With 40% of the private sector economy in stagnation mode, Thomas Aubrey discusses the variance between sub-sector productivity rates - what is causing some to increase, others to decline, and how policy can address it.
UK productivity grew 2.6% between 2019 and 2021 which is to be welcomed given its previous low rate of growth following the financial crisis. However, it is too soon to celebrate: a disaggregation of the sources of that growth raises significant concerns for the future, particularly when it comes to productivity in the private sector.
A sectoral disaggregation[1] indicates that the main driver of this recent growth has been the public sector, mainly due to the fact that it has expanded.[2] However, once this public sector growth has been removed, the private sector excluding real estate activities (which is largely imputed rent for housing) remains stagnant. Between 2019 and 2021, private sector productivity growth was only 0.2%.
This remains a major concern for the UK economy and for future productivity – which matters not because economists care about it, but because it is the engine of improvements in living standards over the long term. This is all the more worrying given the expected economic slowdown due to the rising cost of living, and the challenge facing UK firms dealing with increased post-Brexit trade frictions and costs.
Although private sector productivity growth was stagnant between 2019-2021, there is a great degree of variance in the performance of individual sectors. The Professional & Scientific sector experienced the highest overall growth which was largely driven by the performance of Legal & Accounting activities.
The Wholesale & Retail sector continues to provide a significant net positive contribution to productivity growth, although it has declined in size relative to the economy as a whole. This is likely to have been a function of the pandemic driving firms to focus on digital channels. In addition, the Financial Services sector made a positive contribution to productivity growth subsequent to its negative contribution in the decade after the financial crisis.
Among the sectors dragging productivity growth down, Mining & Quarrying – largely driven by the decline of North Sea oil and gas – continues to contribute negatively. Administrative Support Services, Arts, Recreation activities and Accommodation & Food Services were all impacted by the pandemic, and have not yet fully recovered. These sectors may well perform better as the effects of the pandemic recede.
That leaves about 40% of the private sector economy in stagnation mode (blue in the table above). While manufacturing experienced a significant increase in its own productivity growth, it continues to decline almost as rapidly in terms of its relative size thereby reducing its overall contribution. However, there is significant variance in the performance of individual sectors across manufacturing.
Just two sub-sectors accounted for half of the increase in productivity growth within manufacturing including the chemicals and pharmaceuticals sectors. The chemicals sector experienced a 9% increase in real terms Gross Value Added (GVA)[3] between 2019 and 2021 which is significant given that real GVA for the UK economy in 2021 is still lower than it was in 2019. The main driver behind this renaissance appears to have been the pandemic increasing the demand for soaps, detergents and cleaning products. In addition, the pandemic appears to have boosted the pharmaceutical sector given the stimulus to find new vaccines and drugs to mitigate the effects of Covid-19. The sector experienced an 18% growth in its real GVA over the period.
Conversely, the automotive and aerospace sectors in the UK continue to decline, in both productivity growth within the sector and their relative size. The real GVA of the automotive sector has fallen 23% since 2019 while other transport equipment, which includes aerospace, is down 26%. To what extent these sectors are able to turn themselves around now the UK is outside the single market which has reduced their competitiveness remains to be seen. The recent performance is not encouraging. Finally, Transportation & Storage continues to be impacted by the significant drop in travel due to the pandemic. However, as was the case with other sectors impacted by Covid-19, once the effects of the pandemic recede, performance might stop deteriorating and begin to improve.
One key driver of productivity that matters is whether firms have a competitive advantage in producing products and services that are in demand. For example, this is why Taiwan has experienced significant growth in productivity in manufacturing. Yet while higher demand can result in rising productivity growth as was the case for the UK chemicals and pharmaceuticals sector, it doesn’t always follow that falling demand reduces productivity growth. It is possible that certain sectors might be able to innovate faster to offset the fall in demand which was the case during the Great Depression in the United States. Hence, although the UK economy is projected to reduce its growth rate of GDP in 2023, it doesn’t have to mean that private sector productivity growth will deteriorate further.
However, given the importance of scale in supporting a higher rate of growth, firms that are not operating in economies with large domestic markets or who experience greater trade frictions, are likely to experience a loss in competitive advantage. This is particularly the case for sectors that are part of integrated supply chains such as manufacturing. The challenge for the UK is that to support productivity growth in these sectors it will need to reduce trade frictions which would mean rejoining the single market. While the government is keen for firms to explore new export opportunities, it can take years for firms to build up knowledge of new markets when trade relations with key partners are disrupted by government policy.
These factors are, however, less likely to impact more knowledge-based service sectors such as Financial Services, Computer Programing, as well as the broader Professional & Scientific sector assuming there is a sufficient supply of labour enabling them to expand. This highlights the importance of skills policy to supporting further growth in these areas. Furthermore, the Wholesale & Retail sector could also continue to perform well with increased automation despite a fall in its relative size. Hence, while it is not inevitable that UK private sector productivity growth will continue to stagnate, the current outlook does not look particularly rosy.
[1] The sectoral disaggregation uses GEAD (Generalized Exactly Additive Decomposition) based on Tang & Wang 2004
[2] Productivity is driven by two different effects. The within effect is the pure growth in labour productivity component which can be understood as a change in value added per hour across a sector. The between effect is the reallocation of activity between sectors. An increase in relative size can be driven by increased labour share and / or a change in real output prices.
[3] GVA is a proxy for GDP measured using the output approach which can be understood as the value of an industry’s outputs less the value of intermediate inputs used in the production process.
The views and opinions expressed in this post are those of the author(s) and not necessarily those of the Bennett Institute for Public Policy.
