Press release

4 Nov 2020 London, GB

UK productivity saw record decline in Q2 – EY ITEM Club comments

UK productivity saw a record fall in the second quarter as economic activity contracted and fell significantly more than hours worked.

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  • UK productivity saw a record fall in the second quarter as economic activity contracted and fell significantly more than hours worked
  • The impact of COVID-19 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 the first quarter having shown some much-needed, albeit modest improvement over the second half of 2019
  • Output per worker was down 19.3% quarter-on-quarter and 21.7% year-on-year in the second quarter
  • There is a risk that the significant impact of COVID-19 on the UK economy over the first half of 2020 has a lasting effect on productivity and UK growth potential
  • Business investment has been pared back and there is the risk – especially given heightened uncertainties stemming from the renewed rise in COVID cases - that companies remain cautious for an extended period with implications for productivity. Uncertainties over the UK-EU’s future trading relationship are also currently likely to be weighing on investment
  • Part of the UK’s recent poor labour productivity performance has been that – where possible – companies have generally 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
  • There are a number of other factors that 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 a record decline in the second quarter as it fell 2.0% quarter-on-quarter, according to the Office for National Statistics (ONS).

“Output per hour worked fell 2.0% quarter-on-quarter in the second quarter of 2020 as gross value added (GVA) contracted a record 19.8% while hours worked declined 18.4%.

“However, the ONS reported that the results on a sector level mask much bigger changes. By far the most significant fall in output per hour was in the hotels and catering industry. Productivity in this industry decreased by 72.2%. There were also marked falls in other services (21.3%), government services (14.0%) and transport and storage (12.4%). Outside of the services sector, the largest falls were in transport equipment manufacturing (34.5%) and textiles, wearing apparel and leather (30.9%).

“Output per hour worked was down 1.8% year-on-year in the second quarter. The ONS has said that quarterly movements in productivity measures can be erratic so year-on-year rates gives a better indication of trend. Output per hour worked declined 0.5% quarter-on-quarter and edged up 0.2% year-on-year in the first quarter.

“Output per hour worked had been flat 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 compared with the first half of the year and the second half of 2018.  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 equally 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 0.3% in the second quarter of 2019, which had been the equal 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 19.3% quarter-on-quarter and 21.7% 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 the “disparity between two measures that are usually closely aligned is because of the government’s furlough schemes. These have caused employment to stay close to pre-pandemic levels, decreasing by only 0.4% on the same quarter a year ago. However, the substantial fall in total hours worked in Quarter 2 2020 took this metric below the level observed two decades ago.”

UK has a catching up to do on productivity

Howard Archer adds: “The impact of COVID-19 magnified existing concerns around the UK’s productivity performance, which has been weak for some time. Indeed, the flat 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: “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 as growth returned.

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

“Extended uncertainties over Brexit caused some companies to limit their investment, with implications for productivity. Significantly, 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 too.

“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 financial services, 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 risk is that COVID-19’s impact on the UK economy over the first half of 2020 has a lasting effect on productivity and UK growth potential. This is reinforced by the economic impact of the lockdown restrictions.

“In particular, business investment has been pared back (it contracted a record 26.4% quarter-on-quarter in the second quarter) and there is the risk that companies may be very cautious for an extended period over making new investments. This risk is reinforced by the renewed rise in COVID cases and uncertainties over the future UK-EU trading relationship.”