Let's face it: the UK's stagnant productivity levels are here to stay

John Mills
Very little medium- and low-tech manufacturing in the UK can compete with foreign competition with the exchange rate where it is now – even after the 16 per cent reduction since the Brexit vote (Source: Getty)

Key elements of the chancellor’s Autumn Statement were policies both to increase productivity and to curb the government deficit. Unfortunately, neither of these goals is likely to be realised.

Stagnant productivity certainly is a major millstone round the UK economy’s neck. Output per hour today is only fractionally above what it was 10 years ago, which is, of course, a major reason why so many people are no better off now than they were before the 2008 crash.

The chancellor’s remedy is more expenditure on housing and infrastructure. Desirable though this extra spending may be, unfortunately it will do little, if anything, to increase productivity.

This is because, ever since the Industrial Revolution got under way 250 years ago, living standards have only ever been lifted by a very narrow range of economic activities – mechanisation and technology – and very little else. Spending money on roads, schools, hospitals, rail and housing – all largely public sector activities – are hugely important socially, but, on average, they only produce returns which barely cover the interest costs of financing them and no substantial surplus to spread throughout the rest of the economy.

Where mechanisation and technology really come into their own, pushing up output per hour, is in light industry. But very little medium- and low-tech manufacturing in the UK can compete with foreign competition with the exchange rate where it is now – even after the 16 per cent reduction since the Brexit vote. So no-one is going to invest heavily in reindustrialisation. This is why productivity will stay more or less static, as will real wages.

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The reason the chancellor’s policy to get the government debt down won’t work – despite the fact that it is now rising towards £1.9 trillion – is because of another huge imbalance in the UK economy. We have a massive balance of payments deficit, currently running at nearly 6 per cent of GDP.

Because deficits like this are caused by more payments going abroad than are received within the UK, they suck demand out of the economy. Unless this missing demand is replaced from somewhere, the economy will tank.

General Election - Documents Stock
The government deficit won't budge (Source: Getty)

So what happens is that the missing demand has to be made up from borrowing and spending money which has not been earned, and there are only three places from which this can come.

One is the corporate sector, another is from consumers and the third is from the government. Now consider the figures. We are currently running a balance of payments deficit of at least £100bn per annum. The business sector, having hoarded cash for a long time after the crash, is now a small net borrower at about £10bn per annum. Net consumer borrowing, at about £20bn, is higher and may be unsustainable at this level.

To make the figures balance, this leaves the government with a borrowing requirement – the same as its deficit – of about £70bn.

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But surely the government can still reduce this deficit by cutting expenditure or increasing taxation – the mantra on which the government has operated ever since the 2008 crash.

Unfortunately, it can’t. Raising taxes or cutting spending – exactly as the government has found out by consistently failing to get the deficit down to where it promised – simply tips the economy into a recession while the deficit stays as large as it was before. Tax receipts go down while unemployment and other social benefits increase. And all the while, the deficit remains the same.

Just as balance sheets have to balance, all deficits and surpluses in the economy have to sum to zero as an accounting identity. It is because this non-intuitive fact has been ignored that this part of government policy too is built on sand.

So what is likely to happen? Predictions in economics have often been compared unfavourably to those from astrology. But expectations for the future which either misjudge where increases in output per hour come from or which defy the laws of accounting and arithmetic are both unlikely to be successful.

Expect, therefore, that productivity will remain more or less static and that the government deficit, despite all the rhetoric, will remain stubbornly high.

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