The real reason behind Britain’s productivity puzzle lies in the detail

 
Econhedge

THE UK’s “productivity conundrum” has been hotly debated. The Office for National Statistics, the Bank of England and others have all made stabs at explaining the marked divergence between GDP and employment growth. Since the end of the third quarter of 2011, the economy has broadly flatlined. But the number in work has increased by almost 2.5 per cent over the same period, leaving overall employment at a record 29.76m in the three months to April.

A number of explanations have been put forward: a rise in part-time work and the phenomenon of “zero hours contracts” (though this is discounted by strength in aggregate hours worked, which has grown by 2.8 per cent since the end of the third quarter of 2011); a rise in self-employment (acknowledged to show lower rates of productivity than employee workers); and/or simply the insufficiency of data (GDP revisions are a particular focus).

Most of these arguments have some validity, but if we look at the sectoral breakdown of growth and employment data, we may see that the extent of the UK’s productivity fall has been exacerbated by the uneven dispersion of economic fortunes.

Using this approach, a chunk of the much-discussed productivity deterioration should reverse in the quarters ahead. Looking at the last six quarters of GDP by production data, we see that the overall industrial sector has shrunk by more than 3.5 per cent, the construction sector by a disastrous 12 per cent, whereas services have shown cumulative expansion of 1.75 per cent.

Compare output falls with changes in sectoral employment; “only” a 3.4 per cent fall in the number of construction jobs since the third quarter of 2011, and a 2.2 per cent rise in the number of industrial sector jobs. Isolating data from the first quarter of 2013, we can see that 90 per cent of the fall in annual productivity could be traced back to the construction, manufacturing, extraction and agriculture sectors, which together account for less than a quarter of UK value add.

We know that, within these sectors, drag effects have impaired performance since late 2011; construction, for instance, has suffered from a post-Olympic hangover, a dearth of credit, and the impact of the government’s heavy capital investment cuts; the industrial sector, from the fall-off in North Sea Oil production (a capital-, not labour-, intensive industry) and a period of inventory liquidation.

We should now expect to see a number of these restraints fade, with the most badly-impacted sectors of the economy experiencing a decent turnaround in output fortunes: construction shifting from a contraction of 7.1 per cent year-on-year in the first quarter of 2013 to close to flat by the fourth quarter; the industrial sector shifting from a 2.3 per cent decline to 2 per cent growth.

Of course, the impact of this on UK productivity could be impaired by an acceleration in hiring. But this looks unlikely. Companies will practically struggle to hire at this rate, and there is decent evidence that, over the last 18 months, UK corporates have been happy to hoard “cheap” labour (apart from distortions in yesterday’s employment data related to the delay of bonus payments, real wages have been negative year-on-year on a consistent basis since mid-2008). On this basis, productivity growth is liable to be decently positive again by the end of 2013.

Econhedge is a pseudonym for a hedge fund professional. He tweets @econhedge