Living standards are finally recovering – but we ignore poor productivity at our peril

 
Adam Memon
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Productivity is the ultimate determinant of real wage growth (Source: Getty)
The metamorphosis of Labour’s attack lines on the economy has been a sight to behold. In the early years of this Parliament, the party argued that spending cuts were being implemented “too far and too fast”. After that came the infamous “flat-lining growth” hand gesture, and finally the “cost of living crisis”. This latter criticism of stagnant living standards has been by far the most effective. While the fall in real household incomes was large, it is the historical weakness of the recovery in earnings that has been so difficult for many people.

It is within this context that, yesterday, the Institute for Fiscal Studies (IFS) published a briefing note showing that real median household incomes have now recovered to pre-crisis levels in 2007-08. Younger workers have done much worse than older people – a 7.6 per cent fall in median earnings for the under 30s, compared to a 1.8 per cent rise for the over 60s – and real weekly earnings growth is flattered by the dramatic and probably temporary fall in inflation. However, there are certainly signs of improvement. The Office for Budget Responsibility (OBR) forecasts that real disposable incomes will grow by about 6 per cent on a per capita basis over the next five years. The percentage of workers receiving real rises in their hourly earnings has risen from 34 per cent in 2011 to almost 50 per cent in 2014, and job switching among full time workers – which pushes up earnings – is rising in line with vacancies.

Yet in the long run, productivity is all that counts. It is the ultimate determinant of real wage growth and, without it, workers would be condemned to stagnant living standards. Of course, short-term tax and benefit changes make a difference to real incomes, and cutting a huge budget deficit requires difficult decisions on that front. Also, the spectacular rise in employment in recent years has pushed up average household incomes. However, as the OECD, IFS, OBR and others have all made clear in recent reports, it is the weakness in productivity that started before the financial crisis which is applying the biggest drag on real incomes. Productivity is weak, and improving it is essential for sustainable real income growth.

There is a significant heterogeneity in productivity performance across different sectors. In manufacturing, for example, it has grown by 5.2 per cent over the year. However, finance remains a key weakness. Indeed, a recent ONS study suggested that the financial sector contributed a quarter of the slowdown in productivity from 2007. Investment as a share of GDP in the UK is significantly lower than across other G7 or OECD countries, and R&D spending is also weaker.

Living standards are finally recovering, but improving productivity is essential to maintaining this momentum. If political parties want to be taken seriously on living standards, they must outline a coherent plan to boost productivity through higher investment, training and innovation. Ruling out higher taxes on income and capital would be a good start.

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