Solving UK's productivity puzzle is key to government finances

Britain's advanced economy and comfortable living standards have been built on productivity growth. Ever since the industrial revolution, economic growth has rested on the firm foundation of better use of buildings and machines and improvements in the level of output for every hour worked.

According to economists, little is more important than the efficient use of labour and capital. Over a decade ago, Paul Krugman, the Nobel prize-winning economist, famously said: "Productivity isn't everything, but in the long run it is almost everything".

Britain has a deep problem. Before 2008, an apparent iron law of the British economy was that output per worker - measured by amount of GDP generated - grew at a steady annual rate of roughly 1.75 per cent a year. Since the financial crisis, it has stalled, whether measured by output per worker, per hour or a composite measure taking into account the buildings and machinery also used to produce output.

Weak productivity growth is not solely a problem for the UK. The International Monetary Fund this month said "productivity has been increasing at modest rates across all major advanced economies", but Britain's Office for National Statistics has noted that the UK's productivity slowdown is almost three times as great as in the rest of the Group of Seven.

Understanding why Britain's productivity has been so poor could not be a more important subject for next month's general election. The Office for Budget Responsibility calculated in December that if productivity growth rebounded to the rate of the early 1980s, so great would be the boost to the economy that no further government spending cuts would be needed. Conversely, if productivity continued to stall, the parties' promises on tax and spending would be overwhelmed by budgetary crises over the next five years.

Theories have come and gone over the causes of the productivity slump, with little agreement save for the fact that there is unlikely to be one cause. The FT's analysis has produced a detailed examination of the sectors of the UK economy that have contributed, both before and after the recession.

Before the financial crisis, some sectors of the economy punched well above their weight in terms of productivity. Between 1990 and 2008 manufacturing, for example, contributed about a third of total productivity improvement for a sector that produced only a little over 10 per cent of output. Finance produced 25 per cent of the total productivity improvement for only 8 per cent of the economy. Lawyers, accountants and other similar professions accounted for 15 per cent of total productivity growth for a sector that only accounted for about 6 per cent of output, with telecommunications and computing contributing a similar amount.

In contrast, the oil and gas industry was a constant drag on productivity from the mid-1990s as it took more effort and people to extract the dwindling supplies of oil from under the North Sea. The education sector was also a persistent drag on productivity growth.

After 2008, some industries - in particular construction and the retail sector - were hit hard as demand dropped off suddenly while employment held up. But productivity growth has bounced back as companies have laid off staff and as consumer spending has recovered.

The oil and education sectors had weak productivity growth before the crisis and after, so have not contributed to the recent puzzle.

The FT's model, which estimated the contribution of each sector to the drop in productivity growth, found that four sectors - the professions, telecommunications, banking and manufacturing --account for 75 per cent of the drop in labour productivity growth.

The reasons are different for each group. Lawyers, accountants, management consultants account for nearly a quarter of the drop in productivity growth, mainly because this group had been so important in driving productivity before. Output grew over 7 per cent a year before the crisis, but only 2 per cent a year afterwards, while trends in hiring did not change nearly so much. The same story holds in computing and telecommunications.

In banking, output has declined since 2008 as balance sheets have shrunk and activities such as a selling personal protection insurance have ceased, while at the same time as staffing has continued to rise to meet stiffer regulations.

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