Britain May Be on the Brink of a Productivity Breakthrough

Ryan Bourne

Nobel Prize winning economist Paul Krugman once said: “productivity isn’t everything, but, in the long run it is almost everything”.

Hammering home the point, he claimed that “a country’s ability to improve its standard of living over time depends almost entirely on its ability to raise its output per worker”

Britain’s post-crisis story of sluggish growth, stagnant wages, and worse-than-expected public finances can be entirely explained by this. Output per hour worked was just one per cent higher in 2017 Q3 than before the crash.

If the trend growth seen between 1970 and 2007 had continued, productivity would be 23 per cent higher today.

It’s therefore heartening that the most recent data shows a sharp uptick. At 0.9 per cent growth for the quarter, the figures for 2017 Q3 were the biggest improvement in output per hour worked for six years. The question now is whether this is evidence of a robust recovery or another false dawn.

Productivity growth generally comes from human ingenuity generating ideas, that are then dispersed by markets.

As with all economic data, one has to be a bit careful not to over-interpret. Productivity stats are an aggregate measure for the whole economy of output divided by total hours worked. If people freely choose to work longer hours, they produce less per hour, worsening measured “productivity”, though economic welfare has improved.

Economy-wide stats can likewise be dragged down by what we’d otherwise consider positive trends, such as more low-skilled workers or migrants moving into the labour market.

In some industries, such as politics and the media, underlying productivity might actually be improving. But people spending more of the time “freed up” to engage in leisure at work, by surfing Twitter or reading others’ articles, might mask this.

After recessions, too, statistical agencies can be slow to measure new types of output. The economist Jonathan Haskel, at Imperial College London, thinks about a third of Britain’s “productivity puzzle” can be explained by a failure to measure intangibles effectively, such as design and branding.

Yet all these caveats cannot explain the unprecedented structural break after the financial crisis. And one line of thought says that nothing fundamental in Britain really changed after the crisis, so the country could see the return of fast growth soon.

The economic historian Anton Howes explained this most clearly last year. Productivity ultimately arises through the proliferation of inventions and innovations in techniques and organisation.

These new ideas are dispersed through the economy, bringing with them economic gains. Sluggish productivity is then explained either by slowing innovation, or roadblocks to the diffusion of new ideas.

It is a stretch to suggest that the rate of inventions has slowed.

By 2030, the Boston Consulting Group estimates a quarter of all miles driven in the US will be in self-driving electric cars. Virtual online assistants proliferate on major company websites. Google has released headphones that can instantly translate 40 languages as you hear them. Microsoft now reckons that artificial intelligence is on par with humans in a conversational speech task for the first time.

So if inventions are progressing as swiftly as ever, has diffusing ideas become more difficult?

After 2008, capital markets were impaired. Extraordinary monetary policy may have kept zombie companies on life support. Weak foreign growth prospects may have deterred investments, and large fiscal stimulus crowded out private sector activity.

But as each of these potential headwinds unwinds, there is no reason to expect productivity growth to have slowed permanently.

In fact, if innovation has been largely unchanged post-crisis, Britain may be set to experience rapid catch-up growth as it integrates new innovations.

Now, changing demand patterns could quell this somewhat.

Suppose self-driving vehicles rapidly enhance productivity by delivering trucking and tax activities far more cheaply, and free up commuter time to work or read while travelling. This could bring huge gains to the economy. Yet if any savings were then spent on services such as health or social care, where productivity improvements are inherently difficult, then in future productivity growth could slow.

Yet even here there is great promise. An AI programme operating in the Houston Methodist Research Institute in Texas is able to review mammograms 30 times faster than humans, for example, with a 99 per cent accuracy rate. The possibilities are endless.

After a decade of slow growth, we adjust our expectations. But productivity growth generally comes from human ingenuity generating ideas, that are then dispersed by markets.

Provided Britain maintains its commitment to the latter, and does not opt for a socialist experiment under the likes of Jeremy Corbyn, the good times really could be just around the corner.

Ryan Bourne holds the R Evan Scharf Chair for the Public Understanding of Economics at the Cato Institute.