Press release

8 Jan 2020 London, GB

UK productivity shows improvement but concerns continue over extended poor performance

A slightly improved UK productivity performance in the third quarter of 2019 does not mask a still pretty grim picture.

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  • A slightly improved UK productivity performance in the third quarter of 2019 does not mask a still pretty grim picture. Output per hour worked rose 0.3% quarter-on-quarter in the third quarter but was still up only 0.1% year-on-year. This marks four quarters of year-on-year declines in output per hour worked, which included a fall of 0.6% year-on-year in the second quarter of 2019. This was the sharpest year-on-year drop in productivity since the second quarter of 2014.
  • The Office for National Statistics highlights the year-on-year rate in output per hour worked as this is less volatile and gives a better trend view. Worryingly the minimal rise seen in the third quarter of 2019 followed four successive quarters that output per hour worked has failed to see a year-on-year gain.
  • The poor productivity performance over the first three quarters of 2019 followed an underwhelming performance for 2018, when output per hour rose just 0.5% over the year as a whole and was down 0.1% year-on-year in the fourth quarter. This was below the annual average growth rate of 2.0% seen before the 2008/9 downturn.
  • The slight improvement in productivity in the third quarter of 2019 does little to ease concerns over the UK’s overall poor productivity record since the deep 2008/9 recession.
  • Part of the UK’s recent poor labour productivity performance has undoubtedly been that relatively low wage growth has increased the attractiveness of employment for companies. It is apparent that many companies have preferred to take on labour rather than commit to costly and difficult to reverse investment, given a highly uncertain economic and political outlook, magnified by Brexit uncertainties since mid-2016. The low cost and flexibility of labour relative to capital has certainly supported employment over investment.
  • There are a number of other factors that may have impacted productivity. In particular, many of the new jobs that have been created are in less-skilled, low-paid sectors where productivity is limited. There is also an argument that the UK has been particularly poor at transferring technology and know-how from the most productive companies to other companies.
  • Pressure for UK companies to get more out of their workers has come from recruitment difficulties in some sectors (reflecting the tight labour market) as well as the recent pick up in pay growth – although earnings growth has eased back from the 11-year high seen around mid-2019.
  • Companies are likely to increasingly prioritise productivity-enhancing measures, and there is likely to be a growing incentive to undertake investment aimed at saving labour.
  • Heightened concerns over Brexit have clearly caused some companies to limit their investment with damaging implications for productivity. Significantly, business investment in the third quarter of 2019 was 2.0% below the peak level seen in the fourth quarter of 2017.
  • The hope is that the uncertainties facing businesses are significantly diluted by December’s decisive General Election result and the UK now set to leave the EU with Boris Johnson’s deal on 31 January, and that this has a positive impact on investment intentions, which in turn boosts productivity.
  • However, the concern is that the upside for business investment will remain limited in the face of still significant uncertainties over the UK’s relationship with the EU (including when the transition arrangement is due to end on 31 December) and a challenging global outlook – and this will continue to weigh on productivity.

Howard Archer, chief economic advisor to the EY ITEM Club, comments:

“Modestly improved but still pretty grim underlying news on UK productivity The Office for National Statistics (ONS) reported that UK productivity (measured in terms of output per hour worked) rose 0.3% quarter-on-quarter in the third quarter of 2019, after drops of 0.2% quarter-on-quarter in the second quarter and 0.5% quarter-on-quarter in the first quarter. This followed an overall gain of just 0.5% over 2018 as a whole with erratic quarterly performances. This was below the annual average growth rate of 2.0% seen before the 2008/9 downturn.

“The ONS has observed that quarterly movements in productivity measures can be volatile so year-on-year rates gives a better indication of trend.

“This does not make for happy reading as output per hour worked was still only up 0.1% year-on-year in the third quarter of 2019. This actually followed four quarters of year-on-year declines which included a fall of 0.6% in the second quarter, which had been the sharpest annual drop since the second quarter of 2018. Output per hour worked had previously been down 0.1% year-on-year in both Q1 2019 and Q4 2018, and it fell 0.2% year-on-year in Q3 2018. In contrast, output per hour had been up 1.4% year-on-year in Q2 2018 and 0.8% in Q1.

“Output per hour worked rose 0.1% year-on-year in the third quarter of 2019 as gross value added (GVA) and hours worked both rose by 1.0% but the ONS reported that “GVA grew slightly more than hours worked”.

“Output per hour worked was up 0.1% year-on-year in the services sector in the third quarter of 2019 as GVA rose 1.6% and hours worked increased by 1.5%. However, output per hour worked was down 1.9% year-on-year in the manufacturing sector as GVA fell 1.1% and hours worked increased by 0.9%.

UK has a lot of catching up to do on productivity

“The poor overall productivity performance over the first three quarters of 2019 after an underwhelming 2018 will fuel concerns over the UK’s overall poor productivity record since the deep 2008/9 recession. 

“The ONS observed that “Labour productivity has demonstrated weak growth since the economic downturn, while in the previous 10 years it was close to historical long-term average growth rates of 2.0% per year. This sustained period of minimal labour productivity growth has been labelled the UK's "productivity puzzle", and is arguably the defining economic question of our age.”

“The ONS also reported that “The median labour productivity growth of the post-downturn period is around one-quarter of what it was during the pre-downturn period (starting with Quarter 1 (Jan to Mar) 1998), shown by the 50th percentile lines.”

The UK’s “productivity puzzle”

“The UK’s “productivity puzzle” is a source of much debate and analysis. Part of the UK’s recent poor labour productivity performance has undoubtedly been that low wage growth has increased the attractiveness of employment for companies. This helped employment to hold up well during the 2008/9 downturn and to pick up markedly as growth returned. 

“Employment may have been lifted in recent times by some UK companies being keen to take on workers – or at least hold on to them – given increasing concerns over labour shortages in some sectors and reports of fewer EU workers coming to the UK since the 2016 Brexit vote. 

“It also is apparent that many companies have taken on labour rather than committing to costly investment, given the highly uncertain economic and political outlook. The low cost and flexibility of labour relative to capital has certainly supported employment over investment.

Structural factors are limiting productivity

“There are a number of structural factors that may have hurt productivity. Many of the new jobs that have been created are in less-skilled, low-paid sectors where productivity is limited. Significantly, a report by the NIESR and the Joseph Rowntree Foundation in 2018 concluded that productivity is particularly poor in low-paid jobs in the UK compared with other major economies, lagging up to 20-30% behind similar roles in Germany, France and the US.

“Similarly, analysis in 2018 by the ONS concluded that much of the slowdown in UK productivity was due to the changing composition of the UK economy with workers moving from more (such as mining) to less efficient sectors (food & catering). Nevertheless, the ONS also observed that there had been a slowdown in productivity growth in a number of sectors, including financial services, telecommunications and manufacturing. 

“In a speech in 2018, the Bank of England’s chief economist Andy Haldane argued that the UK’s productivity problem was influenced by an unusually wide gap between Britain's most productive firms and the much longer tail of its least productive companies. Andy Haldane suggested this was a consequence of a diffusion problem with the UK relatively poor at transferring technology and know-how.

“The economy’s past prolonged weakness and challenges in the financial sector may have also hurt productivity through under-investment and an inefficient allocation of resources. There is concern that an extended inability to access capital may have held back innovation and investment by smaller companies.  

“In addition, there has been concern about the impact of so-called “zombie” companies that have been helped to stay alive through very low interest rates. Not only are these companies generally less productive, but there is a risk that they may be preventing credit and resources from being reallocated to newer companies and backing new products and processes. 

Brexit

“Heightened concerns over Brexit have clearly caused some companies to limit their investment with damaging implications for productivity. Significantly, business investment has been largely in the doldrums since the second half of 2017 and in the third quarter of 2019 (when it essentially stagnated for a second successive quarter) it was 2.0% below the peak level seen in the fourth quarter of 2017.

“The hope is that the uncertainties facing businesses are significantly diluted by December’s decisive General Election result and the UK now set to leave the EU with Boris Johnson’s deal on 31 January, and that this has a positive impact on investment intentions and productivity.

“However, the concern is that the upside for business investment will remain limited in the face of ongoing Brexit uncertainties and a challenging global outlook.

“In addition, we suspect that a difficult global economic and trading environment will also weigh down on business investment in 2020 as well as hampering UK export.”