivity has doubled but that is unlikely to be recorded, whereas if I had made and sold twice the normal number of widgets it would be.  The UK has the benefit of a flexible labour market and, much as we might take issue with zero hours contracts, they reduce the costs of hiring and firing staff.  While it may be disconcerting for UK output not to have progressed as employment has grown, should we not relax on the basis that more people have an income?

At this point we can return to Krugman’s comments.  In the short-term low productivity may not matter.  However, there are some big long-term issues to face.  First, if uncertainty surrounding the Brexit outcome continues to inhibit business investment, low productivity will continue and wealth will not grow.  Secondly, the disparity across the country and across businesses makes productivity a more serious immediate issue. London’s productivity level has been running at around 60% higher than that of Northern Ireland for example.  Much of the productive success in London comes from the finance and insurance industries, but this could be seriously undermined if Brexit negotiations prompt a decline in London as Europe’s financial centre.

The search for an escape from this zombie status reveals routes that are difficult to follow. Investment in physical and human capital requires action from the government and it is difficult to see how this can be afforded in the near-term – leaving us with an ongoing stasis.  There is a strong case for prioritising government spending on infrastructure over increasing public sector pay, given the longer-term benefits that will accrue, and there are steps that can be taken to encourage businesses to invest.  Reductions to corporation tax may help, while not necessarily reducing the tax take.  Much will depend on confidence, and for this we will need some progress in Brexit negotiations.  As regards raising interest rates, this may have a short-term negative impact as zombie firms get forced out of business, but in the long run that may be helpful.


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