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28 January 2016

Britain’s productivity problem is as bad as ever – and George Osborne doesn’t have a plan

Growth is still low - and productivity is part of the problem.

By Spencer Thompson

This morning’s GDP data shows that economic growth is still low, with 0.5 per cent growth in the size of the UK economy in the last three months of 2015.

Aside from illustrating the continued fragility of the economic recovery, today’s GDP figures also point to a return to falling productivity. In the third quarter of 2015 hours worked fell slightly as the economy grew by 0.4  per cent , indicating the amount of economic output we create per hour of work went up. More recent labour market estimates suggest that this pattern flipped at the end of last year, with hours worked rising faster than GDP growth. It seems the welcome rise in productivity was just a blip.

The UK has two inter-linked productivity problems. Firstly, we are still a long way off getting back to levels of productivity seen before the financial crash. Second, and just as concerning, there is a long-standing gulf between productivity levels in the UK and our leading competitors. We are 20 per cent  less productive than the average of our G7 partners, for example.

We care about productivity growth because, in the long run, it is the central determinant of living standards, and because it can also do a lot of the heavy lifting on deficit reduction, creating more wealth for the UK to spread around its citizens and public services.

The government, for its part, has noticed this and made productivity a central plank of its economic agenda. Fixing the Foundations, the government’s productivity plan, has a lot to say on the issue, pointing to transport and digital infrastructure, universities and science investment, low-carbon energy, deregulation and skills as being key. The overall impression is of productivity growth being delivered first and foremost through focus on cutting-edge enterprise.

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In fact, just as important to the UK’s productivity problem is the performance of businesses in lowwage service sectors. These firms, including retailers, hotels, restaurants and cleaners, aren’t often thought of as central to the productivity problem, but in fact make a sizable contribution to our productivity gap.

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Estimates we’ve produced at IPPR suggest that, were the UK to raise productivity in low-wage sectors to levels seen in those same sectors in France, 40 per cent of the productivity gap with our friends across the channel would disappear. If UK retailers, cleaners and hoteliers were as productive as their colleagues in Germany, we would close 26 per cent  of the gap. These are sizable numbers, and suggest to me that policymakers should carefully consider what their role should be in raising productivity in low-wage sectors.

But a discussion of productivity in low wage sectors and how to raise it is sorely lacking from the government. Despite acknowledging the retail sector’s contribution to the productivity slowdown, for example, the government’s productivity plan only makes one further mention of retail, arguing that retail brownfield sites should be turned over for starter housing.

Many of the solutions traditionally employed to raise productivity are unlikely to work as well for low wage sectors, being more targeted at supporting high-growth, highly-skilled and high-tech businesses. The R&D tax credit, which offers a tax cut for businesses engaged in innovation, offers little to a retailer looking to shift its business model up the value chain when it can only be applied to spending on activity ‘achieving an advance in science or technology’, for example.

Low-wage sectors innovate differently, pursuing small, incremental improvements to products and processes, and implementing ideas for how to organise their business and workplace that have been developed elsewhere. But evidence from cross-country surveys shows that UK firms in these sectors tend to do less of this than in other European countries.  

And firms in these sectors, especially small and micro-businesses, face significant barriers in accessing the knowledge and expertise to make changes in their business that would raise productivity. These include the financial costs of external support, but also a lack of appetite on the part of managers themselves, who are currently happily pursuing profitable low productivity business models. One of the reasons why they are able to do so is the availability of low-wage labour itself. But, with the introduction of the National Living Wage, expected to rise to over £9 an hour by 2020, businesses will have a strong incentive, and in many cases an imperative, to raise productivity. Government should be at the ready to support this transition, whether by reducing the costs of accessing external advice or by other means.  

Getting back to sustained productivity growth is going to require businesses across the economy to up their game. This is especially true of businesses in low-wage sectors. The government needs to think creatively about how productivity growth takes place in these sectors, and the role for policy in supporting it.