Productivity under the Coalition

In this piece Ken Mayhew (Oxford) considers the low level and low growth of productivity in the UK, especially in the ‘disastrous’ period since the crisis. He argues the UK needs not just more human capital but a higher ratio of investment to GDP, and a labour market which offers better and higher paying jobs. An article on UK productivity in the Labour government period can be found on the Labour government 1997-2010 page, free to download.

The IFS reported that real take home pay was 1 per cent lower in the third quarter of 2014 than in the third quarter of 2001. Though real wages have started to rise slowly in recent months, there has been a real threat to standards of living in the UK. This is closely associated with a disastrous performance on productivity since the beginning of the recession.

Defining productivity

Productivity can be defined in a number of ways: output per head of the population, output per worker, output per worker hour. Which is the appropriate measure to use depends upon precisely what one is attempting to analyse. Commentators have voiced concern about the UK’s performance on all three measures since the onset of the 2008 recession. Not only has it been linked with the very slow recovery in the standard of living but it is also an important indicator of an economy’s productive efficiency and of the quality of jobs on offer.

Output per head of the population will be influenced not just by the productivity of workers but also by the employment rate. Output per worker is affected not just by the number of workers employed but by the hours they work; for example, it used to be said in the 1960s and 1970s that higher Japanese manufacturing productivity per worker was largely explained by the fact that the Japanese worked much longer hours than people in other developed economies. This note concentrates on efficiency and jobs and therefore highlights output per worker hour.

Productivity under Labour

First, however, it gives some historical background. In his article for OXREP’s issue on the Labour Government’s Economic Record, John van Reenen discussed this background. He split GDP per capita into two components: output per worker and the employment rate. He argued that the growth of UK GDP per capita “outstripped” the US, France and Germany under the 1997 – 2010 Labour Government. The growth of output per worker was better than in Europe but worse than in the US. Conversely the growth of the employment rate was better than in the US but slightly lower than in Europe. He went on to remind us that GDP per capita also grew healthily under the previous Conservative Governments (1979 – 1997) when the country did well in terms of output per worker.

Rehearsing the various reasons advanced by researchers for Thatcher’s and Major’s success, van Reenen considered the argument that Labour might simply have continued to reap the rewards for their policies. However, he argued, it is important to distinguish between levels and growth and that it was implausible to believe that growth could have continued without some further stimuli.

He suggests that Labour’s specific contribution was in three areas.   The first was Labour’s product market competition policies. Noting the increase in higher education participation rates and in staying on rates at school, he tentatively suggested that improvements in human capital might also have had a role to play – though he does acknowledge that there may have been quality problems in what our education and training system was producing. The third explanation he advances is innovation, which he believes may have been stimulated by tax policies to encourage R & D and by science spending via the research councils.

All of this is against a background of long-standing governmental concern about the country’s poor productivity performance when compared with other OECD countries.

And indeed there have been several, at least partially, false dawns. The so-called productivity miracle of the 1980s still left us lagging. Indeed once it was realized that that there had been significant over-recording of capital stock at the beginning of the 1980s and that therefore its growth through the decade was greater than had originally been thought, a significant part of the miracle disappeared. Output growth had been attributed to productivity gains when in fact it was attributable to an increase in capital stock.

In any event it was a strange miracle that took us back to more or less the productivity growth of the 1960s. What in effect we saw was a recovery from the disastrous performance of the 1970s, at a time when most other OECD countries had not experienced such a recovery.

Productivity since the crisis

Whilst it was reasonable for the last Labour government to claim some further catch-up, on output per worker hour we were still behind some of our traditional comparator countries. By just before the onset of the recession, though the gap with rest of the G7 as a whole had been closed, we still lagged the US, France and Germany. Since the beginning of the recession, the UK’s productivity has flat lined whilst other countries have experienced slow growth in output per hour. So, on Office for National Statistics (ONS) numbers for 2013 (Figure 1), we are 31 per cent behind the US, 28 percent behind Germany, 27 per cent behind France, 9 per cent behind Italy and 1 per cent behind Canada. Only Japan performs worse.

Figure 1: Output per hour, 2013

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Source: Reproduced from ONS, “International Comparisons of Productivity”, 20 February 2015

According to the ONS (Figure 2) output per hour is probably just about at the level it was in 2007, just before the onset of the recession, and the ONS suggests that the gap with the average for the rest of the G7 is at its widest since 1992. In fact output per hour actually fell slightly in 2013 despite the signs of economic recovery and the ONS calculates that it is 15-16 points “below a counterfactual level had the UK’s strong productivity growth prior to the downturn continued”. The ONS continues, “ the productivity gap on the same basis for the rest of the G7 is around 6 percentage points”.

Figure 2: Productivity gaps, 1997-2013

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Source: Reproduced from ONS, “International Comparisons of Productivity”, 20 February 2015

So this raises two questions.

  • First, why could we not catch up with the likes of France, Germany and the US before the recession?
  • Second, why did we fare so relatively badly during the recession?

Why the limited UK productivity catch-up?

Productivity growth can be enhanced by improvements in dynamic efficiency and static efficiency. Dynamic efficiency is all about obtaining productivity improvement via investment – through technical progress embodied in new physical plant and equipment, in knowledge generated by R & D and in increasing human capital through education and training. Static efficiency is about improving the efficiency with which existing productive assets are deployed.

It is conventionally thought that the productivity gains under Thatcher were largely achieved by enhancing static efficiency. Whatever else motivated them, Thatcherite policies towards the labour market had this as a central aim. This was one explicit justification for the measures taken to reduce the power of unions and increase managerial prerogative, as it was for the removal of various forms of low pay protection and for reducing the extent of employment protection.

Similarly privatization and the introduction of quasi-markets into public sector activities, notably health and education, were justified partly on efficiency grounds. It was also argued that private business pursuing the profit motive in competitive and/or suitably regulated product markets would operate more efficiently than state-owned enterprises run by civil servants.

Reform of the tax and social security systems had similar intent. The reduction of higher rates of income taxation was meant to increase the incentive to work; so were attempts to reduce replacement ratios – the ratio of incomes from social security whilst out of work to income in work.

The Labour and Coalition governments maintained and probably increased static efficiency. However the UK’s long-standing failure was in dynamic efficiency. Investment/GDP ratios have been stubbornly low compared to many of our competitors, as has investment in R & D. The component of investment on which all governments from Thatcher onwards have placed massive emphasis has been on increasing human capital both via the formal education system and via work-based training.  Even the Thatcher government devoted significant subsidies to private sector training.

Under Blair and Brown the emphasis on human capital became even greater and this emphasis has continued under the Coalition. Originally this emphasis was part of the high skills vision which had initially been popularized in the US by economists such as Thurow and Reich. They asked how a rich country like the US could compete in an increasingly competitive world as more and more “developing” countries became serious players in international trade.

They argued that, for any well- defined product, US producers could not compete at the low end. Imagine a range of specification for that product – it becomes more highly specified the more characteristics it possesses, the more its producer is willing to customize the offer for different segments of the market and the more frequently it changes its specification. Any emerging economy could produce the low spec version of that product and the only factor which could give competitive advantage was price or unit labour cost. US producers would be beaten on price and therefore should move up-market where price was not such a constraining factor.

All OECD governments espoused this vision – the high value-added vision. Accompanying it was the belief that as a country moved up-market, production processes would become more skill intensive. Thus the high value-added vision became the high skills vision. Improving human capital was a necessary condition for successfully implementing such a national strategy. However it was not a sufficient condition.

If firms did not change their product and production strategies the human capital investment could be wasted. As noted above, van Reenen voiced some justifiable doubts about the quality of some of the human capital that was produced. The content of some of the lower vocational qualifications has been dubious, whilst exactly what our universities are producing bears some scrutiny.

But, even if there were no quality problems, there are certainly underutilization problems. Cedefop, studying the 2001-2011 period, estimates that between 10 and 15 per cent of UK workers reported that they did not need their highest qualification to get their job. We were not alone in this.

More revealing, in 2010, again according to Cedefop, about 60 per cent of UK workers reported that they believed themselves to be over-skilled for their jobs. This was a higher percentage than for all but four of the EU 27 countries. These four were Slovenia, Cyprus, Greece and Romania.

So the UK’s experience before the recession suggests that our failure to fully catch up with our comparator countries may well have been down to investment, and not even the stress on human capital investment had the leverage that governments had hoped for.

At the time some commentators were widening the discussion of investment deficiencies and arguing that inadequate infrastructure investment together with over-restrictive planning regulations were adding to our problems. They were also starting to suggest that officialdom often seemed to be slipping from regarding improvements in human capital as a necessary condition for achieving the high skills vision to thinking of it as a sufficient condition.

Why such poor progress under the Coalition?

So why have the last few years proved so disastrous? Investment and R & D performance have remained poor, whilst there is absolutely no evidence to suggest that the underutilization of skill has diminished. The ‘success’ story of the post-recession period has been the rapid growth of employment. Unemployment rose by less than in the major continental economies and fell fairly quickly. Unemployment rates are lower and employment rates are higher.

But the big doubt is about the quality of this employment growth.

Long before the recession struck Goos and Manning had introduced us to the notion of the hourglass labour market. They argued that over a couple of decades there had been growth in “top-end” jobs and in “bottom-end” jobs but that those in the middle had been squeezed – hence the hourglass shape.   Much of the employment growth during the recovery has been in lousy, low-end jobs where productivity is naturally low.

Late last year the TUC claimed that only one in 40 of the jobs created was full time and that the vast majority of employment created was either part time and/or self-employment. Of course neither part time work nor self employed work is necessarily less productive than full time work, but these figures are probably an indicator of this employment being created towards the bottom of the labour market.

A Joseph Rowntree Foundation Report found that in 2011-12 more households with members in work were in poverty than those with only workless members. The report attributes this to part time work and low pay. Thirteen million were classified as being in poverty. Even in better jobs, the fact that all power has been with management and that wage growth has been slow reduces the incentives for employers to increase the efficiency with which they deploy their workers.

Our recent productivity experience is historically unique for the UK and this adds to the worry is that it is not just a temporary blip on the route to a more productive and higher paying labour market. Investment in its many forms remains the key but so does trying to encourage a labour market with better and higher paying jobs.

 

References

Guardian, coverage of IFS report, 30.01.15

M. Goos and A Manning, ‘Lousy and Lovely Jobs – The Rising Polarization of Work in Britain’, Review of Economics and Statistics, February 2007.