The UK productivity puzzle

The Office for National Statistics (ONS) portrait of the UK economy by value added shows the strong dependence on services, with manufacturing, and mining down to just 10.3% of the total. It also reveals the importance of the public sector, which dominates health, social care, education and defence – accounting for 19% of the total.

The figures are a bit distorted by 12% for real estate, which reflects the value of people’s homes turned into an imputed rental income. The figures for other sectors can be adjusted up by a tenth to remove this accounting distortion.

If we compare this with the pattern of employment, we see the balance of services is even more extreme. Manufacturing, mining and extraction account for just 7.2% of the total jobs, revealing their high rate of labour productivity. In mining, oil and gas productivity is especially high, with 0.1% of the workforce delivering 0.9% of the added value.

Within services, finance and insurance is also a very productive area, with 3.4% of the workforce providing 9% of the added value. In contrast, the public services need 25.9% of the workforce to deliver 19% added value, reflecting the need for good ratios of teachers, nurses and doctors to pupils and patients as well as capturing the high administrative personnel ratios of the public sector.

UK productivity lags well behind US and has been growing more slowly. According to ONS figures UK, productivity only grew by 0.7% per annum from 2009 until the outbreak of Covid-19 and has only recently recovered from lockdowns to exceed the 2019 level.

Prior to the banking crash and great recession in 2008-9 the UK regularly grew productivity at 2% per annum. The poor outturns this century have sometimes been called the UK productivity puzzle.

The reasons productivity has wilted

Labour productivity is the measure of productivity most people refer to, though you can also look at capital productivity. High and low figures for labour productivity are not value judgements on the staff and nature of the work. They are mainly determined by how much must be done by people as opposed to done by machinery.

A care home must have much lower labour productivity than an oil refinery, as we need personal care, whereas our petrol can be produced mainly by complex and expensive automated plant. It does not make a care home less worthwhile or less important. An advanced modern economy needs both. Total productivity will reflect the balance of activities and changes in that balance.

Since 2009, there have been several important changes in the structure and nature of the UK economy that have detracted from higher productivity.

The first is the sharp decline in the UK oil, gas and coal industries. These industries have very high labour productivity ratings, with a relatively few well paid jobs controlling extensive capital investment and producing a valuable output. The sharp decline has lost us a lot of productivity and profitable turnover. This will continue given the wish to exit from these activities soon, with a preference to import.

The second is the decline of productivity in the very productive finance and insurance sectors. Here there has been a substantial increase in regulatory activity, leading to the recruitment of large numbers of people to audit, risk assessment, personnel, training and compliance to ensure high standards and conformity with the larger and more demanding rule books. Where quality improves this is not allowed for in the productivity figures.

The third is the expansion of accommodation, food and hospitality, which is a low productivity sector requiring high staff levels to deliver good service.

The fourth is the decline in manufacturing, as net zero and expensive energy policies have driven energy intensive business abroad. The UK is busy shutting down steel, has closed all but one of its aluminium smelters, is closing refineries and petrochemical works, and reducing a range of energy intensive activities. These are all high labour productivity businesses.

The fifth is the UK public sector. There has been no productivity growth in the public services this century. We will review this in a later piece.

Future trends

If a fifth of the economy delivering public services continues to grow and continues to avoid productivity improvements that will remain as a brake on overall UK productivity performance. There is a case for more teachers and doctors relative to pupil and patient numbers and for more uniformed personnel, but not the same case for increases in total numbers of public sector employees delivering services which can be helped by modern computers and artificial intelligence (AI).

It is likely the energy sector will continue to decline as a contributor to overall higher productivity. The progressive closure of the oil and gas industries will cut out one of the most productive sectors. The further decline of energy intensive industry from steel and other metals to petrochemicals and oil refining will also reduce a highly productive sector.

UK service sector exports have leapt ahead of goods exports reflecting the UK’s relative advantage in professional and financial services. The more the economy bases itself on services and the less it does so on manufacturing, mining and extractive industries the more it will lower the average productivity figure as services are more labour intensive and less capital intensive. Germany within Europe has achieved higher productivity by having a much larger manufacturing sector where extensive mechanisation does much of the work.

Sectoral trends will continue to be a substantial headwind for the labour productivity of UK economy, already service heavy and industry light. The UK economy has needed large numbers of new employees in relatively low wage low productivity jobs as it has expanded its service offers.

The poor performance of the public sector is also a substantial brake on raising productivity.

To the extent that lower overall labour productivity reflects a strong bias to people intensive services that deliver high quality and are internationally competitive, this is not a problem. To the extent that poor labour productivity keeps down wages and creates labour market issues it is a problem.

Higher pay comes from higher labour productivity. That comes from working smarter and from employers putting in enough computers, robots and automated plant to allow more people to report high turnover per head.