The Problem. Both HM Treasury and the Bank of England have recently highlighted the puzzle of Britain’s terrible productivity growth. The Chancellor devoted a chapter of his budget report to the topic and the Bank’s chief economist gave a lengthy speech last week. So what do we know?
Echoing Winston Churchill’s put-down of Clement Attlee, economics is modest on what drives productivity and has much to be modest about. However, Andy Haldane did a good job in rounding up the usual suspects with regards to causes …
- Mismeasurement – with services comprising four fifths of the UK economy, measuring “output” has become increasingly difficult
- After-effects of the financial crisis – through restricting and distorting the supply of credit
- Low interest rates – in preventing the “creative destruction” of weak firms
- Slowing innovation – more recent innovations may have been less potent in sparking strong output growth
- Slower spread of technology – perhaps due to the restrictive nature of intellectual property rights or the monopolies enjoyed by several large ICT firms
He also noted that the productivity slowdown is global, it is not recent but dates to the 1970s and it is occurring in both advanced and emerging economies. And, finally, recent research has highlighted the long tail of low-productivity non-frontier firms. Britain has a few world class, industry leading companies but a vast number falling a long way short.
Possible Solutions. The Treasury solution was classic Sir Humphrey Appleby. Set up an independent review (with a peer as chairman); publish green papers; re-jig technical qualifications; create a National Productivity Investment Fund (but don’t give it much money); and so on. This may help at the margin but it will not transform UK productivity.
Meanwhile, Andy Haldane’s big idea was to create an app! This app would measure a firm’s productivity and benchmark it against other similar companies. This in turn would encourage them to do better. He would also introduce a mentoring system. It looks underwhelming.
To be fair, though, Haldane finishes by saying that “marginal improvements accumulated over time can deliver world-beating performance”. He may be right.
Economic Consequences. In our view, the productivity puzzle is more important for inflation than growth. The UK labour market is close to full capacity and the Brexit vote reduces the supply of imported labour. Thus, unless firms operate more efficiently, they will be forced to bid up wages and in turn prices.
The other key point is living standards. Theory suggests, and the chart roughly shows, that real wages depend upon productivity. If the authorities do not solve the productivity puzzle, then Britain’s standard of living will stagnate.
Market Consequences. Other things equal, flat productivity growth at full employment implies either higher inflation or slower growth. In practice, we may get both. The consensus for next year is 1.2% growth and 2.7% inflation.
This may push gilt yields up a bit but not much. Similarly, those numbers are not good news for the equity market but they are not disastrous. We are sure that the FTSE 100 and the FTSE 250 would much prefer to see 2.7% growth and 1.2% inflation. However, the actual consensus does not herald a bear market by any means. Sadly, it looks like soggy returns ahead for both gilts and UK equities.
Our investment strategy committee, which consists of seasoned strategists and investment managers, meets regularly to review asset allocation, geographical spread, sector preferences and key global market drivers and our economist produces research and views on global economies which complement this process.
Our quarterly report presents our views on the world economic outlook and equity, fixed income and foreign exchange markets. Please click the link to download.
