Hamish McRae: Productivity is clouding the picture on employment front

Productivity may not be increasing very fast. That raises big questions about future prosperity

Let's start with a puzzle. If the UK economy was shrinking during the first three months of this year, how is it that between February and April it added a net 166,000 jobs? Now try another puzzle. If economic activity is still some 4 per cent lower than it was at the peak in early 2008, how come the total number of people in employment is fewer than 300,000 lower than it was then – 29.28 million against 29.57 million in March-May 2008?

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There are three possible explanations. One is that the employment figures are wrong; another is that the output figures are wrong; and the third is that there has been a continuing fall in productivity, of output per person.

The first is unlikely because employment records are pretty good. Companies do not say they are employing people, paying their National Insurance and so on, if they are not. While some increase in employment has been self-employment and that may not be entirely voluntary – people who are made redundant setting up on their own – presumably these people are finding some work.

The second seems to me to be most of the explanation: that we are under-recording output and that, far from shrinking, the UK economy, after a dip last summer, is growing again albeit slowly. But there is probably something of the third explanation. While it would be astounding were productivity to be falling, for that would be a reversal of a 200-year trend for output per person to increase in the Uk by close to 2 per cent a year, it may not be increasing very fast. That raises big questions about future prosperity.

Come back to that in a moment: first some data. I have put at the top the official figures for growth during the long boom, the crash, and the subsequent recovery, together with an estimate of current activity calculated by Goldman Sachs. Goldman does this to give a more speedy and more accurate estimate of what is happening than the official figures provide. As you can see the two lines fit together pretty well until the last few months, when the Goldman indicator was more pessimistic last year about output but now is more optimistic. The bank thinks that output is now growing at an annual rate of about 1.3 per cent.

That is not great, for it would be below the UK's long-term trend growth, and there is another problem that these figures will not be taking into account the very recent fall in confidence as a result of the turmoil in Europe. More of that in a moment. But it would be reasonably consistent with the fall in unemployment registered by the ONS, as shown in the next graph – the rise in unemployment last year and then the subsequent decline.

Within the employment and unemployment figures there are some consistent patterns. One is the growing importance of part-time work, with half the net new jobs being part time. Another is the decline in public-sector employment, 39,000, and the rise in private-sector jobs, 205,000. Still another is the rise in self employment, which has reached 4.17 million, the highest since records began in 1992. That is something that has been highlighted here before, and something that politicians have yet to acknowledge. It is quite plausible that in a few years' time there will be more people self employed than working for the public sector, reversing a situation that has prevailed at least since the Second World War. Finally, the pattern of non-British people competing better in the workforce than British, has I am afraid continued, and that is true whether you define it by place of birth or by nationality.

All in all, this is a picture that gives rise to concerns but is not entirely negative. We have a flexible labour force and we are creating jobs. Now to the big "but".

All these figures are predicated on the European situation not deteriorating. In the past couple of weeks there have been disturbing signs that what is happening there has started to undermine confidence here. It does not seem to have damaged consumer confidence but it has certainly undermined business confidence. That concern was behind the new Bank of England plan to dish out money to the banks for boosting lending to companies, which went into action yesterday. As we can see from the new minutes of the Monetary Policy Committee out yesterday, the Bank may well vote for more quantitative easing next month. Sir Mervyn King is primus inter pares on the committee but the fact that he has swung in favour of more QE is a pointer to the way the Bank is likely to move, particularly should the eurozone economy move into a serious recession. British companies are shifting exporting effort away from Europe not for any ideological reason but simply because this market is a slow growth one. But for the time being export demand does depend on Europe and there is no quick escape from that.

Meanwhile there is a longer-term issue: productivity. As you can see from the final graph, there is no significant growth here. On a short view this can be seen as welcome, for it suggests that companies have been flexible in keeping staff on during the downturn, which is one of the main reasons why unemployment did not rise to the dire levels in some of the forecasts. That would square with anecdotal evidence from the Chambers of Commerce and the Bank of England agents. But it raises troubling questions about the long-term growth potential of the economy. If the UK cannot grow at somewhere between 2 per cent and 2.5 per cent, the projections for cutting the debt have to be reworked. Remember, the aim for this parliament is merely to stop the debt growing. During the next parliament we have make a start on trying to get it down.

This is not just about debt, though that is the immediate concern. It is also about living standards. Somehow we have to restart the great engine that increased living standards since the industrial revolution, by for example, improving productivity in the service sector as fast as we have been able to do in manufacturing and tackling the huge issue of productivity in the public sector. So the fact that we are still generating employment is most welcome in the short term. The fact that we are not increasing productivity is a real worry in the long term.

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