Economics Weekly - 1UK productivity: trends and prospects; Weekly economic data preview - Key data and MPC testimony put UK in spotlight this week
Economics Weekly - 14 September 2009
UK productivity: trends and prospects
One of the key
indicators of how well economies perform is productivity. Over the medium to
long term, real income growth, and hence living standards, depend on how fast
an economy can grow its output based on its labour and capital inputs. Those
economies that perform well on this score tend to be those that are the most
flexible and dynamic â€“ i.e. those that have a high degree of skilled labour,
undertake strong capital investment, employ a high proportion of their
available workforce, and combine their labour and capital inputs in the most
Given this, it is
unsurprising that the US tops the G7 league
table of productivity levels (based on output per hour), while Japan has dropped to the
bottom. What is more surprising, perhaps, is the historically weak performance
of the UK compared with some of
our European neighbours, notably Germany and France. Although
these continental European economies are constrained by structural rigidities,
the amount of output they produce per
hour worked is materially higher than in the UK â€“ see chart a.
UK productivity has been held back by under investment and a
relative lack of skilled labour
Admittedly, part of the
explanation for the UKâ€™s underperformance on
this measure reflects differences in working hours. Given the law of
diminishing returns, those economies that have shorter working weeks, such as Germany and France, tend to have higher
rates of output per hour than those that work longer, such as the UK. If productivity is
instead measured on the basis of output
the UK is around 3% more productive
than Germany. Still, the fact that UK workers have to work comparatively
longer to generate broadly the same level of output as German workers is hardly
indicative of productivity strength. Moreover, even on this measure, UK productivity still
falls short of France (by around 7%), and is
no better than Italy (although Italyâ€™s output per worker is
likely to be flattered due to the size of its informal labour market).
A myriad of factors has
been cited for the UKâ€™s historically poor
productivity performance. Chief among these has been the limited availability
of skilled labour; relatively low levels of capital spending on R&D and infrastructure
investment; the slow pace of innovation; and the decline in relatively
higher-value add manufacturing. A lack of competition, over-regulation,
financial market volatility, and poor labour relations have also been put
forward as explanations. In France and Germany, capital spending per
worker has traditionally been far higher than it has in the UK, while research
suggests that the structure of the firm in these continental European countries
has been more conducive to efficiency gains. In other words, they have been
good at combining labour and capital.
Global structural change has helped to foster a marked
improvement since the early 1990s
Since the early 1990s,
however, the UKâ€™s productivity
performance â€“ in both absolute and relative terms has improved noticeably. Although the overall
level of productivity remains below those of some of our major trading
partners, the gap has closed substantially. Between 1991 and 2007, output per worker in the UK rose by 43 per cent -
see chart b - while output per hour worked increased by 52 per
cent. Both rates of increase were the highest in the G. Part of the reason why UK productivity growth
has improved is because average hours worked have risen. Economic policies have
also helped. For example, the decline in union power over the 1980s, the
withdrawal of sterling from the ERM in 1992, the decision to give the Monetary Policy
Committee operational independence in 1997, and a host of other initiatives to
boost entrepreneurship and skills are likely to have had a beneficial impact on
productivity growth. But perhaps most important of all has been the benign
economic backdrop. Over the past twenty years, increased globalisation,
heightened competition and technological development have fostered productivity
gains by raising returns on capital (and thus spurring investment) and by
encouraging firms to become more efficient or risk losing market share. Although
all the major economies have benefited from these structural changes, they
appear to have had a disproportionate impact on those with relatively low
productivity levels, such as the UK.
The recession has caused cyclical productivity to drop back, but
it should soon turn higher
The above analysis
refers to some of the key drivers that have raised the UKâ€™s trend rate of
productivity over the past twenty years. Over a shorter horizon, the
productivity performance of the UK is dominated by cyclical
factors. Since the onset of recession in early 2008, output per worker has
fallen by over 4%. As charts c & d show, sharp falls in productivity are
typical during downturns, as falls in employment lag declines in GDP. The one
notable exception was the recession of the early 1990s, when the fall in
employment was particularly severe, and the decline in GDP was cushioned by the
UK governmentâ€™s decision
to exit the ERM in 1992. The fall in cyclical productivity over the past two
years is of a similar magnitude to the declines that occurred in the early 70s
and 80s recessions. Although the falls in productivity during these downturns
were quite volatile, they were generally short-lived. Productivity growth rates
picked up relatively quickly once output started to recover, amid continued job
shedding. For similar reasons, we believe that productivity growth is either
at, or close to, a low in the current cycle. Recent indicators suggest that the
recession is likely to have ended in Q2. Still, given the challenges facing the
UK, there appears little
prospect of a substantial output-led improvement in UK productivity growth
over the coming year. Instead, productivity gains are likely to be driven predominantly
by continued cuts in employment. Although GDP may be showing signs of bottoming
out, we suspect it will be at least another twelve months before the labour
market does likewise.
But boosting trend productivity growth poses a formidable
productivity is likely to recover over the coming year, prospects for a
sustained improvement in trend productivity growth will depend on how
successful the UK is in reinventing
itself and embracing structural change. The traditional impediments to an
improvement in UK productivity, namely
the lack of a highly-skilled workforce, a limited culture of entrepreneurship
and a lack of home-grown technological innovation, remain. Add to this list the
impediments resulting from the credit crisis, such as the constraints on credit
availability, the loss of capital investment (both public and private), the
rise in bankruptcies, and the prospect of tighter regulation in certain
industries, and it seems clear that boosting the trend rate of productivity will
be a formidable challenge.
Still, there are
grounds for cautious optimism. The depth of the current recession and the UKâ€™s disproportionate exposure
to the credit crisis has highlighted the need for the UK to undertake an
internal rebalancing away from consumption towards investment and exports. If
what emerges is a stronger, more competitive manufacturing base, reduced
private sector debt levels, and greater emphasis on improving vocational skills,
there a good chance that, over time, a rise in UK productivity results.
Such an outcome is not only desirable, but essential if the UK is to maintain its
position in the world economy over the coming decades.
Adam Chester, UK Senior Macroeconomist, Corporate Markets
Weekly economic data preview -14 September 2009
Key data and MPC testimony put UK in spotlight this week
Although the Bank of England decided to
leave policy unchanged this month, data and events this week are expected to
highlight why a further extension of its asset purchase programme remains a
strong possibility in November by when the current total of Â£175bn should be
spent (around Â£146bn to date). A busy calendar includes the publication of UK inflation, retail sales, labour market
statistics and M4 money supply. Members of the MPC will also testify to the
Treasury committee on the August Inflation Report on Tuesday. In the US, retail sales data for August will attract
the most interest this week, with a robust increase
predicted after the surprise decline in July, primarily reflecting the impact
of the â€˜cash for clunkersâ€™ programme. US consumer and producer prices data and
the latest housing starts figures are also due. The German ZEW survey provides
the main data highlight in the euro zone, with investor confidence predicted to
show a further gain in September after hitting its highest level in more than
three years last month. The Bank of Japan is poised to leave its benchmark overnight
lending rate at 0.1% on Thursday but could upgrade its economic assessment.
ô€‚„ UK data last week further raised hopes that the recession may
have ended in Q2 and growth resumed in Q3. However, prospects for the labour
market remain poor, with employment likely to continue to fall for some time.
The latest figures published on Wednesday are expected to show that the LFS
measure of the unemployment rate rose by a further 0.2% to 8% in the three
months to July - the highest level since November 1996. The narrower claimant
count measure is expected to reach 5% in August for the first time since 1997.
Rising spare capacity in the labour market will keep strong downward pressure
on wages, with the headline index of average earnings expected to ease by 0.5
ppt to 2% in the three months to July. The fact that workers appear to have
been more willing to accept pay freezes or more modest rises may help to
explain why employment has so far actually held up better than in earlier
recessions. Muted wage pressures are also a strong reason to doubt a swift
upturn in inflation in the short term. Although UK consumer price
inflation has proved stickier than anticipated, we expect to see a sharp
decline in the annual rate in coming months due mainly to base effects.
Tomorrow, we expect a fall to 1.4% in August from 1.8% in July, with the â€˜coreâ€™
rate also predicted to fall back sharply to 1.2% from 1.8% in July. However, for
clues about the impact of QE, the BoE MPC may be more interested in Thursdayâ€™s
official retail sales figures and Fridayâ€™s M4 money supply data. We look for
only a modest rise in retail sales in August, while headline M4 money supply
growth is expected to have slowed significantly. Meanwhile, the worrying state
of the public finances will again be underlined on Friday, with public sector
borrowing set to near Â£70bn in the fiscal year to August compared to Â£26bn last
year and a full year target of Â£175bn, reflecting the sharp deterioration in
revenues and rising spending due to the recession.
ô€‚„ The impact of the â€˜cash for clunkersâ€™ programme, which helped
sales of cars and light trucks surge 25% from July, should also be reflected in
a strong rise in US headline retail sales in August. We look for a gain of 2%
but it will also be interesting to see just how much consumers cut back in
other areas. We forecast retail sales less autos rose by just 0.5% last month,
with the risks to the downside. Although annual readings of headline US
consumer and producer prices this week are expected to post increases in
August, the rates themselves will remain sharply negative at -1.8% and -5.3%
respectively, while â€˜coreâ€™ rates are forecast to show further declines,
highlighting subdued price pressures. The latest housing starts and building
permits data on Thursday should add weight to the view that the US property market may
finally be stabilising. Fed speakers this week include chairman Bernanke on
ô€‚„ The German ZEW index is published tomorrow, with improvements in
indices of both economic sentiment and current conditions expected in September.
Recent data suggest that the German economy could post the strongest gain in Q3
GDP in the G7. On Wednesday, we expect confirmation that the pace of
contraction in annual EU-16 CPI inflation slowed to -0.2% in August from a
record low of -0.7% in July. Although this is a sharp gain, any concerns about
inflation are clearly premature at this stage.
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