The hunt for UK growth

This week, the UK government announced a need to change the way the public sector is managed. As it launched its public spending round to try to fix budgets for the three years from 2026, it faces the dilemma that there are plenty of demands for more spending but, at the current low rate of growth, there is insufficient income from taxes to pay for them.

This not a new problem, but today it is an acute one. The Chancellor Rachel Reeves has said she cannot do again what she did in the last budget – increasing spending considerably and paying for it with substantial tax rises and some greater flexibility on borrowing for investment.

Government economic policy has come up against the intractable so-called productivity puzzle. Why has UK productivity grown slowly this century? If labour productivity grows faster, pay can rise faster, output expands faster and tax revenue rises. All parties and governments accept this – but find it elusive.

G7 Productivity performance

The latest Office for National Statistics (ONS) figures for the dollar value of output per hour of each employee show the US in the lead at $98, Japan the lowest at $57 and the UK in the middle at $80. The output of G7 nations per hour in dollars is as follows

• US: $98
• Germany: $95
• France: $93
• UK: $80
• Italy: $76
• Canada: $71
• Japan: $57

This shows it is not a uniquely UK problem. Growth in productivity in western Europe has been generally disappointing this century. As people usually concentrate on labour productivity, the figures will be better for any country that specialises in capital-intensive activities.

Under the scoring system, an oil refinery or gas well, an automated car plant or a data centre will record much higher productivity than a hotel, a government administrative office or a shop. Germany scores better than many because it has a relatively high proportion of output still based in manufacturing where automation is at a high level. The US does well because it has plenty of digital revolution activity where output per head is boosted by big investment in computing and software and a large oil and gas sector.

The UK has a larger public sector than the US relative to GDP. This has been a particular source of weakness this century, with no overall gains in public sector productivity after the falls of the last few years eliminated some past growth. The UK has also gone further and faster in phasing out oil and gas production, oil refining, steel making, manufacture of diesel and petrol cars and other automated industrial activities. As the public sector increases, and the capital-intensive private sector diminishes, productivity slows.

The latest UK ONS figures show output per hour down 1.8% in the year to September. Health, at 10% of the economy, and public administration, at 6%, were both negative. Higher productivity manufacturing is down to just 10% of the economy, dwarfed by more labour-intensive services. The longer-term position shows public sector productivity at 1997 levels in 2022 quarterly figures, with ONS proposing a small upwards adjustment for quality of service. ONS sets out how public sector productivity did little 1997-2010, rose a bit 2010-19, slumped in 2020 and has now recovered a bit.

The UK government’s remedy

The prime minister and the Cabinet Office minister for the civil service have announced ways to try to boost the success and cost effectiveness of the public sector. Mr Starmer called for “nothing less than the complete rewiring of the British state”. He expressed his frustration that ministerial aims do not always seem to get translated into effective programmes of action.

They have called for more short-term contract executives to come in from the private sector – especially from technology companies – to problem solve and challenge existing thinking. They have set out an immediate trial programme for family support and temporary accommodation in four local areas. They need to find the people, settle them into the civil service and then be ready to roll out any cheaper better solution more generally.

It will take a lot of these change teams and require many good people capable of finding the better ways of doing things. The new Cabinet Secretary has been tasked with the wider challenge of trying to get the existing civil service to get closer to ministerial wishes, and to recapture lost productivity in recent years.

Ministers want to have more prison places, but they must wait for expensive time-consuming building of new prisons. They want to see 1.5 million new homes built, but it will take more than some extra planning permissions to create the demand, find the finance and do the building. They want to channel more public-sector pension fund money into infrastructure and private equity investment but must wait for more amalgamations of pension fund investments and more Trustees who will sign off the extra risks.

The UK private sector productivity

At its best, the UK private sector is world class. Factories like the Nissan plant in Sunderland have great records on labour productivity. Much of the US-led digital investment is competitive and well run.

Consultancy PWC points out that, in the period 1999-2019, pre pandemic manufacturing labour productivity doubled against service sector productivity rising 21%. Whilst manufacturing productivity growth has slowed, this reminds us that having a small and contracting manufacturing sector will depress overall productivity figures.

The UK’s policies to speed green transition and to phase out oil and gas more quickly are likely to reduce labour productivity further as traditional factories and energy facilities are closed. The UK needs bigger investments in new manufacturing to offset the losses. So far, the UK has become more import dependent, with China in a strong position in the key areas for green technology, in vehicles and steel.

Europe and the UK need more capacity

The UK and Europe have long shopping lists for more electric vehicles, more battery storage, more nuclear power stations, more renewables. If this is linked to more home-based investment in manufacturing capability this could help spur the productivity rate.

In the short term, the growth of the public sector and services in much of the EU and UK will weigh on the productivity numbers and limit the capacity of the economy to generate more tax revenue and higher real wages.