The UK ‘Productivity Puzzle’ Revisited

by George Hatjoullis

Policy makers seem very concerned, and somewhat puzzled, by the trend in UK productivity. A Bank of England study published in the Q2 Bank of England Quarterly Bulletin (http://bit.ly/1jtIX0k) provides a thorough if conventional perspective on the puzzle but admits the coverage of possible explanations may not be exhaustive. Here are a few more possibilities.

One hypothesis is that productivity has grown in the UK but has been overwhelmed by contemporaneous structural changes in the economy. In particular there has been a shift in employment towards low productivity sectors. This structural change would temporarily depress aggregate productivity growth. However the underlying aggregate trend will reassert itself once the structural change has taken place. Is there any evidence that this is a possible explanation? The striking feature of the post-crisis period has been the willingness of educated and skilled people to accept unskilled employment and lower wages. These are arguably typically low productivity jobs. This does beg the question as to why these sectors have been able to absorb the job seekers. It may be that there was a shortage of people willing to work in these sectors and this was previously holding bank expansion. The large number of evidently european migrants working in such sectors (coffee shops, restaurants, supermarkets etc) would suggest this is the case. However there has also been some obvious expansion in some sectors (gambling). It is a testable hypothesis.

A second hypothesis is that changes in employment regulation has encouraged labour retention and over staffing. Two possible examples immediately leap to mind. First, maternity leave and legislation encouraging the employment of women. It is very hard to adapt to a competent professional suddenly taking a significant amount of time off. It is easier if one has a little excess capacity in the first place. It is logical for employers to budget for such capacity when they employ women of childbearing age. Of course this issue is also present in other european countries which also typically have more generous maternity entitlements. It is unclear why it would have impacted UK productivity disproportionately in recent years. It may be that UK employers have only recently fully embraced the maternity leave entitlement and its implications. Second, the lengthening pension retirement age. Older workers will be retiring later and there is very little employers can do. This is a temporary problem but a relatively recent one in the UK and the response may well be to hire younger employees as well and except a period of excess labour capacity. Neither maternity leave nor lengthening retirement dates are unique to the UK but it may be that these and other developments are affecting the UK disproportionately at this juncture. Once again a testable hypothesis.

Finally, investment may be being temporarily depressed by political uncertainty in the UK. Specifically the matter of the EU and continued membership. This is not an argument that the UK is better off in the EU. It is that existing UK companies may view exit as damaging to their business and are holding off further investment until the risks become clearer. The May 2015 election is thus very important on so many levels. This is not ex ante testable but it is not hard to assess which companies might wish to relocate if the UK were to exit and how their investment plans may have been affected.

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