Productivity crisis: Is the UK’s ‘Lost Decade’ at an end?

An ‘unprecedented’ slowdown in UK productivity has stifled ambition and growth – and tackling the issue must be a priority for both industry and government, according to business leaders.

It’s been more than ten years since the global financial crash, but its effects are still being felt – not least, in the UK’s stagnant levels of productivity.

“It has taken the UK a decade to deliver 2% growth, which historically was achieved in a single year,” says Richard Heys, Deputy Chief Economist at the Office for National Statistics (ONS).

Experts say the slowdown has had an ‘unprecedented’ impact on the nation’s output – but is there any solution in sight for the UK’s ‘productivity puzzle’?

What’s the problem?

It’s difficult to overstate the importance of productivity for a company, a sector, or even a nation.

It’s a line oft-quoted, but Nobel Prize-winning economist Paul Krugman once said: “Productivity isn’t everything, but in the long run it is almost everything. A country’s ability to improve its standard of living over time depends almost entirely on its ability to raise its output per worker.”

Yet that is a challenge which has been firmly beyond the UK over the past decade.

ONS data reveals labour productivity has been lower over the past ten years than at any time in the 20th century – but in truth, the UK’s ‘lost decade’ compares unfavourably with other eras from even beyond that timeframe.

Nicholas Crafts, of the University of Sussex, and Terence Mills of Loughborough University, are two of the country’s leading economic historians, and their joint research reveals the current downtown is actually the worst the country has ever faced.

Their analysis compares today’s picture with past economic slumps, and reveals not only how much has been lost, but also casts light on the underlying reasons.

They said: “We find the current productivity slowdown has resulted in productivity being 19.7% below the pre-2008 trend path in 2018.

“This is nearly double the previous worst productivity shortfall ten years after the start of a downturn.

“On this criterion the slowdown is unprecedented in the last 250 years. We conjecture that this reflects a combination of adverse circumstances, namely, a financial crisis, a weakening impact of ICT and impending Brexit.”

With increased clarity on the Brexit issue, at least, there could be some encouragement looking forward. Most recent quarterly productivity scores show 0.3% growth – recovering the -0.2% and -0.1% losses of the previous two quarters.

But Heys said: “UK productivity has moved very little over the past 18 months, with quarterly fluctuations broadly cancelling each other out.

“Over the longer term, growth in productivity remains much slower than before the economic downturn of 2008-2009.”

What’s needed?

Where to start? Courage, impetus and investment from both public and private sectors will all be needed to inject fresh momentum – but none of this comes easy.

However, the reward for remedying this issue is huge, according to Alex Tuckett, Senior Economist at global accountancy firm PricewaterhouseCoopers.

He said: “Evidence suggests this productivity shortfall is due to low levels of investment and R&D spending and a longer tail of companies and workers with relatively low productivity and skills.

“The UK has the third lowest investment rate in the entire OECD and low R&D spending – at just 1.7% of GDP it is below the EU average of 2.1%, behind France and Germany and barely half the level of Sweden.

“The economic prize would be significant if the UK were to close the per-worker gap to German levels, for example. This could see the UK economy grow £180bn per year larger – £5,800 for each worker in the UK.”

PwC Partner Phillippa O’Connor says this requires action from all levels of business.

She said: “We believe leadership and management practices play a central role in unlocking this puzzle. But equally important is the impact of the individual; their engagement, wellbeing, digital literacy, and their interaction with the workplace environment.

“Combined, these enable individuals to be their most productive self.

“Even simple changes can make a material impact. It’s not an easy task, but business has much to gain from getting it right.”

Government influence

While businesses can certainly shape their own destiny, momentum to positively impact productivity on a national level arguably begins with government – a view shared by many within the business community.

Suren Thiru, Head of Economics at British Chambers of Commerce, acknowledges productivity problems run deep, but says the government must accept responsibility for finding solutions.

He said: “Tackling the UK’s low productivity growth means addressing the deep-rooted problems in our economy.

“Critical skills shortages, underinvestment in our infrastructure and a challenging domestic business environment continue to hold back growth.

“Alongside clarity on the future trading relationship with the EU and partners across the world, the government has an important opportunity to improve the business environment here at home.”

The imminent Budget – the first by Boris Johnson’s government since the December election – will be vital, says Thiru.

He continued: “The Budget should include a moratorium on new upfront costs and initiate a long-awaited review of the broken business rates system to help companies manage their cashflow and invest in growing their businesses and the wider economy. Extending the current £1m Annual Investment Allowance for a further two years would give firms the confidence to push ahead with investments and boost productivity.

“Investment in infrastructure should also continue apace. The commitment to get on with HS2 is welcome, and we now look forward to seeing it delivered in its entirety alongside other key regional rail projects to connect businesses with customers, supply chains and labour markets.”

Tej Parikh, Chief Economist at the Institute of Directors, agrees. He said: “Productivity growth remains a weak point. The UK economy ended 2019 in a funk, and despite a recent rise in optimism, businesses will be looking for a significant boost from the Chancellor.

“Firms entered 2020 with more of a spring in their step. Confidence has shot up, while hiring plans and investment intentions have also risen a notch, but the post-election bounce may tail off.

“Uncertainty from the next stage of Brexit negotiations will increasingly play on the minds of business leaders. Meanwhile, ongoing hiccups in global growth, including the fallout from coronavirus, could eat into the economy if global financial markets and trade slow.

“This makes the Budget a crucial moment to get the economy moving. The Chancellor must clear the way for entrepreneurs to create jobs and drive up productivity, by unleashing investment in start-ups, slashing business rates, and revamping our skills system.

“The Budget must focus on providing business investment incentives and boosting skills across the country if productivity is to pick up any time soon.”

Mike Cherry, National Chairman of the Federation of Small Businesses, says the Budget is an opportunity to deliver long-overdue clarity and support for UK business.

He said: “Small firms have been desperate for certainty for years and will look to the upcoming Budget as an opportunity to help them grow and succeed.

“After years in the doldrums, the new Chancellor must illustrate his support for the small businesses that form the backbone of the British economy.

“It’s vital that the cost of doing business, specifically when it comes to business rates, protecting incentives to grow, and accelerating the delivery of key infrastructure commitments, are delivered sooner rather than later.”

And it is that delivery of infrastructure which is viewed as key to ensuring any upturn in productivity impacts nationally, instead of being concentrated in certain regions.

Parikh said: “The chasm in productivity across the UK’s regions and nations is holding back our economy.

“The Prime Minister has talked about ‘levelling up’ the regions. Long-overdue upgrades to broadband, rail and roads will be crucial, but the government also needs to create the conditions for companies to take risks and innovate today to raise our game on productivity and sustainability. Boosting investment in new and growing firms is key, as is ensuring they have the skills they need to thrive.

“Without significant investment outside London and the South East, the rest of the country will continue to lag behind, eating into the UK’s overall potential.

“More funding should go toward developing our regional skills systems, and enhancing the role our world-class universities play in local economies can be starting point. Upgrading local road and rail links and our digital infrastructure must be a priority, alongside enhancing connections between our towns and cities.

“(But) the benefits of big-ticket infrastructure improvements, although crucial, won’t be felt immediately. We need greater regional investment incentives for new and growing firms to help catalyse innovation and jobs growth in the here and now.”

What next?

“Lingering uncertainty and domestic cost pressures are likely to limit longer-term investments in new machinery or technology,” warns Thiru.

“With business investment expected to remain weak, UK productivity is set to remain sluggish over the near term.”

And that view is broadly shared by the Bank of England’s Monetary Policy Committee (MPC), which is predicting growth at last – albeit on a moderate scale, while Brexit details are still to be finalised.

It predicts a 0.75% growth for the coming year, rising to 1% by 2021 – an encouraging step in the right direction, though still well short of the 2.25% experienced pre-crisis.

The committee said: “The MPC judges that productivity growth will pick up a little over the forecast period, but will remain well below its pre-crisis pace. That limits the rate at which the economy can grow without putting upward pressure on inflation.

“The MPC’s projection of subdued productivity growth reflects a continuation of the post-crisis trend, recent weakness in business investment and the reduction in openness that occurs as the UK economy adjusts to its new trading arrangements with the EU.”