Press release

12 Nov 2020 London, GB

UK productivity saw strong rebound in Q3 but underlying concerns remain – EY ITEM Club comments

UK productivity saw a substantial pick-up in Q3 following Q2’s contraction, as economic activity rebounded strongly and rose significantly more than hours worked.

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Related topics Growth COVID-19
  • UK productivity saw a substantial pick-up in Q3 following Q2’s contraction, as economic activity rebounded strongly and rose significantly more than hours worked
  • However, performance has recently been distorted by new COVID-19-related restrictions, and the Q3 rebound does not fundamentally change what is still a weak underlying trend
  • Output per hour rose 5.2% quarter-on-quarter in Q3 after falls of 2.0% in Q2 and 0.5% in Q1. Output per hour was up 3.0% year-on-year in Q3 having been 1.8% lower in Q2
  • Output per worker rose 16.2% quarter-on-quarter in Q3 after a substantial 19.0% decline in Q2; it was still down 8.8% year-on-year
  • A risk is that the significant impact of COVID-19 on the UK economy over 2020 has a lasting negative impact on productivity and UK growth potential
  • Business investment has been pared back and remains weak. There is the risk – especially given heightened uncertainties stemming from the 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 are also currently likely to be weighing on investment
  • If a vaccine for COVID-19 becomes available in the UK in the near term, it could provide a significant boost to business confidence and willingness to invest, with favourable implications for productivity
  • Part of the UK’s recent disappointing labour productivity performance has been that – where possible – companies have 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 – rebounded in the third quarter after a record decline in the second quarter as it rose 5.2% quarter-on-quarter, according to the Office for National Statistics (ONS). This followed a decline of 2.0% quarter-on-quarter in the second quarter.

“Output per hour worked was up 3.0% year-on-year in the third quarter after a fall of 1.8% in the second. 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 had earlier declined 0.5% quarter-on-quarter and edged up 0.2% year-on-year in the first quarter. Output per hour worked rose 3.0% year-on-year in the third quarter of 2020 as gross value added (GVA) fell at a reduced rate of 9.5% while hours worked were down 12.1%.

“Output per hour worked had previously 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 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 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 has been significantly affected by furlough scheme

Howard Arched continues: “Output per worker rose 16.2% quarter-on-quarter but was still down 8.8% year-on-year in the third quarter. This followed a record decline of 19.0% quarter-on-quarter and 21.1% year-on-year in the second quarter. There was an earlier fall of 2.7% quarter-on-quarter and 3.0% year-on-year in the first quarter. When releasing the second quarter data, 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 [the second quarter] 2020 took this metric below the level observed two decades ago.”

“In the third quarter, an increasing number of people returned to work”.

UK has a catching up to do on productivity despite Q3 rebound

Howard Archer continues: “The rebound in productivity in the third quarter does not fundamentally change what is still a weak underlying trend. The UK’s productivity performance has recently been significantly affected by COVID-19, and 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. While business investment rose 8.8% quarter-on-quarter in Q3, this was a modest rebound after a record decline of 26.5% in Q2 and also a decline of 0.5% in Q1. This meant that business investment in Q3 was 20.5% below its level in Q4 2019.

“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 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 keep going through very low interest rates.”

Outlook

Howard Archer comments: “The concern is that COVID-19’s impact on the UK economy over 2020 has a lasting negative impact on productivity and UK growth potential. This is reinforced by the current challenge posed to economic activity by new COVID-19 cases.

“In particular, business investment has been pared back and there is the risk that companies will be cautious for an extended period in new investments.

“Should a vaccine for COVID-19 become available in the UK in the near term, it could provide a significant boost to business confidence and willingness to invest, with favourable implications for productivity.”