UK productivity up in Q1 2021 after small increase over 2020 – EY ITEM Club comments

• UK productivity – measured in terms of output per hour – improved in Q1 2021 after a small overall increase of 0.4% in 2020, despite the economy contracting 9.8%. Output per hour rose 0.8% quarter-on-quarter (q/q) and 1.0% year-on-year (y/y) in Q1 2021. 
• The improvement was largely due to more productive sectors of the economy keeping going during lockdown, while less productive sectors were more likely to be among those closed down.
• The UK’s productivity performance through 2020 was erratic as it was heavily distorted by COVID-19-related restrictions on economic activity. The ONS indicated that positive productivity growth despite the pandemic was due to a change in the distribution of economic activity between industries.
• Output per worker fell 1.8% q/q in Q1 2021 and was down 4.6% y/y. Output per worker fell 9.6% over 2020. This reflected the fact that the jobs furlough scheme reduced hours worked but protected workers’ status as employed.
• It looks like the pandemic has had a mixed impact on overall UK productivity. Higher productivity companies have increased their share of output and many businesses have become more efficient to keep going.
• However, business investment was weak overall in 2020 despite some recovery in the second half and it experienced a renewed decline in Q1 2021, which is not good news for productivity. Productivity may also have been affected by businesses having to invest to make their premises compliable with COVID-19 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.
• The hope is that a robust recovery from Q2 fuels a significant boost to business confidence and willingness to invest, with favourable implications for productivity. A tax incentive to invest contained in March’s budget should also help matters.
• Part of the UK’s recent disappointing labour productivity performance has been that before the pandemic – 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 – prior to the pandemic – 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 – improved in the first quarter of 2021 as it rose 0.8% quarter-on-quarter, according to the Office for National Statistics (ONS).

“Output per hour worked was up 1.0% year-on-year in the first 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 rose 1.0% year-on-year in the first quarter as gross value added (GVA) fell 6.1% while hours worked were down 7.1%.

“The ONS said that, throughout the first quarter in 2021, with restrictions temporarily closing down large parts of less productive industries in the economy, output per hour worked – the ONS’ preferred labour productivity measure – grew by 1.0% quarter-on-year.

“Impressively, despite the pandemic, output per hour worked managed to edge up 0.4% overall in 2020. The ONS reported that ‘a change in the distribution of economic activity between industries is the primary reason we have not seen a similar drop to the 2008-09 downturn.’

“Additionally, the ONS said that industries that saw a fall in their relative share of hours worked tended to be lower productivity industries. Compared with a whole economy average productivity level of about £36.00 per hour worked in 2019, the food and beverage services industry was about 54% less productive. By contrast, industries with an increased share of hours worked tended to be high productivity industries. The legal and accounting and computer services industries had productivity levels of £41.40 and £38.20 per hour worked in 2019 respectively, 15% and 6% above the whole economy average. As a result, the allocation effect was strongly positive in 2020.”

Output per worker has been significantly affected by furlough scheme

Howard Arched continues: “Output per worker fell 1.8% quarter-on-quarter in the first quarter of 2021 and was down 4.6% year-on-year. 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. Overall, output per worker fell 9.6% in 2020.”

UK has catching up to do on productivity

Howard Archer continues: “With marginal overall improvement in productivity over 2020 in terms of output per hour, the UK clearly still has a long way to go following what has been a weak trend since the 2008/9 recession. 

“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 quickly 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 this.

“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. Business investment fell 10.2% over 2020 as it was adversely affected by the pandemic, although it did see limited recovery over the second half of the year. This meant that business investment in Q4 2020 was still 8.3% below its peak level in Q2 2017. However, businesses investment suffered a renewed decline in the first quarter of 2021.

“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 – prior to the pandemic – have been 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 – such as food and 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: “It looks like the pandemic has had a mixed impact on overall UK productivity. Higher productivity firms have increased their share of output and many companies have become more efficient to keep going.

“However, business investment was weak overall in 2020 despite some recovery in the second half, and the renewed decline in the first quarter of 2021 is not good news for productivity. Productivity may also have been negatively affected by businesses having to invest to make their premises compliable with COVID-19 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 interaction and not being able to build up experience by having people in the office.