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UK in focus: Raising UK productivity
While activity indicators appear to be improving after the UK fell into recession last year, the UK’s long-run growth challenges – particularly poor productivity – might be extremely difficult to overcome. This poses ongoing headwinds to UK living standards, corporate profits, the public finances, rates, and GBP.
Pull the other one
With a general election fast approaching, it is understandable that politicians are talking about boosting economic growth. UK Chancellor, Jeremy Hunt, has said “smart” tax cuts are a route to economic dynamism. Labour leader, Keir Starmer – who polls suggest will be the next Prime Minister – has said he will pull “the growth lever”.
The problem is, the UK has faced 15 years of lacklustre growth. At the heart of this lies an inauspicious shift in productivity performance. Before the Global Financial Crisis (GFC), UK output per worker grew in line with that of the US, at 2% per year. While much of the developed world has seen a slowdown since, UK trends have become more European. Over the past 15 years, UK productivity has grown at 0.5% per year, in line with the eurozone.
Source: ONS, Eurostat, BEA, Macrobond, HSBC calculations
*GDP per worker
Source: ONS, Macrobond, HSBC calculations
What's gone wrong and can it be fixed?
To work out whether a (metaphorical) ‘growth lever’ actually exists, it first makes sense to work out what lies behind the UK’s so-called ‘productivity puzzle’. To start, we think around a third of shortfall versus pre-Global Financial Crisis trends reflects the end of unsustainable growth in North Sea oil output and the financial sector. Not much can be done about that.
Much of the rest of the ‘puzzle’, we think, hinges on weak investment, driven by a number of headwinds which have become more acute in recent years. These include high house prices, costly infrastructure projects, restrained public investment spending and perhaps, more recently, Brexit. Some of these headwinds could be alleviated, but doing so may well be fiscally or politically costly. So, unless new technologies such as Artificial Intelligence come to the rescue, there’s a risk that the next 15 years might not look much better than the last 15.
Six inconvenient implications
We see six implications of ongoing UK productivity weakness. First, lagging living standards. Second, paltry profit growth. Third, the government could face increasingly tough choices between raising taxes, increasing borrowing, or allowing public services to atrophy. Fourth, limited cost-saving productivity growth might make it harder for central banks to deal with inflationary wage ‘shocks’. Fifth, in the long run, low potential growth could keep long run ‘equilibrium’ UK interest rates low – more in line with the eurozone than the US. And sixth, the combination of low growth and low interest rates could act as long run headwinds to GBP.
Can things only get better?
There are things that policy makers could do, whether it is planning reform or refocusing fiscal policy more towards investment. But either fiscally or politically, major reform might be hard to implement and might take a very long time to bear fruit. So, while we don’t think there’s much scope for the UK’s productivity woes getting much worse from here, it is hard to see things getting much better any time soon. And until then, the adverse implications for prosperity, profits and policy will be here to stay.
