Productivity growth matters because it is what ultimately drives increasing living standards. Yet it has only had a walk-on part in the Conservative leadership contest, says Thomas Aubrey, Founder Credit Capital Advisory.
As the Conservative Party leadership contenders battle to become the next prime minister of the United Kingdom, whoever wins will need to be honest about the UK’s productivity prospects, and direct investment to where it will have greatest potential impact. This will be one of the defining policy issues for the UK given slow growth, inflation and the slump in real wages.
Productivity growth matters because it is what ultimately drives increasing living standards. Yet it has only had a walk-on part in the Conservative leadership contest. The Office for Budget Responsibility (OBR) is forecasting productivity growth in the UK will rise to 1.3% a year in the medium term. Since 2019, actual labour productivity growth (excluding real estate activities which is largely imputed rent for housing) has been quite close to this forecast growing at 3.5% over the three years between Q1 2019 and Q1 2022.
What are the prospects that this can continue?
To understand the UK’s productivity performance it is necessary to compare current productivity in different industries to pre-pandemic data. The data indicates that over four-fifths of the growth from the start of 2019 to the first quarter of 2022 has been due to public sector productivity growth. Once the public sector contribution to productivity growth is removed, the private sector looks to be in quite poor shape. Its output per hour (labour productivity) grew by only 0.6% between Q1 2019 and Q1 2022.
Table 1 highlights decent growth for Professional & Scientific, Utilities, and Transportation & Storage, which together make up 22% of the private sector economy (in green). Conversely, 15% of the private sector economy is contributing negatively to productivity growth including Construction, Arts Recreation & Other Services, and Mining & Quarrying (in red). Crucially, 62% of the private sector economy has stagnated over the last three years (in blue).
Table 1: Labour Productivity Growth disaggregation Q1 2019 – Q1 2022
Differences in performance can also be observed in the subsectors that make up each sector as indicated in Table 2. For example, the success of Professional & Scientific has been driven by Legal & Accounting Activities, which have seen an improvement in value-added as well as an expansion of labour activity. Although Information & Communication as a whole has stagnated, the Computer Programming subsector has experienced both an increase in value-added and labour activity, while Telecommunications has seen a significant drop in labour activity. Moreover, there is some evidence that computer programming could grow much faster if its skills shortage challenges can be resolved.
Warehousing activities are responsible for the growth in Transportation & Storage productivity, which has been driven by investment in greater automation supported by the high penetration of ecommerce and relatively high labour costs. Due to the decline in North Sea oil and gas production, it must be expected that Mining & Quarrying will continue to contribute negatively towards productivity growth – even if the next Prime Minister provides a short-term boost to gas production.
Table 2: Best and worst performing subsectors labour productivity growth Q1 2019 – Q1 2022
While there has been a lot of rhetoric during the Conservative leadership election about honesty, it is important that the new prime minister is indeed honest about the UK’s realistic economic prospects. For example, the decline in UK competitiveness in the manufacture of transport equipment, which includes the automotive and aerospace sectors needs to be recognised. These sectors have been affected by the imposition of trade frictions on UK firms previously closely tied into European supply chains. Global production in the automotive sector increased by 8% between 2016 -19 mostly driven by China, India and Japan. While the US has experienced mild growth, Germany and the UK have seen declines, but the UK industry has declined more rapidly as shown in Table 3.
Table 3: Value added of motor vehicles, trailers, and semi-trailers industry in MUSD 2016-2019
With regards to aerospace, global value added was up by 18% between 2016 and 2019, with Germany experiencing a 59% rise compared to a UK decline of 12% as shown in Table 4. Ignoring the frictions imposed by policy decisions and pretending the UK still has world-beating aerospace and automotive sectors may well lead to a poor allocation of resources and even slower growth. As an important recent paper by Coyle and Mei found, the biggest contributions to the post-2008 slowdown in UK productivity came from sectors long thought to be world-leading.
Table 4: Value added of air and spacecraft and related machinery in MUSD 2016-2019
The Conservative leadership debate has touched on the issue of energy security in light of the Russian invasion of Ukraine and the dramatic rise in gas prices. Although energy security will require a significant amount of investment, this would most likely have positive spill-over effects into other sectors, as was the case with the electrification of factories in the twentieth century. Moreover, the recent success of the renewable energy auctions indicates that the generation of cheap, sustainable and dependable energy might be where the government should focus its resources.
The recent renewable energy auction including offshore wind, onshore wind, solar and tidal, secured nearly 11GW of energy, enough to power 12 million homes. The various projects have agreed to generate electricity for an average price of £48 per megawatt hour which is significantly cheaper than the £196 /MWh for the current cost of running a gas-fired power station. But this positive outcome was the result of specific interventions made by the coalition government.
Higher investment will be needed to drive productivity growth in the years ahead, but if potential leaders just focus on tax cuts, it is not clear where the investment is likely to come from. This is particularly the case in innovative sectors where returns might need to be supported or de-risked by the government before the sector reaches a viable scale. Politicians need to start being honest about the challenges of productivity growth and the actual strengths and weaknesses of the economy. Electioneering slogans are unlikely to be of much use when it comes to raising living standards.
 The sectoral disaggregation uses GEAD (Generalized Exactly Additive Decomposition) based on Tang & Wang 2004. The ‘within’ effect is productivity growth in activities within the sector, the ‘between’ effect measures the reallocation of labour between sectors.
The views and opinions expressed in this post are those of the author(s).