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Productivity decline creates headache for Hammond

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“Productivity isn’t everything,” wrote the Nobel Prize-winning economist Paul Krugman, “But in the long run it is almost everything.”

What he meant by that, he went on to say, is that a country’s ability to improve its living standards over time depend almost entirely on its ability to raise output per worker.

On that basis, latest productivity figures from the Office for National Statistics (ONS) will not have been welcomed with much rejoicing in the Treasury.
According to the ONS, productivity – as measured by output per worker per hour – during the second quarter of the year was 0.1% lower than in the first three months of the year.
It wasn’t all bad news: productivity in the services sector, which accounts for three-quarters of UK GDP, actually rose by 0.2%.
But the overall figures were dragged down by a 1.3% drop in productivity in the manufacturing sector.
This potentially creates a problem for Philip Hammond, the Chancellor, because next Tuesday the Office for Budget Responsibility – the body that provides independent oversight of the UK public finances – is due to publish analysis in which, according to a report in the Financial Times, it will admit that it has persistently over-estimated UK productivity.
The expectation is that it will therefore downgrade its productivity forecasts for the year – and, with it, by extension, their growth forecasts.
That will in turn impact the public finances and the Chancellor’s ability to minimise any adverse impact of Brexit on the economy.

Image: Productivity improved in the services sector
The OBR was forecasting as recently as March that productivity would increase by 1.5% during the second quarter.
For 2017 as a whole, the OBR has been forecasting productivity growth of 1.6%, followed by 1.5% in 2018 and 1.7% in 2019 and 1.8% in 2020.
If those forecasts are revised lower, it is inevitable that lower forecasts for GBP growth will follow.
As the OBR noted in July: “If trend productivity and GDP growth were just 0.3 percentage points a year lower than we assume, half the £26bn of headroom the Government has against its structural deficit target for 2020-21 would be lost.”
Why did productivity growth go backwards?
Quite simply because the increase in the number of hours worked during the period was greater than the increase in economic output in that period.
The figures confirm Britain’s dismal productivity record in recent years.
Output per worker per hour remains roughly the same as it was before the crisis.
It is worth pointing out that this is not just a British problem.
Since the global financial crisis, there has been slower growth in most major economies, including slower productivity growth.

But the figures published by the ONS also offer an international comparison and this is by no means favourable to Britain.
The ONS notes that the gap between productivity in Britain and the rest of the G7 advanced economies – the US, Japan, Germany, France, Italy and Canada – narrowed last year.
That’s the good news. The bad news is that output per hour worked in the UK was 15.1% below the average for the rest of the G7 in 2016.
The most popular way of expressing this productivity shortfall is to say that, roughly speaking, a French, German or American worker can produce as much in four days as a British worker does in five.
Economists and politicians have spent many hours debating why UK productivity remains so poor compared with that of our major international competitors.
One theory is that it is because, compared with a country like France, we prefer to have lower rates of unemployment.
In France, where the jobless rate is more than double that of the UK’s, the least productive workers are on the dole. In Britain, they go to work.
But that doesn’t explain the productivity shortfall with countries like the US and Germany that have comparable levels of unemployment with Britain.
Another theory is that business investment in Britain lags that of competitor economies.

Image: The issue could impact Philip Hammond’s ability to take action to minimise the impact of Brexit
In Britain, most GDP growth since the crisis has been due to more people entering the labour force – partly reflecting the UK’s attractiveness to migrant workers – rather than more capital being invested.
Another explanation could be that Britain is a smaller and more crowded country than our competitors.
All the other G7 economies have lower population densities than Britain, with the exception of Japan, which has a similar productivity issue.
Every traffic jam, every delay on the railways, every constraint on production caused by cramped office space, every delay to take-off and landing at the UK’s airports all contributes to weaker productivity.
And here’s another possible explanation – while Britons are at work, some of them may not actually be doing very much.
Early closing of shops in France does not necessarily mean lower retail sales overall – it simply means the same amount of shopping is packed into fewer hours.
That would manifest itself in a French shop worker being more productive than their British equivalent.
It all goes to show just what a nebulous subject productivity is – and why politicians of all parties have found it so hard, over the years, to inspire an improvement in it.

Source: SKY