The public-sector productivity problem

The single biggest factor in the disappointing UK productivity figures this century has been the poor performance of the one fifth of the UK economy that provides health, social services, education, defence and other public services – predominantly in the state sector.

The March 2024 Office for National Statistics (ONS) figures reveal that public sector productivity remained 6.4% below its pre-Covid 2019 peak, whilst the private sector has now surpassed its 2019 level. In its study of the long period from 1997, the ONS shows that over more than a quarter of century the public sector did not increase its productivity at all. It fell a little to 2010, rose a bit to 2019 and then lost all the gains leaving it back where it started by this year. The big fall in 2020 was not fully recouped by the recovery in 2021.

Why productivity matters

If the public sector had matched the private sector and grown productivity by 2% up to the banking crash and then by, say, 0.5% thereafter the overall productivity figures would look a lot better and public services would be more affordable. If the productivity rate had been a sustained 1% a year we would get 31% more service for the same money, after 27 years. Even at 0.5% per annum we would get 14%. In practice governments would have shared those gains between providing more service and spending less.

Whilst governments have understood the need for private sector productivity to stay competitive worldwide and to add to national growth and higher real wages, there has been less interest in public-sector productivity. This means that the failure to deliver any overall productivity gain has caused an obvious shortfall in national productivity as public services are around one fifth of total activity.

The last government which presided over the Covid-19 collapse in productivity wanted to recoup the losses. The Treasury estimate the cost of the lost productivity since 2019 at £20bn a year. If you apply the latest ONS figure of 6.5% loss on one fifth of the economy, you come out with a larger figure of around £30bn. This is extra cost that must be raised as borrowings or recouped by higher taxes as the government seeks to get to a balanced position for revenue compared to current public spending.

Wage inflation and strikes

The government has embarked on a round of inflationary wage awards to public service workers, which is adding to the costs of service delivery. These are important in the largest public service, the NHS. The train driver awards are likely to entail further subsidy to the railways, with an increasing number of train companies nationalised where the losses are automatically covered by the state. To secure agreements the government has not pressed for improvements in working practices. There are also briefings suggesting its forthcoming Bill to change employment law will make it easier for Union leaders to call strikes by reducing the number of members who must vote in favour of strike action.

The government argues that it will buy goodwill with the Unions and believes it will be able to reduce the number of future strikes by virtue of having closer and friendlier links with the Union movement. History is two edged on this argument. The Labour government 1997-2010 enjoyed lower strikes but also kept in place the main elements of the Conservative trade union reforms of the 1980s. They did not change the need to ballot members before undertaking strike action. The Coalition and Conservative governments (2010-19) also kept strikes down.

Conversely, the unions swept aside Labour’s “In place of Strife” policy of the later 1960s, and helped bring down the Labour government in 1978-9 with the winter of discontent strikes in the public sector. Offering higher pay awards to settle disputes can bring forward more disputes, as other groups of workers see the above-average settlement and demand something similar for themselves.

The bad industrial relations of the 1970s and 1980s were characterised by skilled workers demanding differentials or a skill premium be preserved, and by many workers wanting comparability increases if one group got a special deal.

The government claims it inherited stretched budgets from the outgoing government, with the need to increase the planned spending figures in some areas. It has also added substantially to these revisions with its pay policy awards.

Part of the argument about future deficits and borrowing revolves around what assumption the budget makers can make concerning future pay award costs and productivity levels. If the government could get back the lost productivity from 2019 quickly it would offset the additional costs they have identified. If they could sustain a better rate of productivity growth in the public sector, it could afford more non-inflationary pay rises and contain the deficits better.

The Chancellor has imposed a restriction on the deficit by saying current costs will be matched by tax revenue. If there is no productivity gain to factor in, that means higher tax rises in the forthcoming budget to meet the extra service costs.

Likely outcome

The government may resume some work on productivity gains in the public sector as they see the difficulties in the deficit and borrowing figures. It may accept a spend to save approach which the government has sometimes adopted. This would, for example, propose more widespread adoption of artificial intelligence and computer-led service responses which would allow less recruitment of personnel but entail additional spending on new systems and software.

It will allow some additional enhanced pay awards to public sector groups which want special settlements such as doctors and train drivers. This means higher spending, higher taxes and higher borrowings compared to current plans as the new approach beds down.