Productivity puzzle a result of greater supply of labour, fall in union activity and lower wages, say IFS

Leading think tank the Institute of Fiscal Studies has released a report showing that the current recession since 2008 is the longest and deepest in over a century.

The UK is experiencing what's known as a productivity puzzle, whereby a relative recovery in employment and working hours has been accompanied by a fall in output, as measured by GDP.

Source: IFS, ONS data

This has some real consequences for British workers. The IFS shows how real hourly wages across income levels (deflated using the Retail Prices Index) were four per cent lower in April 2011 than they were in April 2008, compared to five per cent higher in the early 1980s and ten per cent higher in the early 1990s.

The IFS finds that wages are positively correlated with productivity, but can't explain definitely whether there is any causal relationship between the two.

As welfare cuts hit (particularly the elderly and single parents) and the value of household wealth falls, more are pushed back into work. The increasing labour supply has created a greater competition for jobs, and moved workers' priorities towards stability over than pay. This has pushed wages down and, between 2010 and 2011, 70 per cent of those staying in the same job faced a reduction in real wages.

The decline in trade union membership, meanwhile, has contributed to a more flexible workforce, meaning employers are more able to reduce wages or make job cuts to save on costs. Greater freedom to hire and fire, combined with low pay, the IFS say, may explain the productivity puzzle.

Policymakers are unlikely to be comforted then by the news yesterday that Britain's manufacturing output fell by 0.2 per cent in April 2013, following encouraging increases of 1.1 per cent in March and 0.7 per cent in February.

However, the wrong thing to do at this point would be to increase welfare spending and employment regulation to take the least productive back out of the workforce and hamper small businesses' ability to hire through regulation and a higher minimum wage, as the TUC are currently campaigning for. The recovery may be taking longer this time, but the UK could emerge stronger than ever and it's important we don't become impatient.