UK's productivity gap has grown under coalition government

"We literally cannot afford to go on like this," was the stark warning from the UK coalition government four years ago in 'The Plan for Growth' - its assessment of the economy's problems and how to fix them. "We have to become much more productive so we can be a leading high tech, highly skilled economy."

Since then, the UK's productivity problem has only worsened: output per hour lagged behind the rest of the G7 by 6 per cent in 2007, by 15 per cent in 2010 when the coalition took power, and by 17 per cent on the most recent data.

Economists neither agree nor fully understand why UK productivity growth has stalled since the financial crisis. But all would agree that government policies on investment, education, regulation, innovation and skills affect productivity growth over the long term.

In spite of its rhetoric about the need for change, economists say the coalition's approach to so-called supply side policy has been broadly similar to that of the last Labour government, both in terms of its strengths and weaknesses.

"Changes in policy under the coalition government are unlikely to have made a big difference," Nicholas Crafts, a professor at the University of Warwick, concluded in a recent paper. "On the one hand, this means opportunities for radical reform have been ignored; on the other hand, there has been no repeat of the 1930s debacle," when the response to crisis was to abandon free trade.

Although UK productivity levels have lagged behind the G7 average for decades, the gap had been closing . That was thanks to reforms initiated by Margaret Thatcher's government in the 1980s and continued by New Labour after 1997, according to Prof Crafts. Trade barriers were reduced, competition encouraged and higher education expanded.

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The UK also punches above its weight in science: with 0.9 per cent of the world's population and 4.1 per cent of its researchers, the country accounts for almost 16 per cent of the world's most cited scientific publications. From the steam engine to the internet, science and innovation have been fundamental drivers of productivity growth. The coalition has tried to preserve the UK's advantage by protecting science funding from spending cuts in cash terms. And it has set up seven "catapult centres" in strategic sectors to promote research and development collaboration between scientists and businesses.

But in areas where the UK was weak, economists say the coalition has done too little. Chronic under-investment in infrastructure is one example: the net stock of public capital - which includes government-owned infrastructure assets - relative to GDP fell from 64 to 36 per cent between 1980 and 2010. The coalition carried out its predecessor's plan to cut investment spending sharply in the early years of the parliament.

"It was a big mistake of Labour to plan big investment cuts and it was an even bigger mistake of the coalition to implement them, and they know that perfectly well, I think," said Jonathan Portes, director of the National Institute of Economic and Social Research.

The planning regime also hurts productivity by distorting land prices and curbing the growth of cities. The coalition's 2012 National Planning Policy Framework introduced a presumption in favour of development, but for Prof Crafts this was "only a timid step in a direction favourable to growth".

Similarly, the coalition has tried to inject more competition into the UK's banking system: new lenders would help promising start-ups find funding. Even though six new banks have been authorised by regulators since 2013, Barclays, Lloyds, HSBC and Royal Bank of Scotland still control 85 per cent of small business banking between them.

"Arguably the coalition had a window of opportunity after the crisis to do much more to de-concentrate the banking system," said John Van Reenen, a professor of the Centre for Economic Performance at the London School of Economics.

The UK also suffers from high youth unemployment and a shortage of skills in sectors such as engineering and construction, two productivity-damaging problems that could be addressed through better vocational training.

The coalition has boosted the number of apprenticeships and commissioned the Richard Review - a detailed examination of how to make them more rigorous and responsive to business needs.

Baroness Alison Wolf, a professor who specialises in the relationship between education and the labour market, praises the Richard Review but warns there are still too many subsidies for full-time higher education rather than vocational training.

The challenge for the next government will be to build on these modest beginnings. But, as Mr Portes warns, it will be a long haul.

"Supply side policies are slow, they're complicated, and they don't necessarily get you anything in the short run."

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