Welcome back. Britain’s weak productivity growth has been scrutinised for well over a decade. It has spawned a sub-industry of research into its causes, splicing the problem by firm size, sector and region. The main culprits for Britain’s sluggishness have, however, remained mostly the same.
So this week, I argue that there is no “productivity puzzle” in the UK.
Economists tend to model a nation’s output capacity as a function of capital, labour and how efficiently it combines the two (also known as total- or multi-factor productivity). Output per hour worked is the most common measure of productivity.
The slowdown in productivity growth following the global financial crisis is a worldwide phenomenon. But relative to its solid trajectory before, the UK’s drop-off has been starker.
“Around one-third of the slowdown is a result of weaker capital per worker,” says Bart van Ark, managing director at the UK-based Productivity Institute. “The other two-thirds comes from poorer contributions from total-factor productivity.”
Indeed, in the aftermath of the 2008 downturn, UK businesses expanded their production capacity mainly by increasing labour inputs. But in that period, broader efficiency improvements and investment lagged behind.
Right now, Britain ranks middle of the G7 for productivity, with GDP per hour worked on a purchasing power parity basis around 20 per cent below the US.
“UK workers have to make do with a third less capital per hour than their counterparts in higher-productivity peer countries,” says Tera Allas, senior adviser to McKinsey. “This has accumulated from decades of under-investment in equipment, research and development, training and infrastructure, by both the public and private sector.”
In the past decade, business investment has also suffered from heightened economic uncertainty. This includes years of to-and-fro Brexit negotiations following the 2016 referendum, political turbulence (including six chancellors between 2019 and 2022), and a particularly tough pandemic period.
As for poor TFP growth, there are multiple explanatory factors. For starters, poor investment can worsen efficiency outcomes over time. Using old technology impedes knock-on innovation. Infrastructure wears and tears, and can get clogged up as the population expands.
“Every French city with a population greater than 150,000 has a mass transit system (tram or metro), while there are 30 British towns and cities that large that go without,” notes Ben Hopkinson, head of research at Britain Remade.
Weak management skills are another challenge. A recent study finds that domestic manufacturing firms become, on average, 4.9 per cent more productive and 23.3 per cent more capital-intensive after hiring foreign managers. “The diffusion of best practices and technology across businesses and especially regions is also slower in Britain,” adds van Ark.
Next, although English adults outperform the OECD average for literacy, numeracy and problem-solving skills, the country is the worst among rich nations at matching workers to jobs at the appropriate qualification level. More than a third of all vacancies in 2022 were the result of skill shortages, according to a Department for Education survey.
Again, this is partly a function of investment, not just in absolute terms, but also in its distribution across the country. “By failing to build homes in and around our most productive cities, workers are priced out of living near well-paying jobs,” says Hopkinson. “The lack of reliable mass transit shrinks the effective size of our cities by limiting who can easily get to the city centre.”
How capital is allocated also matters. In Britain, pension funds have been shifting money away from UK equities towards bonds for over two decades. This shift has not occurred in other major pension markets. This, alongside broader challenges in finding venture capital, has long sapped domestic companies’ ability to scale.
Then there is red tape. For measure, the UK’s tax code comes in at 22,000 pages, more than any other country in the world. The Federation of Small Businesses estimates that a small company spends 44 hours per year on average on tax administration, at a total annual cost of around £25bn across all small enterprises.
The code itself contains numerous inefficiencies that distort work, growth and investment incentives, including cliff-edges in income tax and business valued-added tax thresholds, and transaction taxes on property and stocks. UK tax expert Dan Neidle outlines these here.
Building also requires hefty paperwork, which slows projects. As Britain Remade found, reopening a 3.3-mile train line to Portishead from Bristol took 79,187 pages of planning documents. Printed out, that’s 14.6 miles of paperwork — 4.5 times the length of the actual railway. The process has taken 16 years so far. (Construction should start soon.)
There are two broader macro factors that tend to get lost in all the TFP microanalyses.
First is Britain’s industrial electricity costs, which are the highest across the rich world. “As energy capacity has been destroyed or mothballed, it has not been adequately replaced,” notes Kallum Pickering, chief economist at Peel Hunt. “And since electricity availability peaked in 2005, Britain’s trend rate of productivity has slowed sharply.” Simply put, the more cheap energy available, the more goods and services can be produced per hour at competitive prices.
Second is demand. Weak wage growth is itself a function of poor productivity growth. In Britain, since 2000, average earnings growth has only just pipped the change in price level. But the costs of compulsory expenditures — including house prices, council tax, utilities, education and childcare — have grown significantly higher than both wages and inflation in that time. Public sector inefficiencies are central to this.
Squeezed household budgets crimp domestic sales revenue and impact investment plans. According to quarterly CBI surveys, throughout the 2010s, on average close to 80 per cent of UK services companies cited demand as a constraint on business. Over 50 per cent of manufacturing firms said uncertainty about sales limited capital expenditure over the same period.
More recently, the UK’s departure from the EU has restricted the country’s access to a large external market. Demand for British exports has weakened since 2020.
This is just a snapshot of the factors driving Britain’s productivity woes. Many rightly allude to measurement issues too. Output in service sectors, intangible inputs and knowledge are not easy to capture. That said, enough can be explained by clear obstacles to growth. “There isn’t really a puzzle here,” says Allas.
It is, indeed, surprising how little these productivity blockers have changed from when I began my career at the Bank of England in the early 2010s: poor investment, scaling problems, regional inequalities, skills shortages, et cetera.
Britain is still talking about the same problems. Admittedly, substantive political bandwidth has been absorbed by Brexit and the related instability. The investment problem has also recently garnered policy attention: the UK introduced a full expensing tax allowance for capital investment in 2023; the current government is focusing on the labyrinthine planning system and pension fund capital.
Yet after over a decade of growth plans, white papers, government inquiries and think-tank research, Britain has little to show for it in on-the-ground growth improvements.
The solutions are known, but delivering on productivity policy is hard. Retrofitting old, existing infrastructure can be costlier and harder than starting from scratch. Finding the optimal level of regulation isn’t easy. Major tax reforms risk alienating one group while benefiting another. Building irks NIMBYs. Reforms, for instance to healthcare, education and training, can take years to bear fruit, meaning they struggle to gain traction. Initiatives may not survive the next government, limiting their effectiveness.
There is glut of research on why the country’s productivity has fallen, but far less action on designing practical solutions to turn it around. The UK isn’t alone here.
Britain has a puzzle. But it is one of policy, not productivity.
Send your rebuttals and thoughts to freelunch@ft.com or on X @tejparikh90.
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