How can George Osborne revive UK productivity? Reform regulation and the public sector

Andrew Sentance
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Osborne needs to set out an agenda for public sector reform (Source: Getty)
In Wednesday's Budget, George Osborne announced that he would publish a Productivity Plan today. After growing by about 2 per cent a year for many decades, the UK’s productivity growth appears to have come to a juddering halt since the financial crisis.

So what should be in the plan – in addition to the measures already announced in the Budget? It should start with an assessment of why productivity growth has been so poor recently. In business, there has been no slackening in the desire to raise productivity and efficiency. But the headline figures don’t reflect this – for three main reasons.

First, productivity growth before the crisis was flattered by a number of tailwinds which boosted the performance of key sectors that trade internationally – manufacturing, finance, business and professional services, and information and communications. These sectors account for nearly three-quarters of UK exports, and they experienced very strong productivity growth as the world economy opened up from the 1990s, allowing export-oriented businesses to expand rapidly and achieve economies of scale. They were also big beneficiaries of the internet and mobile communications revolution which started in the 1990s. And financial sector productivity – on paper at least – was boosted by the global credit boom that preceded the financial crisis.

These sectors remain highly productive in relation to the economy as a whole. But their productivity growth has slowed to more normal rates. In finance, productivity has gone into reverse due to the shock of the crisis and increased regulation. So one explanation of the “productivity puzzle” is that these past tailwinds – globalisation, credit growth and technology – have faded away.

Second, energy-related sectors in the UK economy have seen a productivity decline since the mid-2000s. This partly reflects the increasing cost and difficulty of extracting North Sea oil and gas. Environmental regulation is also affecting productivity in energy-producing industries, as well as in the water industry and waste disposal.

Third, the public sector has been a drag on UK productivity performance since the mid-2000s. This is a bit surprising. Spending restraint should create pressure to raise productivity. However, education and health – the main sectors which contribute to the productivity of the public sector – have been largely ringfenced from the spending squeeze. Official figures show productivity in government-related services switching from positive growth before 2005 to minus 0.7 per cent annually since then.

Taking the sectors dragging down productivity out of the equation, the UK’s performance looks a lot better. Since 2009, UK productivity has been growing by over 2 per cent a year in manufacturing and 1.5 to 2 per cent in private services – excluding property and finance. Productivity took a big hit during the financial crisis. But since then, it has grown at a respectable rate in the core of the UK economy.

Does this mean that Osborne should be relaxed about productivity growth? Far from it! Part of the productivity puzzle lies squarely in the public sector. He needs to set out an agenda for public sector reform and refocusing to address this. Second, the other sectors which are acting as a drag on productivity growth – energy and finance – are heavily regulated. The government needs to ensure that the burden of regulation is proportionate and economically efficient. Third, there are many government policies which affect how efficiently businesses can operate in the private sector. A major overhaul of the planning system and all other forms of business regulation should be the centrepiece of the Productivity Plan released today.

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