The Productivity Puzzle
A recent OECD report has revealed that
Britain’s real GDP growth is stronger than the OECD’s average, with
unemployment also only 6pc. This has all helped to increase business and
consumer confidence. However, since the ‘Great Recession’, the UK has failed to
increase its productivity, with the productivity gap compared with other G7 economies
increasing, and it is currently at its largest since 1992. On the other hand,
the USA’s productivity is 9pc higher than its pre-crisis levels and France too
has increased its productivity by 2pc since 2008.
Productivity is a measure of the output per worker or hour worked. Simplified, it is output divided by input.
Four key industries account for 75% of the
stagnation in productivity. These are:
- ICT
- Banking
- Manufacturing
- Professional Services
Banking
Productivity in the banking sector is 10pc
lower than in 2009. However, it is important to note that before the crisis,
banks were trading and lending ‘recklessly’, therefore resulting in
artificially high productivity. Furthermore, since the crisis, banks’ output
has declined, but they have not reduced their workforce to such a large extent,
resulting in decreased productivity.
Indeed, this practice is also evident in the
wider economy, due to the fact that firms have felt that the fall in demand for
their services will be temporary, and so they have kept their workers whilst reducing
output. They have felt that keeping workers when demand is low would be more
beneficial than dismissing them and then being forced to hire more workers when
demand increases. This is because senior managers would need to conduct a
rigorous hiring process to recruit new workers, taking time away from their
work and so reducing their output. Moreover, when the economy recovers, the
pool of workers is expected to decline, resulting in the most highly skilled
workers being ‘taken’ by rival firms. Furthermore, it can be argued that
increased unionisation has resulted in fewer dismissals of employees, meaning
that whilst inputs remain high and outputs decrease, productivity decreases. Also,
other businesses face ‘overhead labour’ constraints, meaning that they have a
minimum number of workers in order to run the business. However, as output has
been declining, productivity has decreased. An example of this is seen by the
fact that a building needs security guards whilst it is in use, regardless of
the company’s ‘output’.
Moreover, banks are also facing increasing
regulations, thus decreasing their investment. Although, we should note that
these regulations should help to ensure that future financial crashes are less
likely.
Services
It should be noted that the services sector
accounts for 78% of the UK’s economy and it is hard to measure, and increase, productivity
in this sector. For example, although reducing the workforce in a local shoe
shop, for example, may increase ‘productivity’, it may reduce customers’ experience
as consumers experience longer waiting times.
Manufacturing
With regards to the manufacturing sector, low
productivity is mainly as a result of low levels of investment. Technology and
machines need to be replaced regularly as they deteriorate over time, meaning
that manufacturing processes have become slower and so there has been less
output per hour. Although the Bank of England’s base rate has remained at 0.5pc
firms have failed to invest due to a belief that they will not be able to recoup
the price paid for the machines, especially because of China flooding the UK
with manufactured goods which are below their marginal cost.
However, a potential solution to this
problem, as highlighted in a recent article from The Economist, suggests that
manufacturing firms should cluster together
in order to share their infrastructure and so cut costs. For example, in the
north of England, chemical firms are using a network of pipes to transport
chemicals to each other much more cheaply. Furthermore, these large industrial centres
should act as a greater incentive to attract workers because they know that
should they be dismissed from one job, another firm would most likely have a
vacancy.
Moreover, it should be noted that although
some may warn that increasing mechanisation will have long run negative
repercussions on the labour market, the compensation effect would outweigh the
displacement effect. As ‘robots’ replace humans in certain industries, and thus
productivity increases, wages would increase and so aggregate demand would
increase. This demand would then create demand for complementary goods, derived
goods and other consumer goods that consumers consume more of as they have more
disposable income. Thus, this should create jobs in these fields also.
Zombie Firms
Another factor that is causing a decline in
the UK’s productivity is the presence of ‘zombie firms’, resulting in an
inefficient allocation of scarce resources. The Bank of England’s persistently
low interest rates has resulted in approximately 146 000 firms borrowing at
these rates and creating only enough revenue to pay these low interest rates. However,
this is resulting in workers being employed in firms with low productivity,
meaning that fewer workers are working in more productive sectors of the
economy. It is preventing the reallocation of resources to more productive
sectors of the UK’s economy. The effect of ‘zombie firms' on productivity is
highlighted by the fact that Dixons Retail stated that it benefited from
Comet’s demise due to the fact that PC World/ Curry’s earnt a profit for the
first time in 5 years. The fact that PC World/ Curry’s hired a significant
proportion of Comet’s workforce highlights how labour was transferred from the
least productive firms to the more productive firms.
Furthermore, by funding these ‘zombie firms’,
capital cannot be reallocated to more productive firms, such as small and
medium enterprises who usually bring innovation to the market, thus increasing
productivity through such inventions and technology. Banks are still reluctant
to increase lending after the crisis, but with money already loaned out to
these ‘zombie firms’ little money is available for enterprises who would
generate greater profits.
The importance of SMEs is highlighted by the
case of Uber. Uber was once an SME and could not have been launched without a
$200 000 fund. Uber has increased productivity in both the US and the UK. Upon
interviewing an Uber driver, he revealed that he works approximately 38 hours a
week but earns the same income as when he ran a black cab service and worked 60
hours a week. Indeed, the algorithm behind Uber’s app ensures that drivers and
customers are matched within minutes, thus reducing the time that driver spend
circling the streets, waiting to spot a customer. Therefore, the same number of
customers are driven, but the driver works a shorter number of hours, thus
increasing the output per driver. The reduction in time on the roads also
ensures that fewer pollutants are released into the atmosphere, whilst carrying
the same number of passengers. It also ensures that passengers spend less time
waiting and searching for a cab, freeing up time and thus ensuring that they
arrive at work earlier, or wake up later (and reducing drowsiness), increasing
productivity in their jobs.
The danger of ‘zombie firms’ is highlighted
by Japan’s lost decade(s). It can be argued that Japan’s weakest industries
were shielded from international competition and so they had reduced incentives
to increase their productivity. As banks were funding these firms and were
reluctant to increase their loans, new productive firms failed to emerge.
Furthermore, as these ‘zombie firms’ charged very low prices, the more
efficient firms were reluctant to invest; although they were more productive,
and produced higher quality goods, and greater investment would have decreased
their prices, they could not cut their prices below their competitors and so
they lost market share. Therefore, Japan’s workers stayed in unproductive jobs,
productivity stagnated, prices declined and deflation persisted.
‘Cheap’ Labour
Moreover, it could be argued that the
relatively ‘cheap’ price of British labour has reduced productivity in the UK
economy. Firms have been hiring people rather than investing in technology
despite the fact that technology and machines increase output. Indeed, this is
highlighted by the fact that the capital stock has decreased in Britain since
the crash, in line with productivity. However, firms may increase investment
into machinery and technology with the introduction of the National Living Wage
next year as technology becomes less expensive relative to the price of
workers.
Zero Hour Contracts
Some argue that zero hour contracts should be
imposed in the UK. This would mean that employees do not have fixed working
hours and employers pay these employees for the number of hours that they work
each week. This would reduce costs for firms because they do not have to pay a
‘full wage’ so to speak. However, it should be noted that productivity may
actually decline because employees feel unmotivated as they do not know how
long they will be in work for each week. Furthermore, the government may not
support this initiative because these workers on low wages may receive tax
credits, thus increasing costs to the taxpayer.
Infrastructure
To increase productivity, we need to target
investment towards increasing both physical and human capital. This would mean
improving infrastructure and increasing the education of our workforce. Indeed,
the IMF has recently stated that France, Germany, Canada and Japan’s
infrastructure is superior to Britain’s. Britain’s roads are extremely
congested and many slow railway lines act as a disincentive for many to find a
job in busy cities. This is reducing productivity because it takes a British
worker on average 90 minutes to travel to work and back each day, meaning that
they would feel tired and exhausted whilst at work, reducing their output over their
working day.
We should be supporting productive projects
such as an expansion of our airports and the creation of the HS2 in order to
bridge the gap between the North and South by encouraging investment in the
North.
Moreover, the healthcare system should be
improved to ensure that workers recover much more quickly and so spend fewer
days off work. Moreover, improving the health of workers would also ensure that
they are healthier whilst at work, increasing their efficiency and so
productivity.
Research and Development
The UK currently has a low level of
investment in capital as a proportion of GDP. This low level of Research and
Development means that there are fewer innovations and technological
advancements which could aid increasing productivity, for example by reducing
the time to manufacture cars for example.
However, Catapult centres should help to
increase productivity in the UK as businesses, inventors and academics meet to
discuss problems and provide viable solutions to key issues in their field. Such research centres include the Transport Centre in Milton Keynes, which aims to develop 'green' modes of transport which will also help to decrease journey times.
Apprenticeships
Moreover, more apprenticeships should be
offered to young people so that they can gain the skills needed in the
workplace, especially in manufacturing sectors where training is needed and cannot be provided by Universities, as they focus on academic degrees rather than practical skills. Perhaps
the UK should follow in Germany’s footsteps and create a program where
apprentices receive training in the classroom as well as in industry. This
would ensure that, in the classroom, the apprentices learn all of the relevant
skills needed for their highly specialised industry. This is important because
many young people enter specialised industries, such as manufacturing, with no
experience in the field. Through paid work in the industry, the apprentices
would learn to apply their skills and learn from the experts, thus broadening
their knowledge base. Specialised schools would ensure that productivity
increases because the young people would be able to enter the workforce at
least having some knowledge about how to handle basic tasks in their field.
Moreover, training on site would be reduced, thus ensuring that senior members
in the workforce do not spend as much time away from their tasks, teaching the
apprentices, and so increasing their own productivity.
Conclusion
Should productivity improve, then the
government may be able to decrease its austerity measures as well as reducing
the budget deficit. This is due to the fact that productivity gains lead to
higher wages, which in turn leads to greater spending on the behalf of workers.
Thus, the government receives greater income tax as well as VAT. We should focus on increasing investment by promoting R&D, providing more apprentice opportunities and improving infrastructure.
