Income and Inequality

Productivity Puzzle: Do Sectoral Disparities Lie Behind the “Statistic of the Decade”

Commentary
Posted on: 9th March 2020
Jeegar Kakkad
Head of Productivity and Innovation
a girl plays with a rubik's cube

It’s official: the current productivity slowdown is the worst in the UK for the last 250 years. According to estimates released by the Office for National Statistics in February, labour productivity growth fell by 0.1% in 2019, leaving the UK’s labour productivity just 3.6% higher than in 2010. 

This news won’t come as a surprise to the new Chancellor as he prepares for this week’s Budget and the upcoming spending review: he’ll be hoping that his plans to substantially increase R&D spending and increase infrastructure investment will boost long-term productivity growth. 

Chart 1. UK labour productivity is 26% below pre-crisis trend

What are the big problems with weak productivity growth? 

Productivity is now 26% lower than its pre-crisis trend, which has had direct impacts on prosperity across the whole of the UK. First of all, it represents a massive blow to living standards: average wages could potentially be £5,000 higher if productivity growth had followed its trend. 

It also has consequences for spending on public services and investment. Over the past few years, the Office of Budget Responsibility has revised down its estimates for potential productivity growth in the UK. These revisions have fed through to the outlook for GDP growth and, subsequently, through to forecasts for the tax revenues the Government has available to spend in the coming years. Given the Tories’ manifesto commitment to fiscal rules, any fiscal ‘wriggle room’ may have just disappeared.

How does the UK stack up internationally?

Not only is the UK’s productivity performance historically weak, we have underperformed relative to the US, Germany and France. In the decade before the financial crisis, productivity growth in the UK was on par with the US at around 2.1% per year, and higher than average growth rates in Germany and France. 

Chart 2. UK productivity growth has lagged behind close competitors

Few – if any – countries have matched their pre-crisis labour productivity growth rates. But labour productivity growth in the UK has been particularly weak, having grown by just 0.3% per year since 2010. By comparison, annual productivity growth was 1.5x as much in the US and 2.5x as much in Germany and France over the same period. 

Why are we falling behind other countries? 

While regional and local productivity performance has gained political salience since the election, recent analysis by the Industrial Strategy Council on regional productivity shows that part of the challenge for many regions is the performance of individual sectors in their areas. 

Separate analysis by the Bank of England and McKinsey confirms the importance of sectors to the UK’s labour productivity puzzle: in a handful of sectors – in particular finance, manufacturing, professional services, and ICT – productivity growth has been much lower than it was before the crisis, and they account for about 75% of the post-crisis slowdown in labour productivity growth . These are sectors that not only drove productivity growth before the financial crisis but are also ones where the UK has a particular competitive advantage. 

This highlights two possible explanations for why UK productivity growth has been so much slower than in other developed countries since the financial crisis: 

  • Different industrial structures. One explanation is that the UK specialises in sectors whose productivity has grown especially slowly across all countries, meaning that there is no inherent UK problem – just a global problem that’s hit the UK harder. 
  • Different productivity growth within sectors. The other explanation is that the equivalent sectors in other leading economies have grown faster than their British counterparts, meaning that the UK’s productivity problem is homegrown and needs a more broad-based solution.

We can look at both these explanations, using Germany as an example, to test what’s behind slower productivity growth in the UK. 

In Chart 3, you can see what happens if we take the productivity growth of UK sectors and weight them by the German industrial structure (i.e if our manufacturing industry was the same share of hours worked as it is in Germany, etc…). 

The surprising result is that if the UK had an industrial structure more like Germany’s it would actually have seen even slower productivity growth over the past 13 years. This implies that the UK’s problem lies not in having the ‘wrong’ sectors, but in a more UK-specific productivity problem across sectors.

Chart 3. UK productivity growth underperforms even with the German industrial mix

In which sectors has the relative performance problem been most acute? In Chart 4, we take a sector-by-sector look at differences in annual productivity growth between UK sectors and their German equivalents. For each sector, the width of the bar reflects its share of total hours worked across the UK economy: not only do we see differences in productivity growth, but also how important that sector is. 

So for example, labour productivity in the UK professional, scientific and technical services sector grew by 1.8% per year on average between 2010-2018, but labour productivity in its German counterpart grew by just 0.3% per year; a difference in labour productivity growth of 1.5 percentage points (as shown in Chart 4).
But professional services and agriculture (which account for about 17% and 2% of hours worked in the UK, respectively) are the only sectors in which annual labour productivity growth has significantly outstripped its German counterpart since the financial crisis.

Overall, about 80% of our economy – from construction to extraction – experienced annual labour productivity growth lower than their German equivalent during that period. 

Add it all up, and the UK’s labour productivity growth has been 0.7 percentage points a year lower than Germany’s (the dotted line in Chart 4): the growing wedge between German and UK productivity performance in Chart 3 is down to worse performance across a range of sectors important to the UK economy.

Chart 4. Difference between UK and German productivity growth, 2010-2018, by sector

Sources: ONS, Eurostat, author’s calculations

What does this mean for the Budget?

The Chancellor’s focus at the Budget will be on bringing up productivity levels of regions that lagged behind for many decades. While this is an important priority, if he’s going to have any chance at achieving it, he needs to focus on getting any productivity growth at all. 

This means starting from the recognition that slow productivity growth is a broad-based problem across a range of UK sectors. For prosperity to grow, we need to solve the UK’s productivity puzzle. 

As we’ve said previously, it’s not enough to just turn on the spending taps and hope that productivity growth follows.