By definition, productivity is the measure of output per unit input. Inputs include labour and capital while output is typically measured in revenue. Between July and December data shows that output per hour rose by 1.7% – the fastest rise since 2005. However, part of the rise was due to the fact that the number of hours worked has fallen. Labour productivity grew by 0.7% in Quarter 4 2017 and it was the second quarterly increase in a row leaving productivity at 1.8% above its peak in Quarter 4 2007 (before the financial crisis). However, the output per worker and output per job only grew by 0.1% showing that there has been a fall in the average hours worked. The fall in average hours worked also suggests that workers incomes are stagnating and so due to inflation, their real incomes may be falling.
Productivity plays an important role in the economy as there are many benefits that come with higher productivity. If a firm is more productive, it will have lower costs of production as they are able to produce more goods and services in a set amount of time. This means that the firm can become more competitive, assuming ceteris paribus, the lower costs of production means that a firm can decrease their prices. This decrease in prices can lead to an increase in demand and mean that UK goods and services could become more competitive in global markets. This can also lead to an increase in revenue for the firms and so these can be reinvested back into the firm to make it even more productive. These benefits can also lead to economic growth as output increases due to higher productivity, which in turn brings benefits to the country. If workers are receiving higher wages – as they work the same hours to produce more output meaning that a firm’s costs of production lowers and so firms are able to afford wage increases – this can also cause a further shift outwards of AD due to the multiplier effect. If a worker receives a pay rise, he will then spend some of his extra income on goods and services and so this in turn increases AD.
So the big question that occurs is why is the productivity in the UK so low? It has been a question that is very hard to answer. New machines and technology can make workers more productive, however companies’ capital spending is only 5% above its pre-crisis peak, compared with a 60% increase over the decade after the 1980s recession. This could explain a reason as to why productivity in the UK has remained so low as workers haven’t got the capital they need to become more productive. Another reason that could have caused low productivity is that firms have been retaining relatively (unproductive) workers rather than investing in machines. Helen Miller from the Institute for Fiscal Studies commented that “changes to state pensions and benefits are likely to have contributed” showing that people have been more willing to work in this financial crisis compared to other recessions. Therefore, firms have avoided large costs by investing in machinery and have instead increased the number of workers in order to meet demand. This is supported by the fact that the UK now has the highest employment rate since 1971 at 75.3%. With real pay (after accounting for inflation) down 0.2% in 2017 compared to the same time in 2016 – it shows that it is easier for firms to increase workers due to a low wage demand as inflation is not at a high rate relative to wages. This means output becomes more labour intensive which often have a lower productivity.
The blog also mentions that the government imposed an apprenticeship levy, with the idea to increase skills and training workers receive and this can in turn increase their productivity – the workers can develop the skills needed to produce more goods/services in a set period of time. The scheme was introduced in 2015 and aims to create 3 million new apprenticeships by 2020. However, in January 2018 there were 25,400 apprentices in training compared to 36,700 a year earlier showing that the scheme may not be as effective. However, this is focusing on human capital rather than physical capital such as machines. In some industries, such as construction, it is easy to run an apprenticeship scheme and train labour but in the services industry it has proven much more difficult to provide apprenticeship training. This supports the idea that it is easier to increase and improve labour than capital as the government have focused on encouraging firms to increase apprenticeship programmes. In the long term it is more important to focus on increasing capital than it is labour. This is because as technology advances, capital becomes more advance and so it can aid workers to produce more goods/services in a set amount of time. It is also more important than an increase in skilled labour as if you increase capital – the worker can become more productive too and so produce more goods and services. However, an increase in skills doesn’t affect how productive the capital is and so there may be a limit to how productive a worker can be without an increase in the capital available to them. An increase or improvement of capital means that LRAS will shift outwards and the sustainable output of the economy will increase.
The UK productivity is only above one other G7 country. All of the other G7 countries have a higher GDP per hour worked than the UK. This is shown in the graph below. Here you can see that the UK is the second lowest country despite all being at the same rate in 2007. There has been a slow down in labour productivity in the G7 countries, however there seems to be a higher slowdown in the UK. The UK’s nominal productivity gap in output per worker terms narrowed from 16.9% in 2015 to 16.6% in 2016, compared with the average for the rest of the G7. Compared with the rest of the G7, the UK had below average real productivity growth in both output per hour and output per worker terms in 2016. The UK has the largest gap between pre-downturn productivity trend and post-downturn productivity performance was 15.6% in 2016 which is double the average of 8.7% across the rest of the G7. This shows that the UK has suffered a larger productivity problem compared to the other G7 countries.
Lower productivity levels are detrimental to the UK. If the economy remains unproductive, it will not be able to benefit from lower average costs (unless wages remain low) as firms won’t be able to produce as much as more productive firms in the same time period. This means that UK goods will be less competitive on a global market – due to that prices of UK goods will be higher as costs of production remain higher due to lower productivity. This could worsen the balance of payments as exports remain low, and result in lower Aggregate Demand as the balance of payments is one of the components. The higher priced goods are also bad for UK consumers as demand for goods and services will fall due to the high prices. This means that there will be little, if any, increase in output and employment as demand levels remain the same. Higher prices, and lower demand, will mean that businesses retain lower profit from sales. This means that they don’t have as much money to reinvest into the firm which could be spent on training or capital in order to become more productive. The government will also not receive an increase in tax receipts if productivity remains low, as firms will not be selling as many goods and services and so the amount of Value Added Tax and Corporation tax that they receive won’t change.
Low productivity also means that workers wages will not rise as much as the firms cannot increase wages due to a lower demand and profit. This also means that the government will receive less tax receipts from VAT and income tax. Economic growth is also impacted by low productivity. This is because without an increase in productivity the Long Run Aggregate Supply curve will not shift outwards and so the sustainable output for the economy will not increase.