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Tackling the productivity puzzle

As many firms, especially in hospitality and parts of the retail industry, struggle to keep business afloat, and workers try to hang on to their jobs under the cloud of an economy that is struggling to recover, we dream of better times coming soon. Once a sufficiently large part of the population is vaccinated, the economy may start to show green shoots as well.

It’s not easy to predict what the recovery from the COVID crisis will exactly look like. Economic sectors, businesses and workers have been impacted quite differently. While the economy should grow again in the next year, it remains to be seen how many businesses survive, and how much unemployment will rise before it begins to fall again.

Permanent damage or new opportunities?

Looking further out, the question is how much permanent damage has been done? On the one hand, some regions, industries, firms or cohorts of workers which already struggled before the crisis, may go into a downward spiral, or go out of business, leading to more people losing their jobs. On the other hand, the crisis may have spurred technological change and innovation. For example, accelerated digital transformation may improve performance of businesses permanently, and create room for new firms to start up and drive the recovery.

A new concerted effort by a large group of researchers, business executives and policy makers in the UK, brought together through , aims to provide solutions to the productivity puzzle, which has haunted the UK for at least a decade and a half, and help reverse the slowing productivity trend.

Why productivity matters

Productivity is important from a purely monetary perspective: if production per hour worked since 2007 had increased at the same rate as it did in the 15 years before, the economy would have been some £300 bn. larger today - equalling an average extra gain of about £11,500 per household in the UK.

But that’s not the whole story. The Productivity Institute’s journey starts with a narrative about why productivity matters for business, workers and society, and how it ultimately improves people’s livelihoods across the nation. As Nobel prize-winning economist, Paul Krugman, once quipped: “Productivity isn’t everything, but in the long run it is almost everything.” That statement is no overstretch. Productivity helps businesses to use their resources more efficiently, freeing up money for investment in new business activity and jobs. Productivity supports workers’ income. And productivity helps society as the proceeds from technology and innovation spill over to other aspects of life, including health care, education and smarter ways to clean up our environment.

Yet in recent decades, many of those mechanisms have broken down. Why? For starters, productivity measurement is tricky. While it is fairly easy to count widgets produced, it is much harder to measure the output of services which make up the bulk of our economy today. And what is the value of digital output, such as free apps and video streaming? And how do we compare the productivity of the gig economy with that of a traditional factory worker?

Economists have looked at the productivity issue for decades, but it’s been proven hard to pinpoint the key drivers of productivity. Fortunately, most modern-day economists have incorporated technological change, innovation and market imperfections in their thinking. But other disciplines can help to get to a better understanding of what motivates people to invest in education and training. Why do companies flourish in one place and not in another? And why have productivity gains helped profits more than labour income, and with the latter being increasingly unequally distributed?

Regional variations and short-term thinking

We also need to tackle the unusually large productivity gaps between regions and nations in the UK. Businesses are often facing markets that are too small. There is a lack of coordination to scale up, raising important political economy questions about the benefits and challenges of devolution.

Finally, businesses (and perhaps even policy makers) have become captured by short-term thinking and are driven more by quarterly earnings than by long-term growth objectives. This hampers reaping the long-term benefits from innovation and goes against the grain of building a net-zero carbon economy.

There is no silver bullet to resolve the productivity puzzle. The Productivity Institute has laid out the contours of a research agenda, covering eight critical themes, including Human, Knowledge and Organisational Capital; Geography & Place; Macroeconomic Trends & Policy; Institutions & Governance; Social, Environmental & Technological Transitions; and Measurements & Methods.

What needs to be done to make this concerted effort bear fruit? First, we need multiple disciplines to understand the causes of the puzzle. Second, we need a comprehensive and coordinated approach with research, business and policy in the room. And, finally, we need to focus on the long-term economic and social benefits of productivity, and better manage the short-term trade-offs.

Bart van Ark

This blog is based on the paper “A Concerted Effort to Tackle the UK Productivity Puzzle” written by Bart van Ark and Tony Venables of The Productivity Institute, published in the “International Productivity Monitor” Number 39, Fall 2020.

Blog posts give the views of the author, and are not necessarily those of Alliance Manchester Business School and The University of Manchester.

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