Press release

7 Apr 2020 London, GB

UK productivity improved in Q4 2019 but underlying performance remained weak

UK productivity saw a second successive quarter of modest improvement in the fourth quarter of 2019, but the underlying picture remained pretty gloomy. Output per hour worked rose 0.3% quarter-on-quarter in the fourth quarter and was up 0.3% year-on-year.

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  • UK productivity saw a second successive quarter of modest improvement in the fourth quarter of 2019, but the underlying picture remained pretty gloomy. Output per hour worked rose 0.3% quarter-on-quarter in the fourth quarter and was up 0.3% year-on-year. This followed a gain of 0.5% quarter-on-quarter and 0.3% year-on-year in the third quarter and drops of 0.1% quarter-on-quarter in the second quarter and 0.4% in the first quarter.
  • While slight, the 0.3% year-on-year rise in output per hour in the fourth and third quarters of 2019 actually marked the strongest annual rises since the second quarter of 2018. The fourth quarter of 2019 also marked a second successive year-on-year increase in output per hour, following four successive quarters of flat or declining performances including a fall of 0.5% year-on-year in the second quarter, which had been 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.
  • Overall, output per hour worked was only flat in 2019, which followed a gain of just 0.5% in 2018. This compares highly unfavourably with the annual average growth rate of 2.0% seen before the 2008/9 downturn.
  • A positive spin on the data would be that while the underlying picture is still poor, a second successive quarter of improvement in the fourth quarter of 2019 could be a sign that things are starting to move in the right direction. However, it is hard to judge at this stage and the outlook for productivity has been clouded by the impact of coronavirus on the economy.
  • The persistent failure of UK productivity to show improvement led the Bank of England to downgrade its productivity forecasts in January, and hence its estimate of the supply side potential of the UK economy. The Bank now believes the UK’s supply side capability is annual average GDP growth of just 1.1% over the next three years. The Bank of England cut its forecast for output per hour worked to flat in 2020 (from 0.75%). It sees it rising 0.75% in 2021 and 1.25% in 2022. Of course, this was before coronavirus started to impact the UK economy.
  • Part of the UK’s recent poor labour productivity performance has undoubtedly been that – where possible – 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 factors since mid-2016.
  • Heightened concerns over Brexit clearly caused some companies to limit their investment with damaging implications for productivity. Significantly, business investment only grew 0.6% in 2019 after a drop of 1.5% in 2018. Consequently, the level of business investment in the fourth quarter of 2019 was 1.3% below the peak level of the fourth quarter of 2017.
  • There are a number of other factors that may have hurt 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.
  • The hope had been that reduced uncertainties facing businesses following December’s decisive General Election result and leaving the EU with a deal on 31 January would boost businesses’ willingness to commit to investment, which in turn would have a positive impact on productivity.
  • However, the substantial impact to the economy coming from coronavirus is bound to take a major near-term toll on business investment. There is also a concern that the upside for business investment will be limited by still significant uncertainties over the UK’s relationship with the EU and concerns over the nature of the longer-term relationship.

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

UK productivity – measured in terms of output per hour worked – saw a second successive quarter of modest improvement in the fourth quarter of 2019 as it rose 0.3% quarter-on-quarter. This followed a gain of 0.5% quarter-on-quarter in the third quarter but drops of 0.1% quarter-on-quarter in the second quarter and 0.4% quarter-on-quarter in the first quarter.

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

Year-on-year growth in output per hour was limited to just 0.3% in the fourth quarter of 2019, as it had been in the third quarter. While slight, these were actually the equal strongest annual gains since the second quarter of 2018. Prior to the third quarter of 2019, output per hour had fallen year-on-year for four successive quarters, including a drop of 0.5% in the second quarter of 2019 which had been the sharpest annual drop since the second quarter of 2014. Output per hour worked had previously been flat year-on-year in Q1 2019, while it fell 0.1% in Q4 2018 and 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 0.3% year-on-year in the fourth quarter of 2019 as gross value added (GVA) rose 1.1% while hours worked increased 0.8%. The number of people employed was up 1.0% year-on-year, but the number of hours they worked fell 0.2% so overall hours worked increased 0.8% year-on-year.

The ONS reported that the fourth quarter year-on-year growth in output per hour was due to the construction sector, while there was a marked drop in manufacturing and a small drop in services.

Despite the modest improvement over the second half, output per hour worked was only flat over 2019. This followed a gain of just 0.5% in 2018.

UK has a lot of catching up to do on productivity

A positive spin on the latest data would be that, while the underlying picture is still poor, a second successive quarter of improvement could be a sign that things are starting to move in the right direction. However, it is difficult to judge at this stage.

Indeed, the poor overall productivity performance over 2019 after an underwhelming 2018 extends the UK’s overall poor productivity record since the deep 2008/9 recession.

When releasing the latest data the ONS observed that labour productivity “has demonstrated weak growth since the 2008 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.

It also reported that “after four consecutive quarters of zero or negative growth, the last two quarters of positive growth are an improvement. However, in historical terms 0.3% is still a very low productivity growth rate, significantly below the post-2008 economic downturn median and less than a seventh of the pre-downturn median growth rate. The takeaway story is the continued weakness of the UK’s productivity growth since the economic downturn.

The persistent failure of UK productivity to show improvement led the Bank of England in January to downgrade its productivity forecasts and hence its estimate of the supply side potential of the UK economy – the Bank now believes the UK’s supply side capability is annual average GDP growth of just 1.1% over the next three years. The Bank of England cut its forecast for output per hour worked to flat in 2020 (from 0.75%). It sees it rising 0.75% in 2021 and 1.25% in 2022. Of course, this was before coronavirus started to impact the UK economy.

Number of factors may have held back UK productivity

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.

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.

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. 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 financial sector problems 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.

Outlook

Heightened concerns over Brexit 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 it rose just 0.6% in 2019 after a contraction of 1.5% in 2018. This meant that business investment in the fourth quarter of 2019 was 1.3% below its peak level in the fourth quarter of 2017.

The hope had been that reduced uncertainties following December’s decisive election result and leaving the EU with a deal on 31 January would boost businesses’ willingness to commit to investment, which in turn would have a positive impact on productivity.

However, the hit to the economy coming from coronavirus is likely to take a near-term toll on business investment.

There is also the possibility that the upside for business investment will be limited in the face of ongoing uncertainties over the UK-EU relationship (can a Free Trade Arrangement be agreed by end-2020 when the transition arrangement is due to end) and concerns over the nature of the longer-term relationship.

Brexit uncertainties are likely to remain significant throughout 2020. Even before the coronavirus outbreak made negotiations harder to carry out, there have been concerns over the possibility of another Brexit cliff-edge late on in 2020 (as the transition arrangement is only due to last until the end of the year and its uncertain whether the UK and EU can complete a free trade agreement by then).

There are also concerns over the nature of the UK’s longer-term relationship with the EU and whether less regulatory alignment with the EU may result in additional costs, rules, and frictions at the border.