The economy post-Brexit: More QE or cutting interest rates? The UK's poor productivity's the real elephant in the room

 
Annabelle Williams
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The Bank of England may stimulate the economy this Thursday, but it's productivity we've got to focus on (Source: Getty)

Uncertainty over the health of the global economy persists, as a checkered patchwork of data releases add to speculation over what the future holds.

In the UK, the Brexit vote has amplified worries about the economy. “It remains hard to see how the UK can avoid recession altogether, possibly starting as soon as the third quarter,” says Alastair Winter, chief economist of Daniel Stewart & Company.

The Bank of England is widely expected to announce measures to support the UK after its policy meeting this Thursday, partly since its chief economist Andy Haldane has called for “muscular” intervention.

It will come amid an increasing focus on central bank action – and how far they can go to stimulate regional economies. Both the Bank of Japan and the European Central Bank have been undertaking unusual measures, ranging from negative interest rates to buying up exchange-traded funds. And there are calls for them to go further, perhaps by printing money and handing it out to residents.

Read more: What odd policies will central banks try next?

The Bank of England may well drop interest rates, encourage banks to lend or try something else entirely. It’s all part of the science of managing an advanced economy. But underneath it all, it seems it’s the engine of the economy itself that’s broken ­­– measured by the sorely lacking state of productivity in the country.

It’s been the missing piece of the puzzle since the banking crisis. The Office for National Statistics says UK productivity is 14 per cent below where it would have been if the pre-crisis trend continued. Importantly, projections of economic growth depend on productivity levels. Lower productivity today equals a weaker economy going into the future.

Read more: Five charts that explain the productivity problem

It isn’t unique to the UK, as it’s a problem noted across the world. But the UK seems to be doing particularly badly. Output per hour worked is 18 percentage points below the average for the G7 nations, according to the most recent figures. That gap is wider than the previous year too.

“The only sustained way an economy becomes wealthier or delivers economic growth is by increasing productivity,” says Simon French, chief economist at Panmure Gordon. It means the economy’s a slicker, better-working machine, where “people are working smarter, and you are getting more outputs for the inputs,” explains Toby Nangle of Columbia Threadneedle Investments.

Without an improvement in productivity, there’s also the option of boosting the economy with more workers – perhaps through getting the unemployed into jobs or expanding the workforce with immigration.

It’s an alternative to productivity; instead of getting the existing workforce to work harder, better, or more creatively, “you can have a population boom which can push up the rate of output”, explains Nangle.

Read more: The UK desperately needs a productivity roadmap

As a case in point, Nobel prize winning economist Paul Krugman argued Asia’s rapid growth in the last few decades wasn’t because those economies had found the secret sauce of great productivity, but had experienced a population boom. There were simply more workers to do the work, he says in his paper The Myth of Asia’s Miracle.

But there’s only so far you can go with adding more workers to an economy. Over in the West, “this has been quite a big issue and the economic growth we have had has been fuelled by labour force growth. We are running out of steam on that,” says Nangle.

The problem with productivity is it’s notoriously complicated, and economists don’t agree on why it’s fallen or how it can be fixed. “Even in the murky world of economic policymaking, productivity stands out as a poorly understood concept,” says French.

Many factors contribute to good productivity, and suggestions for improving productivity range from increasing tax credits for R&D and improving adult skills centres, to having workplace healthcare schemes.

Poor productivity could well be down to the proliferation of low wage, low skill business models. There is also an argument to say pre-crisis levels were just a bubble. But nonetheless, tackling weak productivity takes a long time, and results aren’t going to be immediately apparent. “Against this backdrop it is hardly surprising we try unusual monetary policy where visible changes to exchange rates and credit spreads can be relatively easily identified,” says French.

Perhaps the most important point about productivity is that it is linked to social cohesion. For a company, handing out a pay rise is justifiable if a worker’s productivity is increasing while their working hours stay the same.

If the worker’s productivity stays the same, or even declines, while they work the same hours, giving a salary increase means the company has to reduce their profits or pass on the pay rise to customers.

Rapid increases in the number of people in the workforce has also pushed down wages. This accounts for the growing social unrest, reflected in anti-establishment political movements, says Nangle. “Productivity has been so low just because there has been abundant levels of labour... The big question for the Bank is ‘Where is the wage growth?’”

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