The British productivity disease: How to cure it

Dominic Raab

THIS week has brought more bright economic news – with falling inflation and unemployment paving the way for rising real wages. Yet while the UK is now the fastest growing developed economy, the productivity of its workforce languishes a fifth below the G7 average. What can be done to cure this British disease?

US economist Paul Krugman reckons that “in the long-run [productivity] is almost everything”. If he’s right, it’s troubling for Britain. The gap between UK productivity and the rest of the G7 has grown since 2000. Britain lags 31 percentage points behind Germany and 35 off the US.

The root causes are political. For a country with high government spending (still well above the OECD average despite austerity), the UK has squandered it on the wrong things – from subsidising longer retirement, to a welfare system that (until recently) was more interested in re-distributing wealth than providing a social safety net. As well as pushing up debt and taxes, it left too little money for infrastructure or R&D. We’re twenty-eighth on the World Economic Forum infrastructure quality rankings, behind Taiwan and Malaysia. British R&D investment is half that of the top European economies. Patent innovation lags behind the international pack. The coalition is rolling out super-fast broadband, and invested £92bn in transport, apprenticeships and science during the 2010 Comprehensive Spending Review. But it will take perseverance to correct such entrenched – and skewed – priorities.

A legacy of poor choices was compounded by lack of honesty. For all Labour’s investment in state schools, grade inflation disguised the dumbing down of standards: we plummeted down the OECD rankings for 15 year olds in maths, science and literacy. For too long, our schools cosseted rather than equipped youngsters for working life. Coalition reforms to restore academic rigour – coupled with investment in wider vocational options – will help reverse that slide.

Politicians must also drop bad habits. The addiction to cheap labour from abroad was used by Labour to insulate business from inadequate home-grown skills, encouraging welfare dependency. And controlled immigration did not improve economic output, measured by GDP per person. But it suppressed wages and dampened the incentive for firms to invest in plant, training or research to deliver efficiencies.

Likewise, a political craving for easy money has added to lacklustre productivity in financial services, which fell 15 per cent between 2008 and 2013. When the financial bubble burst, cheap money released to pull the economy out of its rut kept thousands of zombie firms afloat, yet starved fledgling startups of credit – a lousy allocation of capital.

The most endemic political vice is short-termism. Take oil and gas. It is getting harder to extract North Sea oil, and more costly to maintain rigs. The last government’s failure to replace six nuclear power stations decommissioned on its watch squeezed energy supply and productivity. Today, plans to exploit UK shale reserves – crucial to any long-term energy strategy – are beset by scaremongering pressure groups, which threaten to drain political will. Add in yawning delays in expanding UK airport capacity, and Britain risks looking like a nation that can’t take a long-term decision on major infrastructure.

The Budget sought measures to reverse these trends: increased business investment allowances, export finance and new money for road repairs. We must raise our sights further. We need further cuts, not just to reduce debt and taxes, but also to pay for more infrastructure and R&D to strengthen competitiveness. You don’t have to yearn for a smaller state to recognise that Britain still has a spending problem – born out of flawed choices.

We should cut payroll taxes further, enable “no fault” dismissal of under-performing staff, and allow the low paid to keep performance-related pay tax free. A voting threshold for strike action would stop minorities hollowing out UK productivity – including Luddite union bosses holding back rail modernisation, and teachers trying to stave off reform.

Poor productivity haunts sectors with the least competition, like banking, energy and the utilities. All three cry out for a competition overhaul – from introducing portable bank accounts and more new challenger banks, to greater retail competition in the water industry.

Likewise, we must reverse the decline, since 1998, in the rate of business investment. One radical idea would be to encourage corporate investment by offering tax breaks and stronger voting rights to longer-term equity investors.

A revolution in UK productivity will take political courage. Vested interests will yelp at every turn. As US Fed chair Janet Yellen dryly observed: “Most things that contribute to productivity growth are very painful.” But Britain has no option – if it is to create and spread prosperity in the fiercely competitive century that lies ahead.

Dominic Raab is Conservative MP for Esher & Walton.

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