Weighing up four theories on the UK's productivity gap

Theories abound over the causes of the UK's slump in productivity since the financial crisis; here are four explanations.

It is not as bad as it seems

Solving the "productivity puzzle" means explaining why output per hour worked in the UK is more than 15 per cent below where it would have been if the pre-crisis trend had continued. However, there may be problems in the way we measure both today's productivity and the pre-crisis trend.

For a start, it is possible that output per hour today is higher than we think. Estimates of gross domestic product are often revised over time, and the Office for National Statistics has tended to err on the side of caution - meaning upgrades have been more frequent than downgrades. We may also be exaggerating the number of workers, for example if some of the growing number of self-employed are actually not working.

It is equally conceivable that we were overestimating productivity growth before the crisis. In the oil and gas sector, the depletion of the most accessible basins means it will take more workers to extract the same amount of natural resources. In the financial sector, some of banks' output before the crisis was the result of too much risk-taking, which has proven unsustainable.

Adjusting for these measurement errors goes some way in reducing the gap, but economists believe it is simply too large for this to be the whole story.

Workers stealing the robots' jobs

Some economists, including John Van Reenen at the Centre for Economic Performance, believe the productivity puzzle is a consequence of Britain's slow recovery.

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The problem with this argument is twofold. For a start, other studies, including one by Jonathan Haskel at Imperial College and colleagues have found that the slowdown in investment in new machines and equipment is insufficient to explain the slowdown in productivity growth.It is also possible that, as productivity fell, companies were forced to cut back on the wages they were paying. In that case, it was low productivity that led to low pay, not the other way round.

Credit where credit is not due

The financial crisis has had deep consequences for the functioning of the financial system. The Bank of England lowered interest rates to 0.5 per cent in an attempt to boost the economy. Banks became more risk-averse and less willing to extend credit to new companies. They were also reluctant to stop lending to companies in trouble; instead, "extending and pretending" allowed them to avoid having to recognise losses on their books.

Ben Broadbent, deputy governor of the Bank of England, believes all these factors may have led to a fundamental misallocation of capital in the economy, with less efficient businesses reaping the funding which should have gone to more productive start-ups. The Bank's ultra-cheap borrowing costs had the unwarranted consequences of keeping "zombie" companies alive, preventing the kind of "creative destruction" which can help renovate an economy during a crisis.

Proponents of this argument point to the level of company liquidations in the UK, which has remained unusually low throughout the crisis and to the number of lossmaking businesses, which increased significantly. However, by the Bank of England's own measurement, this theory can only explain less than a third of the productivity gap.

The era of inventions is over

Prof Haskel and his colleagues believe that the productivity puzzle cannot be explained as the consequence of insufficient investment. Instead, they argue the British economy has become less efficient at turning labour and capital into productive output. As economists would put it, Britain has seen a collapse in the rate of growth of "total factor productivity".

Prof Haskel admits it is impossible to pin point one factor to explain why the economy has all of sudden become less efficient. Instead, he makes several conjectures. One is the slowdown in the amount of research and development undertaken by companies and the state since the 1970s compared with the immediate postwar period. As R&D's affect on productivity has a long lag, what happened forty years ago may help to explain the productivity problem Britain faces today.

This argument fits broadly into the view that the pace of innovation worldwide is slowing. As the ICT revolution runs out of steam, economies are unable to generate inventions which produce large gains in efficiency. However, not everyone is convinced: "I do not believe we have become 15 per cent stupider," said Prof Van Reenen. "In fact, with scientists working on artificial intelligence and robotics, we may be on the cusp of a number of major breakthroughs".

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