This report by Daniel Harari for the House of Commons, explains why productivity is important to growth, the public finances and living standards, analyses whether the stagnation in productivity is temporary or permanent, looks at the impact of Brexit on productivity growth and outlines Government policy. International comparisons are also included.

Productivity is directly linked to living standards, with a country’s ability to improve its standard of living over time almost entirely dependent on productivity growth.

Productivity has stagnated since the financial crisis

Historically, UK labour productivity has grown by around 2% per year but since the 2008/2009 recession it has stagnated. The level of labour productivity in Q1 2017 was still 0.4% below what it was over nine years earlier in Q4 2007.

The persistent weakness in productivity has puzzled economists and there are many alternative theories to explain it, including:

  • Weakness in investment
  • Lack of lending to more productive firms
  • Creation of less productive roles
  • Slowing rate of innovation and discovery

None is sufficient on its own to explain entirely what has happened. This makes it difficult to predict when and if productivity growth will return to pre-crisis rates of growth.

Brexit impact

The impact of Brexit on productivity will be felt principally via trade and investment. Economic theory and academic literature show a link between an economy’s degree of openness to foreign trade and investment and its productive capacity.

The UK’s new trading and investment relationships in a post-Brexit world will be important in determining Brexit’s impact on productivity and economic growth.

The changes to the UK’s trading arrangements with the EU and rest of the world will take time to develop and come into effect. The majority of economists believe that the final post-Brexit settlement will leave the UK economy less open, likely lowering the UK’s long-term productivity and growth rates compared to a scenario where the UK had stayed in the EU.

Government policy

The Government had published number of ambitious plans over the last two years, but considering the current state of affairs after the last election, would any of these materialise.

  • In July 2015, the Government published its 15-point productivity plan: Fixing the foundations: Creating a more prosperous nation. The plan aims to improve the UK’s transport and digital infrastructure, increase investment in the economy, enhance the skills of the workforce, build more houses, move people off welfare and into work, encourage exports, and rebalance economy away from London.
  • Prime Minister Theresa May’s Government in January 2017 published a Green Paper on its industrial strategy. The paper states that improving productivity is a key objective of the strategy. The Conservative Party manifesto 2017 emphasised the importance of the industrial strategy in dealing with long-term productivity issues and also stated the ambition to raise overall investment in R&D across the economy from 1.7% of GDP currently to the OECD average of 2.4% within 10 years.
  • To that end, increased government investment will come from the creation of a National Productivity Investment Fund (NPIF), announced in the November 2016 Autumn Statement. Over the course of the four years from 2017/18 to 2021/22, the Government allocated £23 billion in spending for the new fund to be spread across four main areas: housing, transport, digital communications, and research and development (R&D).

Regional and international comparisons

London has the highest levels of productivity, by some margin, of any region or country in the UK. Wales has the lowest.

International comparisons of labour productivity show that the UK was ranked fifth of the G7 countries, with Germany top and Japan bottom. In 2015, UK productivity was 19 percentage points below the rest of the G7 average, the same productivity gap as in 2014 and the largest since at least 1995 when the ONS data series began. Since 2007, only Italy has seen weaker productivity growth than the UK among G7 countries.

The briefing provides latest statistics on UK productivity including breakdowns by sector and region/country of the UK.

Commons Briefing papers SN06492

Author: Daniel Harari