What’s happening with UK Productivity?

The Office of National Statistics’ (ONS) recent numbers for labour productivity and employment illustrate the “productivity puzzle” facing the UK at this time. There are 30.15 mil- lion people (aged 16 and above) in employment, up 280,000 from the previous quarter. However, on an output per hour basis, labour productivity decreased by 0.3%. This fall is reflected by the sluggish output growth towards the level before the global financial crisis. What is baffling is why firms continue to employ workers who are producing less in a contracting economic environment.

Rather, the financial crisis was a prominent factor in the makings of this tradeoff between employment and productivity. We observe productivity continuing to fall, with brief periods of improvement to- wards the pre-crisis benchmark serving merely as glimpses of yesteryears. The latest output per hour decline of 0.6% in manufacturing doesn’t lend a helping hand to the situation as firms struggle to finance new investments that necessitate high productivity. It would seem that banks are still scarred by the events in 2008 and reallocation of capital from less to more productive firms is unlikely to happen until the credit concerns are addressed.

A firm would only have the incentive to hire more disinclined workers if the wages they paid to them take consistent dips. That is, firms will give a higher nominal wage so long as inflation thins real pay. The UK’s considerable consumption demand will motivate firms to do this. This fall in real wages played a role in reducing labour productivity by allowing firms to employ more workers than they would otherwise have done.

Some firms would continue to hoard labour through a downtrend with the promise of readily available human capital when growth resumes. In a competitive world this makes sense, with the firm employing the larger workforce being able to respond quickly and take full advantage of a boom.

What is baffling is why firms continue to employ workers who are producing less in a contracting economic environment

Should we be worried about the productivity puzzle? In short, yes in the long run and no in the short run. Over time, the cost to the economy may be severe. A high productivity economy is important not only for sustained output, growth and competitiveness but also for the development of technology which further enhances workers’ ability to produce.

We can continue to live with this tradeoff because the immediate tomorrow is one with people doing jobs, earning a living and (slowly) contributing to the economy. The worry is what will happen the day after.