It’s productivity, stupid: The chancellor must be bolder on the greatest threat to living standards

Oriol Carreras
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Productivity has risen healthily in European peers like Germany, France and Spain (Source: Getty)

Whenever a new Budget is in the offing, fiscal policy tends to take centre stage.

But while an open and lively debate over the goals of fiscal policy in the coming year is to be welcomed, we should not forget about the economic problems that, lurking in the background, continue to afflict the country. In particular, the absence of meaningful productivity growth remains, by far, the largest risk to the prospects for living standards in our society.

To understand the importance of productivity growth, it is useful to compare its implications against other current economic developments.

Let us take, for instance, the current debate on the economic impact of the recent sharp depreciation of sterling. The depreciation of a currency has often been seen as a quick and, in political terms, easy-to-implement fix to the economic problems of a country. Italy, for example, devalued on a number of occasions during the 80s. Currency devaluations help to boost GDP by making our exports cheaper relative to those of foreign competitors. And, more importantly for policy-makers, they are not usually accompanied by large demonstrations or protests.

Read more: The dramatic fall in sterling is a cause for celebration – not depression

Unfortunately, appetising though it might seem, currency depreciation is not a free lunch. Just as our exports become cheaper relative to those of other countries, our imports become more expensive. In the largely intertwined world that we live in, where the various components of the smartphones we buy each come from a different corner of the planet, this is more relevant than ever as it means a squeeze on the purchasing power of our wages. Consumers, somewhat inadvertently, pay the price of our exports becoming more attractive to the rest of the world.

What is worse, the fact that our exports become cheaper may not even translate into gains in foreign market share. Services make up a large proportion of our exports, and competition is usually on a quality basis rather than price. Think about this: if you run a foreign firm outsourcing its legal services to some other foreign company, would you switch to a UK company just because it is slightly cheaper once you have built a relationship and trust with the existing one? It seems highly unlikely.

So where does productivity fit into all this? Productivity gains encompass a large number of developments: steps firms take to render themselves more efficient at what they do, the creation of new products or ideas, more efficient allocation of resources, and so forth. These are the key elements that promote a country’s growth and do not necessarily rely on making someone better off by making someone else worse off. Gains in productivity, rather than large depreciations, are what have made the UK one of the wealthiest countries in the world.

Read more: Industrial strategy needs a three-pillared approach to boost productivity

And yet average productivity growth in the UK has been flat since 2008, in sharp contrast with our European neighbours such as Germany, France or Spain which, seemingly unencumbered by the limitations of EU membership, have seen average gains in productivity over the same period of 0.6, 0.5 and 1.4 per cent respectively. Only Italy, which has suffered from weak productivity growth since even before the Great Recession, has fared worse than the UK.

These absent gains in productivity should never have been allowed to fade into the background of the public discourse about the economy. The focus of public debate should return to what measures we should urgently implement to promote it again.

The announcement in the Autumn Statement of a £23bn National Productivity Investment Plan was a step in the right direction. But the figure is far too small – the whole package represents less than a percentage point of GDP – and significant parts of it were either directed towards housing, which does little to address the issue of productivity, or are planned to take place beyond this parliament. Let us hope the chancellor takes a bolder stance in the upcoming Budget.

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