“Productivity isn’t everything,” the Nobel laureate Paul Krugman has written, “but in the long run it is almost everything.” Sustainable gains in living standards are only possible if output per worker goes up and Britain’s performance has long been disappointing. Hence, in his spring statement, Rishi Sunak stressed “creating the conditions for accelerated growth and productivity”.
The chancellor is right to perceive the urgency of the challenge. Unless the puzzle of low productivity can be solved, household incomes will stagnate and the country will become relatively poorer. Mr Sunak’s proposed remedies are sensible but they are long term. The risk is that Britain will meanwhile be locked into a cycle of depressed output, real wages and tax revenues.
For most of the postwar era, Britain’s productivity grew by 2 to 3 per cent a year. Between the financial crash and the pandemic, however, it barely expanded at all. Judged by output per hour, its productivity is roughly at the level of Italy, whereas the American economy is estimated to be a startling 23 per cent more productive than Britain’s. The equivalent figure for France is 18 per cent higher, and for Germany it is 10 per cent. Mr Sunak stresses three issues: private sector investment, education and technical training, and a culture of innovation. These are sound aims. The chancellor points to the fact that in Britain corporate investment amounts to 10 per cent of GDP, compared with an average in countries within the Organisation for Economic Co-operation and Development (OECD) of 14 per cent. He has signalled that in the budget this autumn he will provide further tax breaks for business investment.
In his budget last year he gave generous capital allowances for corporate investment in plant and machinery to the end of 2022-23. Whether an extension of this approach will be effective depends on the investment being something the companies would choose to do if financial conditions allowed. Investment is vital but it can sometimes be wasteful, as happened in the dot-com bubble 20 years ago. Tax breaks will work if they bring forward investment programmes that give a more than proportionate boost to national income. The same test holds for public sector investment in infrastructure.
On vocational training, Britain again lags the OECD average. Tax incentives to boost training of workforces in skills is valuable, but the effects are unlikely to show up in the data in the immediate future. Lastly, encouraging innovation through regulatory reform and tax credits for research and development works with the grain of the market. The history of capitalism is dotted with inventions that boost productivity, such as containerisation or the microchip. The market economy allows entrepreneurs to succeed, and government should encourage this activity with financial incentives.
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For Britain the problem is urgent. Its productivity record is poor and it has lagged behind the eurozone and the OECD since 2016. Uncertainty over Brexit has deterred investment and constrained productivity growth. It is Mr Sunak’s task to help turn that performance round. The levers available to him are limited, for wealth creation depends on private enterprise rather than the state. These are the right areas to be looking at, however, and the chancellor’s aims are sound. Britain’s economic prospects and the wealth of the nation rest on breaking a cycle of low productivity.
