We have certainly failed to nurture human capital, but the gains from the digital economy could take time to become clear
Half of Britain’s productivity gap with Western Europe is a statistical mirage: a cyclical effect, or a failure to measure services and the 21st-century digital economy. The other half is painfully real. It stems from two generations of failed policies that have left a quarter of the population outside the modern economy. The pathologies have been allowed to fester for so long that it is beyond the power of any chancellor to reverse, and this one has seen half his fiscal headroom wiped out by lower forecasts.
The Office for National Statistics (ONS) said trend productivity growth was around 2pc until it buckled a decade ago. It has never recovered, and is now 20pc below its previous trajectory. To the extent that the figures are true, this is a death sentence in economics.
Getting more from each hour worked – through better technology – is what lifts living standards, generates taxes, and whittles away debt. Without it, everything goes off the rails.
All rich states have suffered a productivity shock since the Lehman crisis, but not to the same degree. We have slipped six percentage points against the G7 bloc. The ONS says UK levels are 25.6pc below Germany, 22.3pc below France, and 21.8pc below the US.
Philip Hammond joins a long list of chancellors determined to end this malaise. His National Productivity Investment Fund will spread £31bn in seed money over six years. Britain is “taking the first strides” towards a target of 2.4pc of GDP in R&D investment.
Well, high time too. He omitted to say that this distant figure is merely the OECD average. Today we are languishing at 1.7pc while Nordic highflyers are nearer 3pc.
The OECD says the self-defeating austerity cuts of the post-Lehman era have left the UK with a public investment shortfall of 13pc of GDP by 2020, with gaping holes in transport, power, and water. Given that we could have borrowed at real rates of minus 1.5pc for projects with ironclad returns from future economic dynamism, the strategy was obtuse.
The Government has since grasped the nettle. Projects now in the pipeline will gradually unblock bottlenecks that have gummed up the economy.
If you think – as I do – that electric vehicles and self-drive technology will sweep through the auto industry like a forest fire, then it is a national imperative not to be left behind. The £400m earmarked for charging stations is a minimum down-payment. We must be careful not to take self-flagellation too far. Current data overstate the productivity gap, and are misused by EU cheerleaders. Years of mass unemployment flattered the productivity data in France and Club Med, since low-skilled workers are first to be fired. Spain saw rocketing “gains” as it fell into the depression after the housing boom.
Britain’s job-rich recovery had the opposite effect. The eurozone economy is now catching up thanks to ultra-loose money. The jobless rates are plummeting. This distortion will fade.
“Productivity has always been a huge black box and it is becoming even more difficult to understand,” said Bill White, chairman of the OECD’s Review Committee.
Prof Patrick Minford, from Cardiff University, says Britain is penalised in the beauty contest for its service-based economy. “All the official gloom is totally misleading. According to the ONS, productivity in education, healthcare and social services has been falling since 1998 at 4pc a year, an obviously absurd figure,” he said.
This is not the fault of the ONS. It is a global leader for cutting-edge measures of services. The problem is that not every country operates in the same way. If we used (excellent) Irish methods, Britain’s implicit output would be 5pc higher and our “productivity puzzle” would vanish. Some countries raise eyebrows. Few believe that Italy is 9pc more productive than Britain.
Yet Britain has plainly failed to nurture human capital. The message of the OECD’s country report is that chunks of society have been left on the scrap heap. This pulls down the productivity average. London is a powerhouse but it also hogs 30pc of capital projects, receiving £1,000 per capita each year in transport infrastructure spending compared with £200 for Wales and the East Midlands. No other OECD country has such large disparities in productivity.
In the end, the productivity puzzle may solve itself. It is questionable whether the worldwide productivity crisis is as bad as it looks. It flies in the face of galloping digital change we see all around us. Steel ingots are easy to count. The GDP effect of a free map on smartphones is not.
The productivity gains may catch up with a lag in any case. Edison introduced electric power to New York in the 1880s but the electrification boom had to wait until the 1920s.
The Office for Budget Responsibility has just slashed its productivity forecast for the UK after getting it wrong year after year. Perhaps it is the contrarian signal the great snap-back is coming.