By Conor Lambe, Economist at Danske Bank
Over the last couple of weeks, there have been a number of significant publications relating to the national and local economies. The Chancellor of the Exchequer delivered the Budget on 22nd November and this was accompanied by the Office for Budget Responsibility (OBR) publishing its updated forecasts for the UK economy. A few days later, the UK Government launched its Industrial Strategy. And in Northern Ireland, the Statistics and Research Agency released its annual research and development (R&D) data. There is a common theme that links these three publications – productivity.
Firstly, I think it’s useful to set out what productivity is and why it is important. Productivity is the amount of output that is produced in an hour of work. It can also be measured in terms of output per worker, but the hourly measure is a better one to use. When productivity is increasing, workers are able to produce more output in the same amount of time. Over the long-term, productivity changes are a key driver of economic growth, wage increases and living standards.
In the years leading up to the financial crisis, productivity in the UK increased at an average rate of just over 2 per cent each year. Since then, the average rate of annual productivity growth has been just 0.1 per cent. The flash estimate for the third quarter of this year showed that output per hour was just 0.7 per cent higher than its pre-crisis level in the last quarter of 2007. So effectively, in the last decade, productivity in the UK has been stagnant.
The UK’s productivity performance also looks weak when compared internationally. Last year, output per hour worked in the UK was around 15 per cent lower than that in the rest of the G7 advanced economies.
Given the poor productivity performance of recent years, the OBR’s latest economic forecasts – released alongside the Budget – included a large downward revision in its productivity projections. The OBR lowered its assumptions for growth in output per hour in each year of its forecast horizon. It now expects productivity growth in 2021 to be 1.3 per cent, down from the 1.9 per cent it expected in March of this year.
Against this backdrop, the UK Government announced its plan to address this long-standing issue. The textbook response to combatting weak productivity growth typically involves three things – improving infrastructure, investing in skills and encouraging more research and development (R&D) and innovation. These all featured in the Industrial Strategy published by the Government at the end of November. Some of the main policy initiatives included in the strategy are improving the quality of technical education, investment in transport, housing and digital infrastructure and increasing R&D spending to 2.4 per cent of GDP over the next ten years.
In Northern Ireland, poor productivity is one of the key challenges facing the local economy. Output per hour in Northern Ireland is around 20 per cent below that in the wider UK. Picking up on the point about R&D spending, 2016 data has been released showing the amount of expenditure in this area in Northern Ireland. The latest numbers showed a real terms decline in R&D expenditure of 3.4 per cent compared with 2015. The data did include a few positives. For example, in-house R&D spending as a percentage of GVA is marginally higher in Northern Ireland than in the wider UK and the number of businesses spending on R&D increased in 2016. However, if Northern Ireland is to improve its productivity performance, there needs to be strong and sustained real terms increases in total R&D spending.
The ‘productivity puzzle’ in the UK has been a key feature of the post-crisis economic recovery. And, according to the OBR’s forecasts, it is likely to remain a key determinant of the UK’s economic performance over the next few years. Raising productivity is crucial for the UK’s economic prospects. We can take some encouragement from the focus being placed on the issue by the Government. But addressing this challenge will take time. As the last ten years have shown, there is no quick fix when it comes to raising productivity.
This article was published in the News Letter on 5th December 2017.