The UK's productivity puzzle

Car manufacturing at Nissan in the UK Image copyright Getty Images
Image caption Unlike previous recessions, productivity hasn't picked up during the recovery

Raising UK living standards depends on raising productivity, but how?

That was the verdict of the OECD, which highlights one of the biggest puzzles of this recovery. Output has finally recovered; employment recovered first; but wage growth has not and that is related to productivity.

The Bank of England estimated that output per hour is around 16 percentage points lower than it should be if productivity had grown at its pre-crisis pace.

Unlike previous recessions, productivity hasn't picked up during the recovery. For instance, output per worker grew at 0.2% a quarter in 2013 which is just one-third of the 0.6% average growth rate since 1997 until the 2008 crisis.

But, productivity wasn't very high before the crisis either. The OECD points to low investment as a culprit.

As a share of GDP, UK investment began to trail that of the US, Canada, France, and Switzerland in the 1990s. Investment fell from around a quarter of GDP in the late 1980s to just over 15%. With less investment, then there's less productive capital for employees to work with, and thus lower output per worker.

This was also one of the conclusions of the Bank of England when it looked at the productivity puzzle last year.

Cyclical factors

First, they found that mis-measurement accounted for a quarter of the shortfall in productivity. So, revisions to GDP are one example of measurement issues.

But, that still leaves 12 percentage points to be explained, and researchers at the BOE say they can explain around half to three-quarters of the puzzle. They looked at cyclical factors related to the business cycle and also at structural or persistent reasons for lagging productivity.

Some of the cyclical factors have to do with hoarding workers and doing work that doesn't immediately add to output. But, as spare capacity disappears, this is unlikely to be why we still don't see a pick-up in productivity.

The BOE concludes that it's largely due to low capital investment and also inefficient resource allocation where workers are not moving from low to high productivity sectors. That can happen when there are high firm survival rates, or in other words, so-called zombie firms that have survived due to the extraordinarily low interest rate environment.

So, what can be done to raise investment? The OECD proposed a number of policies to increase capital spending, particularly on infrastructure, and to improve lending to businesses.

Divided opinions

How best to boost investment will undoubtedly continue to generate much debate.

After all, some economists argue that with such low borrowing costs - the UK can borrow for 30 years at just 2.5% - there should be scope to borrow and invest. This is also heard in America.

Others would argue that the priority should be to encourage private investment. Help to Grow is one such recent policy to help small businesses with their financing.

The OECD also finds that weak output is a drag on total factor productivity or the productivity of not just labour but also capital.

That brings us full circle in that output per worker or machine can't increase strongly if growth remains subdued.

The OECD says that output has not recovered to the level the pre-crisis trend implied. In other words, UK output should have grown by around 10 percentage points since 2008, but has only expanded by about one-third of that amount.

So, the level of output may have recovered to pre-crisis levels, but there are six years or so of lost growth to consider too.

Importantly, wages are related to productivity. The OECD says that because labour productivity has been "exceptionally weak" since the crisis, real wages and per capita GDP or average incomes have also been flat.

The OECD says that if the UK wants to maintain the strongest growth rate in the G7 - the title it held last year, then raising productivity should be a priority.

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