Productivity is the key driver of economic prosperity. From 1945 to 1980 Britain performed poorly on productivity growth, particularly in the 1970s when the UK joined the European Community.
The 1980s saw a sharp improvement in UK productivity growth, sustained for much of the 1990s and early 2000s.
Alas, the UK’s productivity performance has since deteriorated sharply, with growth averaging just 0.4 per cent in the decade since 2005 compared to over 2 per cent in the prior decade. The UK has fallen from near top of the G7 on productivity growth to near bottom.
The financial crisis
A key part of the explanation is the financial crisis of 2007-8, since unsustainable credit growth had previously led to an overstatement of underlying output and productivity growth.
The crisis policy response, including 0.5 per cent interest rates and starting quantitative easing (QE), was justified to support employment and limit corporate insolvencies in the near term. Many more people remained in work and far fewer indebted companies needed emergency restructuring.
This should not have held back UK productivity too much in the long term if those crisis measures were then unwound. Instead, they were extended for nearly a decade. Government borrowing remains over 4 per cent of GDP as government debt approaches 90 per cent of GDP. QE is still being expanded further, while interest rates were kept at 0.5 per cent and then cut again.
This has held the financial system back from reallocating capital from unproductive uses to new, growing and more productive firms. Firms which borrowed at 6 per cent in the mid-2000s now pay barely 1 per cent. Many are no longer the most productive custodians of capital, if they ever were. Yet supposedly emergency measures still cushion zombie firms and banks, weighing on productivity.
An open door to EU labour
Before 1997, net migration to the UK rarely exceeded 50,000 annually. In 2004, following EU expansion, net migration rose to 268,000 and remained close to that level for a decade. By 2015 it had risen to 334,000.
Within that, the proportion of EU migration rose to around a half. EU workers in the UK increased from just over 600,000 in 2004 to around 2.3m by 2016, with the make-up shifting from older to newer EU member states with far lower incomes and productivity.
Adding so many less productive, albeit hard-working, employees in sectors with high labour input relative to capital has weighed on UK productivity. Employers also have less incentive for capital investment if they can import unlimited low wage employees. Why invest in an automatic car wash if migrant workers are exploited to do the job for less?
Subsidising lower paid workers
Government spending on tax credits is around 10 times greater than the equivalent for families 25 years ago. Tax credits can subsidise the employers of relatively low paid and less productive workers, raising employment but reducing productivity growth. Eligibility cut-offs at 16 or 24 hours weekly working can also incentivise jobs at or just above that level with little regard to productivity.
Tax credit rules have also helped drive a big shift in self-employment, from higher to lower income and productivity, with the Resolution Foundation reporting average self-employed income down from £300 to £240 per week since 2001-2. Only in the last year has HMRC required eligible self-employment to be on a commercial basis.
EU economic distortions
The cost of productivity-sapping regulation associated with EU membership is calculated by Open Europe at £33.3bn annually.
Roger Bootle and John Mills also recently argued in “The Real Sterling Crisis” for Civitas that an overly high sterling exchange rate has reduced productivity growth in the UK, with manufacturing investment suppressed by a strong pound.
With a lower pound and the opportunity to rewrite regulation to suit domestic needs, the UK now has the chance to boost productivity growth. But it must also return monetary policy to normal and improve tax and benefit incentives to drive productivity forwards.
Making Britain more Productive is published today by the Ukip Parliamentary Resource Unit at www.ukippolicyforum.com