News Analysis: UK slips down the productivity league

News Analysis: Extra investment is needed in skills and equipment to match the performance of rival economies

ONE OF the big disappoint ments in the performance of the UK economy, both recently and over the longer term, has been the slow growth and relatively low level of productivity. If there is to be any hope of a "new paradigm" that will allow the economy to return to full employment with low inflation, as David Blunkett, the Secretary of State for Education, called for last week, it will depend on a burst of faster growth in the amount of output the economy can produce per unit of input.

The reason is that in the long run improvements in living standards have to keep pace with underlying gains in productivity; any more, and pay rises will ultimately just trigger higher inflation. The Bank of England therefore puts a mental ceiling of 4.5 per cent on growth in earnings - 2 per cent trend productivity growth plus 2.5 per cent inflation. So far, falling unemployment has not pushed earnings growth beyond that limit, but the latest figures did show a pick-up in earnings to just below it.

So a lot depends on whether that long-run 2 per cent productivity trend still holds. There is a glimmer of hope that the US economy has achieved just such a spurt in productivity. But, as the Bank of England noted in last week's Inflation Report, the reverse is true in the UK. "Since 1995 productivity growth has been below its long-run trend. There is no strong evidence that the trend growth rate has shifted," the report said.

It said labour market reforms might have dampened the figures by bringing into the jobs market low productivity workers, but offered little hope to believers in the New Economy, like Mr Blunkett, on this side of the Atlantic.

Nor is the poor British performance a recent phenomenon. Levels and growth of productivity here have been disappointing for decades. A recent book by Mary O'Mahoney of the National Institute of Economic and Social Research looks in detail at the UK's relative performance and tries to unpick the reasons for it.

Most discussions of productivity centre on a simple measure, GDP per employee. But ideally further refinements are needed, and the new research presents these for five developed economies over a long period. Even for a measure of labour productivity (ignoring the role of plant and equipment) the figures need to be adjusted for changes in hours worked. A further helpful distinction is between the whole economy and the marketed or private sector, as public sector productivity is both notoriously low everywhere and notoriously hard to measure.

Over the entire post-War period, UK productivity growth in both the economy as a whole and the market sector has grown faster than in the US, without ever catching up, but more slowly than in France, Japan and Germany. These three countries made great strides towards catching up towards America's level of output per hour worked. France and Germany overtook the UK by the late 1960s and now stand a long way ahead. Japan never did - the adjustment for hours worked makes a difference here, as Japanese employees typically work long hours.

Productivity growth slowed in all countries after 1973, to such a degree that economists regard the 1950s and 1960s as an unrepeatable golden age. But at least the British slowdown vis-a-vis France and Germany came to a halt around 1980.

A truer picture still of economic efficiency needs to take account of the amount of physical capital used in producing output, with the resulting measure of output per unit of labour and capital known as total factor productivity. The UK has a far lower capital stock than the four other countries in the National Institute study. A dismal record of public sector investment accounts for a lot of this, but there is still a shortfall in the capital stock of the market sector of the economy.

The broad pattern remains the same, however. France, Germany and Japan have experienced significantly faster post-War productivity growth than the UK, and the US has lagged behind all the others in terms of growth. Therefore France and Germany have closed the gap on American total productivity levels, overtaking the UK by around 1970. Japan, which started with the lowest level, has caught up towards the UK thanks to high levels of investment, but has continued to use both capital and labour inefficiently.

The British deficit is far less pronounced in the market sector than the economy as a whole, suggesting the relative productivity performance of the public sector is especially weak.

Picking apart the reasons for differences in performance suggests that variations in investment and therefore the amount of capital available per worker per hour explain about 40-50 per cent of productivity growth. Improvements in other factors such as the skills of the labour force, in production innovations, in organisational improvements and so on must explain the rest.

In short, the British problem is a lack of investment year after year in both human and physical capital, especially in the public sector. The pattern of disappointment can not be blamed on any particular sub-sector.

Although at a disaggregated level productivity in engineering and metals is especially poor, the same pattern is echoed across industry, services, agriculture, construction and the public sector.

It would be a surprise if there were to be no productivity improvement in British industry. As a recent circular from Greenwich NatWest notes, there has been a massive increase in business investment on both sides of the Atlantic.

Until the most recent quarter, however, only the US displayed productivity growth above the long-run trend of around 1.5 per cent. In the UK there is no sign of gains as high as the long-run trend of 2 per cent. Without firm evidence of an improvement the Bank of England would be taking a gamble if it set interest rates on the assumption the economy could afford any further increase in earnings growth from here.

"Britain's Productivity Performance 1950-1996: An international perspective", by Mary O'Mahoney, National Institute of Economic and Social Research, 0171-222 7665.