The Productivity Conundrum

As George Osborne wallows smugly in the better economic figures – which are, in my opinion, as misleading as ever and reflect mainly the return to the bubble conditions of before 2008 – he faces one undeniable problem, the productivity stats. The fact is that productivity growth is lower in Britain than in most of our competitors.

It is a conundrum that has puzzled the sharpest minds in economics, or something like that.

But at least they are agreed that unless we get productivity up, growth will be unsustainable.

I think the explanation for the productivity gap is simpler than has been said. And, guess what, George Osborne’s policies are going to do precisely the opposite of what is needed to redress the problem.

Consider these two facts:

(1) Productivity often rises towards the end of a recession, but it did not do so this time; and

(2) Unemployment usually falls during a recession, but it did so far less this time.

Productivity is output per worker-hour. It rises towards the end of a recession when employers delay taking on new staff by making existing ones work harder. But that didn’t happen this time because they hadn’t laid them off in the first place.  I think this effect explains most of the productivity conundrum.  Working tax credits and a relatively low minimum wage make it possible to keep staff on during a downturn.

Productivity is  boosted by capital investment. If you buy a machine to help your staff work better, productivity will increase. In other words, it is closely related to capital investment. But investment in productive capital does not produce the kind of returns that investment in property (which is static capital) does. That’s why we’re not getting the productivity growth we should be getting. This is the key to the problem at a national level.

Trading hours and retail productivity.

Mr Osborne has announced that he intends to reform the Sunday trading laws so that local authorities can decide trading hours based on local needs. On the whole, I think this is a good idea; but it’s important to consider how extended trading affects retail productivity. The retail sector is an important part of our economy, accounting for about 11% of output.  Extending opening hours will tend to reduce retail productivity – unless, which is most unlikely, the volume of trade goes up proportionally. What actually happens is that at best a marginal increase in volume is spread over a significantly longer trading time. The result is a fall in retail productivity.

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