Productivity: the key to recovery

Comment & Analysis

productivity

Bart van Ark stresses the importance of productivity in any post-pandemic economic revival and highlights seven central issues

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The Covid-19 pandemic is one of the largest challenges to human, social and economic welfare for half a century. But it’s arguable that the uphill work will really only start when it is over. In particular, the aftermath of the pandemic could be a fork in the road for UK productivity.

Why does productivity matter? Wouldn’t it be more important to focus on maximising job growth and helping people make a decent living? The answer is that – as much as job creation is the priority – a job recovery without productivity growth will sputter out. We learned that lesson the hard way after the financial crisis of 2008-09. If “output per hour worked” (the simple definition of labour productivity) had increased since then at the same rate as it did in the 15 years up to the crisis, the economy would have been some £300bn larger today. That equates to an average extra £11,500 or so per UK household.

As Nobel prize-winning economist Paul Krugman once quipped: “Productivity isn’t everything, but in the long run it is almost everything.” That is no overstatement. Being productive helps businesses use their resources more efficiently, freeing up money for investment in new business activity and jobs. Productivity supports workers’ income. And productivity helps society as the proceeds from innovation spill over to other aspects of life, including healthcare, education and smarter ways to clean up the environment.

In recent decades, many of those positive feedback loops seem to have broken down. Many advanced economies have had low rates of productivity. The UK has suffered more than most, including Germany, France and the US. The proximate reason for its poor productivity record is chronic underinvestment in its key growth drivers, notably human and physical capital. But there are other “missing capitals”, such as intangible assets. Making the right capital investment is critical in driving technological change and innovation. It is what powers productivity growth.

The bigger question behind relatively poor productivity is why the UK is lacking – or misallocating – these investments. Major culprits may be fragmented decision-making and the absence of functional ecosystems involving business, government and research institutions at local, regional and national levels. Policy initiatives can suffer from a number of ills, such as overcentralisation, a top-down approach, short-termism linked to the electoral cycle, silos and the absence of effective joined-up government, as well as lack of meaningful engagement with stakeholders (both governmental and nongovernmental) beyond Westminster and Whitehall.

What does this mean for the post-pandemic recovery? Given the complexity of boosting productivity, things look stacked against us. At The Productivity Institute, we believe that seven central issues need to be addressed to understand the challenges and the opportunities:

1) In a “normal” recession, industrial sectors are often the ones hit first and hardest. That is because they are directly exposed to cyclical changes in the global economy through the impact on supply chains, etc. The Covid-19 recession is different. The pandemic has battered domestic services, including the hospitality industry, parts of the retail industry and other sectors that are most affected by social distancing measures. These are labour-intensive sectors that typically have relatively low levels of labour productivity. Hence a perverse effect of closing most of them down is a potential uptick in productivity in the short term, which – if all remains as it was – will evaporate once the recession is over.

2) Productivity typically picks up after a recession because output tends to recover faster than hours worked, as companies wait for the recovery to take hold. But the recent extensive use of furlough programmes could tamp down the usual replacement of less productive companies by more productive ones. It could also limit incentives for productivityenhancing measures and investment. That holds despite the record-low bank rate.

3) The pandemic has accelerated digital transformation in several ways. Most visibly, the rapid shift to “working from home” has boosted the use of communication technologies. Once we are past the pandemic, some of the old “nondigital” behaviours may return, but it is hard to imagine that some good practices will not remain. That is likely to set a new and higher baseline for productivity, but make productivity growth harder. The bigger prize of creating ongoing growth comes down to long-run opportunities in digital transformation and innovation. A lot of ink has been spilled on whether digital transformation actually boosts productivity. Paraphrasing another Nobel prize-winner, Robert Solow: “We see the digital revolution everywhere but in the productivity statistics.”

4) Many businesses, both in manufacturing and in services, have struggled to adapt their innovation models to make the most of advances in mobile technologies, cloud services, artificial intelligence and robotics. One possibility is that it is just a matter of time and that the true effects may become visible in the upcoming recovery. But that will be contingent on critical investments in research and development, people’s skills and complementary intangible assets. Those assets include business innovation processes, management and other types of organisational capital.

5) Productivity and competition have a complex relationship. Productivity benefits from competition between companies, but it also requires coordination between all of the actors involved, including business, government, workers and schools. New technologies tend to favour scale and network effects, and create winner-takes-all companies – especially in the tech sector itself. While such concentration effects can be good for innovation and productivity, they can also create negative externalities in other sectors of the economy. For example, end-users can become locked into one technology, incumbents can dominate newcomers and small companies can be prevented from scaling up, which stifles productivity.

6) When it comes to UK productivity, politics – and in particular Brexit – can’t be ignored. In the short run, Brexit’s disruption to supply chains and the potential loss of foreign markets is likely to weigh on the productivity recovery in 2021. In the longer run, the effects are more uncertain. Much will depend on the ability to restructure the UK economy faster than might have been possible as part of the EU, and on creating resiliency and flexibility to develop and access new markets with competitive products and services.

Workers may experience scarring effects from being out of a job or education for too long

7) Finally, the distribution of the gains from productivity is of critical importance. The recovery from the current crisis looks “K-shaped”. That is, some parts of the economy will benefit while others will suffer. Some industries and companies are better positioned than others to ride the recovery with new technologies and innovation models, with better-skilled workers and growing markets. Some regions may also come out of the recovery strongly, but areas that were underperforming before the crisis are unlikely to be among them. Similarly, well-educated people, especially those with digital skills, are likely to benefit. Other workers may experience scarring effects from being out of a job or education for too long. Then, as digital transformation accelerates, artificial intelligence and robotics will eat ever further into the labour market, potentially creating more losers than winners as even non-routine tasks are automated.

Conclusion

The Covid-19 pandemic creates opportunities as well as challenges. In particular, it’s a chance to create a sustained recovery in productivity driven by technological change and innovation. If we scale up productive companies and help workers develop and apply skills that equip them for the digital economy, we can grasp the opportunity. But it’s only within reach if there is a concerted effort by research, business and policy to create strong ecosystems that operate in a coherent, coordinated and long-term manner. More than ever, such a concerted effort is what is needed in the UK and elsewhere in the advanced world.

Bart van Ark

Bart van Ark is a professor of productivity studies at the Alliance Manchester Business School (AMBS) at the University of Manchester. He is also managing director and principal investigator at The Productivity Institute