Press release

19 Jan 2021 London, GB

UK productivity saw strong rebound in Q3 2020 but underlying issues remain – EY ITEM Club comments

UK productivity saw a substantial pick-up quarter-on-quarter (q/q) in Q3 2020 following declines in Q1 and Q2, as economic activity rebounded and rose significantly more than hours worked

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Related topics Growth COVID-19
  • UK productivity saw a substantial pick-up quarter-on-quarter (q/q) in Q3 2020 following declines in Q1 and Q2, as economic activity rebounded and rose significantly more than hours worked
  • However, performance has been distorted by COVID-19-related restrictions, and Q3’s rebound does not fundamentally change a weak underlying productivity trend
  • Output per hour rose 5.6% q/q and 4.0% year-on-year (y/y) in Q3 2020, the largest annual increase since Q4 2005
  • Output per worker grew 16.6% q/q in Q3, but was down 7.9% y/y in Q3 2020. This was the second largest annual fall since records began in 1959 and reflects the fact that the Coronavirus Job Retention Scheme has reduced hours worked, but preserved workers' employment statuses
  • A risk is that the effects of COVID-19 on the UK economy over 2020 have a lasting negative impact on productivity and growth potential
  • Business investment remains weak. There is the risk – especially given uncertainties stemming from the recent rise in COVID-19 cases – that companies remain cautious for an extended period in new investments
  • Productivity may also be affected by businesses having to invest to make their premises compatible with social distancing requirements rather than investing in new equipment and productive practices
  • Increased working at home may have mixed implications for productivity. On the positive side, the time saved commuting may be lifting output for many workers. However, productivity may be affected by reduced social interaction and the building-up of experience from people being in the office
  • The hope is that a successful vaccine roll-out over the coming months fuels a 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, and given an uncertain economic and political outlook – some companies have preferred to take on labour rather than commit to costly and difficult-to-reverse investment. Other factors include the fact many new jobs have been in low-skilled, low-paid sectors, while some have argued the UK has been poor at transferring technology and know-how across the economy.

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

“UK productivity – measured in terms of output per hour worked – increased in the third quarter of 2020 after falling in the second quarter as it rose 5.6% quarter-on-quarter, according to the Office for National Statistics (ONS). This followed declines of 0.7% quarter-on-quarter in the second quarter and 1.1% quarter-on-quarter in the first quarter.

“Output per hour worked was up 4.0% year-on-year in the third quarter of 2020 after a fall of 1.0% in the second. The ONS 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 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%.

“The ONS observed that “increase in output per hour at the whole economy level was driven by a decrease in hours in less productive industries, creating a positive ‘allocation’ effect as more productive industries now represent a larger share of the economy.”

Output per worker has been significantly affected by furlough scheme

Howard Arched continues: “Output per worker rose 16.6% quarter-on-quarter in the third quarter but was still down 7.9% year-on-year. This followed a record decline of 17.9% quarter-on-quarter and 20.5% year-on-year in the second quarter. There was an earlier fall of 3.2% quarter-on-quarter and 3.3% year-on-year in the first quarter. The ONS has reported that the “disparity between two measures (output per hour worked and output per worker) that are usually closely aligned is because of the government’s furlough schemes.” 

“Consequently, the ONS pointed out that in the third quarter: “When compared with the same quarter a year ago, employment has decreased by 0.8%. Alongside these changes in the labour market, there has been an accompanying 8.6% reduction in gross value added (GVA) when compared with the same quarter a year ago, the second largest drop in history.””

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

Howard Archer continues: “While welcome, the rebound in productivity in the third quarter 2020 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.”

Outlook

Howard Archer comments: “COVID-19’s impact on the UK economy over 2020 has had a significant 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.

“Productivity may also have been affected by businesses having to invest to make their premises compatible with social distancing requirements rather than using the resources to invest in new equipment and productive practices.

“Increased working at home may well be having mixed implications for productivity. On the positive side, the time saved commuting may be lifting output for many workers. On the negative side, productivity may be affected by reduced social interaction and the building-up of experience from people being in the office.

“The hope is that the successful roll-out of the COVID-19 vaccines over the coming months fuels a significant boost to business confidence and willingness to invest, with favourable implications for productivity.”

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 the future of the UK-EU trading relationship 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 2.5% in 2018. While business investment rose 9.4% quarter-on-quarter in the third quarter, this was a modest rebound after a record decline of 25.4% in the second quarter and also a decline of 0.7% in the first. This meant that business investment in the third quarter was 19.0% below its level in the fourth quarter of 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.”