June 27, 2015    3 minute read

How can the UK Productivity Puzzle be Solved?

   June 27, 2015    3 minute read

How can the UK Productivity Puzzle be Solved?

Surprisingly, the recent UK General Election showed little attention to the UK’s long standing productivity puzzle; however, this does not mean economists should make the same mistake. The level of productivity is vital macroeconomic indicator as it shows how much an economy can produce given an existing level of resources. One of the most fundamental determinants of this in the long run is technological progress.

The productivity puzzle has existed in the UK economy since 2008, with employment rising alongside the amount of working hours, whereas labour output has barely grown. This is reflected in the figures published by the Office for National Statistics for Q4 of 2014, which demonstrates that labour productivity fell by 0.2 compared with the previous quarter.

One should note that interestingly labour productivity is not all doom and gloom in all sectors in the economy, for example, the automotive industry has benefitted from a 56% increase in labour productivity since 2009 following investments in technology and supply chain management. On the other hand, the pharmaceuticals industry has suffered since 2009, with hourly output dropping by 11%. Overall in the economy, however, labour productivity is 16% below pre-crisis levels, although small improvements were made in 2013.

In comparison to other developed economies, the UK’s productivity levels are significantly low, whilst there are vast structural differences between the UK and these other economies, these cannot be relied on as a valid explanation.

So what has caused this productivity lag?

Economists highlight two main explanations. The first being that the weakness of labour productivity is cyclical and only reflects lack of factor utilisation due to low demand levels in the economy. The second is diseconomies of scale that occurs as a result of diminishing levels of capital per worker. As investment became more expensive, some firms substituted purchasing machines with hiring cheap labour, hence employment has increased at the expense of labour output.

In addition to these explanations more optimistic outlooks exist too, for example some economists advocate that there is simply a measurement problem, and productivity is greater than the figures suggest.

How should it be solved?

The productivity puzzle has received more attention, as it becomes a greater imminent problem, with UK Chancellor George Osborne promising that his Budget in July will include a ‘Productivity Plan’.

Father of modern day economic growth, Solow, notes the importance of sociological factors as opposed to economic ones. As Chief Economist at the Bank of England, Andy Haldane also points out instead of stressing technological factors he stresses the significance of social and human capital, inequality and infrastructure. As the Labour Party contended prior to the UK General Election, reshaping British Capitalism into a freer flowing system may be the answer. This would mean using Northern European states as model examples where high skill, high productivity jobs have supported good wages as well as high living standards.

This method however is difficult to implement given there are no set policies that can be matched, for example increasing the minimum wage will only slightly change the economy, but does not have the ability to make the major change needed for an increase in labour productivity. There is also a danger affiliated to attempting to replicate the German or Swedish economies with the chance of having an economy that is co-ordinated like that of France, which is far less flexible and therefore disposed to greater unemployment.

Whilst these theories have succeeded in showing the importance of supply side policies, however demand side policies should also be stressed. A combination of the two may be the ideal solution, however this could potentially be a long progress.

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