Press release

13 Oct 2020 London, GB

UK productivity saw significant fall in Q2 – EY ITEM Club comments

The impact of COVID-19 has magnified existing concerns about the UK’s productivity performance, which has been weak for some time

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EY UK&I Media Relations Manager

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Related topics Growth COVID-19
  • Q2’s decline in UK productivity was the biggest since Q1 1974 as economic activity saw record contraction and fell significantly more than hours worked
  • The impact of COVID-19 has magnified existing concerns about the UK’s productivity performance, which has been weak for some time
  • Output per hour fell 2.0% quarter-on-quarter and was down 1.8% year-on-year in Q2. Productivity had previously relapsed in Q1 having shown some much-needed improvement over H2 2019
  • Output per worker was down 19.0% quarter-on-quarter and 21.1% year-on-year in Q2
  • Q3 is highly likely to have seen a considerable rebound in UK productivity given the economy saw substantial recovery in GDP. However, this is unlikely to change the underlying concerns over UK productivity levels
  • A risk is that the significant impact of COVID-19 on the UK economy over H1 2020 has a lasting negative impact on productivity and UK growth potential
  • Business investment has been pared back and there is the risk – especially given heightened uncertainties stemming from a renewed rise in COVID-19 cases – that companies remain cautious for an extended period in new investments with negative implications for productivity. Uncertainties over the UK-EU’s future trading relationship may also weigh on investment in the near term
  • Part of the UK’s recent disappointing labour productivity performance has been that – where possible – companies preferred to take on labour rather than commit to costly and difficult-to-reverse investment, given an uncertain economic and political outlook over the last few years
  • Other factors may have negatively affected productivity. Many of the new jobs that have been created in recent years have been in less-skilled, low-paid sectors where productivity is limited. Some have also argued that the UK has been poor at transferring technology and know-how from the most productive companies to others

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

“UK productivity – measured in terms of output per hour worked – saw the largest fall in 46 years in the second quarter as it fell 2.0% quarter-on-quarter, according to the Office for National Statistics (ONS). This followed a decline of 0.5% quarter-on-quarter in the first quarter.

“Output per hour worked fell 1.8% year-on-year in the second quarter of 2020 – the largest annual drop since the second quarter of 2009 – as gross value added (GVA) contracted a record 21.5% while hours worked declined 20.0%. The ONS has said that quarterly movements in productivity measures can be erratic so year-on-year rates give a better indication of trend – although it did observe when releasing the flash estimate of productivity in the second quarter, “the immediate nature of change has led to us highlighting the comparison with the previous quarter in this flash estimate.”

“Output per hour worked had previously edged up 0.1% overall in 2019 after a small gain of 0.5% in 2018. There had been modest improvement in productivity over the second half of 2019 after weakness over the first half of the year and the second half of 2018. Output per hour worked had risen 0.4% quarter-on-quarter in the fourth quarter of 2019 following a gain of 0.3% quarter-on-quarter in the third quarter. It had previously been flat quarter-on-quarter in the second quarter and fallen 0.5% quarter-on-quarter in the first quarter. Year-on-year growth in output per hour was limited to just 0.2% in the fourth quarter of 2019, as it had been in the third quarter. While slight, these were 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 fall of 0.3% in the second quarter of 2019, which had been the largest annual decline since the second quarter of 2014.”

Output per worker saw significant fall reflecting impact of furlough scheme

Howard Arched continues: “Output per worker was down a record 19.0% quarter-on-quarter and 21.1% year-on-year in the second quarter. This followed a decline of 2.7% quarter-on-quarter and 3.0% year-on-year in the first quarter. The ONS reported that “this is steeper than that observed for output per hour because of the impact of the furlough scheme that retains employees as workers even though they work zero hours.” The total number of workers fell 0.4% on the previous year, which is a much smaller movement than would be expected in response to a 21.5% fall in GVA.”

UK has catching up to do on productivity

Howard Archer adds: “The impact of COVID-19 has magnified existing concerns around the UK’s productivity performance, which has been weak for some time. Indeed, the flat overall productivity performance over 2019 after an underwhelming 2018 extends the UK’s overall poor productivity record since the 2008/9 recession.”

Number of factors may have held back UK productivity

Howard Archer continues: “Part of the UK’s ‘productivity puzzle’ 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 as growth returned.

“It also appears that, given the uncertain economic and political outlook in recent years, many companies took on labour rather than committing to costly and difficult-to-reverse investment. The low cost and flexibility of labour relative to capital has certainly supported employment over investment.

“Extended uncertainties over Brexit caused companies to limit their investment with implications for productivity. Business investment has been low since the second half of 2017 and it rose just 1.1% in 2019 after contraction of 1.5% in 2018. Business investment fell 0.5% quarter-on-quarter in the first quarter of 2020 and then fell a record 26.5% quarter-on-quarter in the second quarter. This meant that business investment in the second quarter of 2020 was 27.6% below its peak level in the fourth quarter of 2017.

“There are a number of structural factors that may have negatively affected productivity.

“Many of the new jobs that have been created in recent years are in less-skilled, low-paid sectors where productivity is limited. 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, ONS analysis has concluded that much of the slowdown in UK productivity has been 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 telecommunications and manufacturing.

“The Bank of England’s chief economist has also argued that the UK’s productivity problem has been influenced by an unusually wide gap between Britain's most productive firms and the much longer tail of its least productive companies. He has suggested this is a consequence of a ‘diffusion’ problem with the UK relatively poor at transferring technology and know-how.

“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.”

Outlook

Howard Archer comments: “The third quarter highly likely saw a considerable rebound in UK productivity given that the economy clearly saw substantial recovery in GDP. However, this is unlikely to change the underlying concerns over UK productivity.

“The risk is that COVID-19’s impact on the UK economy over the first half of 2020 has a lasting negative impact on productivity and UK growth potential. In particular, business investment has been pared back and there is the risk that companies will be very cautious for an extended period in new investments. This risk is reinforced by the renewed rise in COVID-19 cases and current uncertainties over the future UK-EU trading relationship.”