by Andrew Allum, founder and former chairman of the TPA
The UK productivity puzzle is the long-term slowdown in productivity growth. But how long term, and when did it start? It is often discussed as a problem “since the GFC” or sometimes “since 2010” where the blame falls squarely on “austerity” under the Coalition and then the Conservatives since 2015. The chart below, published in 2023 by the Financial Times shows the typical narrative.
The measure is GDP per hour worked referred to as labour productivity. The FT shows a trendline from 1971 to 2008 when labour productivity growth was healthy, skips the post-GFC recession and then shows the 2010-2023 trend, when labour productivity growth has been very poor.
This narrative of timing around the GFC was accepted by the taxpayer-funded Productivity Institute in its 2022 launch document. For example they said "In his submission to the Treasury Committee in October 2021, Huw Pill, Chief Economist at the Bank of England, said: ‘Before the global financial crisis [GFC], UK productivity growth averaged over two per cent per year. Since then, labour productivity (growth) has fallen considerably"
But is this narrative around the timing helping us work out what caused the slowdown?
When analysing causation there is one iron rule: the cause must happen before the result.
Bearing in mind the long-term average of 2 per cent, let’s look closely at the period before the GFC. ONS annual data for labour productivity growth: 2004: 1.3 per cent. 2005: 1.7 per cent. 2006: 1.9 per cent and 2007: 1.7 per cent. Perhaps something was starting before the GFC.
Moreover, the calamity that defines the end of the era in 2008, the GFC, is blamed on financial services which was going a bit crazy at the time.
The ONS publishes data on the contribution to labour productivity by sector. This shows that labour productivity within financial services grew by 50 per cent between 2001 and 2007. That is not a typo. We may observe that such an increase is silly or distortionary or that it is not really measuring productivity – but the key point is that it is included in the ONS data. Multiplying the 50 per cent growth by the 10 per cent share of financial services in the total economy means that about 5 percentage points of the growth in the ONS index shown above occurred within financial services at a time when the sector was going crazy.
Logically, to date the productivity slowdown in the wider economy we must strip out the financial services boom. The chart below shows ONS data for labour productivity growth in the decade running up to the GFC. From 2001 to 2007 the extraordinary high levels of productivity growth in financial services are highlighted (in red bars). The impact really is this large - in 2007 for example, financial services labour productivity increased by 12 per cent according to the ONS.
The height of the blue bars (removing the financial services boom) from 2002 to 2007 is on average 1.2 per cent. Far lower than the long-term average of 2 per cent or more.
Therefore the slowdown in UK labour productivity started in the mid-2000s. Well before the GFC. So then we think afresh about the whole productivity slowdown. What was changing in the mid-2000s? Or slightly before if we consider lagged impacts?
Firstly some social trends that directly reduced labour productivity (some may argue if they were a good or bad thing for other reasons): increased number of low-value degrees being taken; increased low-paid immigration; sharp increase in house prices from mid-90s reducing labour mobility.
The tax burden increased. Capital formation slowed down.
Other big things happened in the 2000s which had as-yet unclear impacts on productivity such as “peak stuff” (tonnage of material used in the UK economy peaked in 2004 and has fallen a lot since) and of course the rise of t’internet changing how we do and how we measure many things.
We can blame the Coalition and the Tories for many things. But causing the productivity crisis is not one of them, because it started in the mid-2000s before they came to power. We can blame them for not “fixing” it, but if they had done something other than reverse the causes, then that may have just layered one problem on another based on the law of unintended consequences. The slowdown started well before the GFC, a fact hidden by the financial services boom.
A generation later (mid 2020s versus mid-2000s) and the next government may mistakenly set about “fixing” the productivity problem without seeking to reverse its causes. To reverse the causes, we need to look closely at what was changing in or before the mid-2000s.