14 May 2020
Desperately Seeking a Pandemic Positive
Could it be productivity?
by Frank O’Nomics
This morning, as you opened your breakfast tin of beans and put them in the microwave, did you pause to thank Napoleon and the Luftwaffe? Probably not, but both the tin and the oven are products of wartime innovation. Napoleon was the first to put his army’s food in tins, and microwave ovens were a by-product of radar technology in WWII. The point here is that, awful though the Napoleonic and Second World wars were, they (as with many other major conflicts) by necessity, spurred invention. Could the Covid-19 conflict ultimately provide similar improvements to our lives? It may be a long time before anyone is of a mind to look for something positive, but when they do a beneficial legacy may be found in the area of productivity.
The short-term economic implications of the current crisis are horrendous. If we regard productivity as the amount of output an economy gains for the resources and effort expended, it is hardly surprising that we will see a sharp reversal with most of the population forced to stay at home and watch Tiger King on Netflix (Ok, there are other things to do). Even though the real impact did not kick-in until well into Q1, the economy shrank by 2% in that period, the largest contraction since 2008. The Bank of England expects a total contraction for 2020 of 14%. We are not alone; even historically highly productive nations have seen massive hits to output, with the quasi-state bank KfW estimating a 25% contraction in the German economy.
What is perhaps worse for the UK is that we started the crisis in a very poor position in terms of recent productivity growth. The 1970s might be regarded as a time of economic challenges for the Britain, but we managed a 22% increase in labour productivity over the period, compared to just 7.3% in the decade to 2019. Increased productivity requires public and private investment and the period of government austerity limited the public element, while a lack of confidence and incentives meant that business investment actually fell in 2018 and only rose 0.6% in 2019.
All of this might lead one to look at a long-term L-shaped recession, rather than the swoosh shape that I described here 2 weeks ago. There are however, some potential positives that will emerge once we get closer to more normal working conditions.
The first is from a public investment point of view. The recent conservative manifesto featured a pledge to commit £100bn to infrastructure investment over the next 5 years. Recent additional pledges, particularly those to help with transport, could provide much needed additional efficiency in the operation of the UK economy. There are of course concerns that there is a very big bill to be paid to cover furloughs and other short-term measures, and we do need to correct our underperformance relative to other nations when it comes to public investment. The Resolution Foundation estimates that we generate 10% lower return than others from public sector investment, due to overly short planning horizons, delays, cost overruns and limited evaluation. Nevertheless, a commitment to public investment and an abandonment of austerity gives some cause for hope.
What about the private side of business investment? This week’s Deloitte’s CFO survey is about as bad as it gets, with 84% saying that they are less optimistic than they were 3 months ago, the largest quarterly fall on record. However, the same report showed that 89% believe that the long-term impact of the crisis will be a diversification and strengthening of supply chains. This will hopefully make for a more resilient and robust private sector. Perhaps the bigger potential positive comes from the continuing availability of cheap finance and the attraction of much cheaper asset valuations. In short, for those who can raise the money, there should be many more opportunities that provide an acceptable return on capital.
While borrowing costs have become even lower, they will still not be low enough to prevent many businesses going under. One should not downplay the very real damage to livelihoods from business failures and unemployment, and there is no doubt that some companies with very real potential could fail, but in the long-term the overall impact could be cathartic. For a long time a steady economy with low inflation and low interest rates has allowed underperforming companies to continue to exist. Many of these so-called ‘zombie’ businesses are unlikely to withstand the extreme short-term hit to demand. Such businesses were a significant factor in maintaining the low level of productivity in the UK, and their failure should leave the overall economy more efficient.
None of these factors can really be described as a conflict-necessitated innovation; however, the final productivity boost arguably is just that – the change to working practices. Many who have been working from home will have found that, helped by developments in online conferencing (who had heard of Zoom prior to March?) and the lack of travel time, they have become more effective. The potential benefits of reducing the working day have been known for some time. In the US in 2016 a Californian based finance company cut the length of their working day to 5 hours and saw an increase in sales of 30%. Not everyone likes a shorter working day (the Californian firm struggled to retain its staff) and the process only helps the ‘knowledge worker’ – an Uber driver would obviously see a negative return – but given the large component of our economy that comes from the service sector, the net benefits for the UK should be positive. This could be particularly true of it means a reduction in traffic and pollution, and increased scope for people to work outside of major cities.
All of these potential benefits may be a long time coming, and economic data will get worse before we see an improvement, particularly if there is a further wave of infections. Further, none of the benefits should divert attention from the very real human issues we face in the short-term. Nevertheless, there is hope that we will come out of the crisis as a more efficient nation, and this efficiency can extend beyond mere economic measures. Regional and gender pay gaps, for example, may narrow as a by-product of the change in working practices. Perhaps one of the ultimate outcomes will be focusing less on increases in GDP and productivity. After all, genuine prosperity is about much more that.