Productivity puzzle

Richard Jeffrey explores why productivity gains have been so hard to achieve in the major economies since the financial crisis


Richard Jeffrey

Richard Jeffrey

Chief Economist

Several countries have now reached a crucial staging post on the long road to economic and policy normality. In fact, were you to look at an array of headline data for the US, Germany and the UK, you would think that those countries were already back onto a normal growth path. However, there is one link in the drive chains of these economies (which have been amongst the more successful over the past seven years) that is not yet in place. While the headline growth numbers look reasonable, the underlying productivity trends have been worrying.

Productivity, which at the simplest level is the amount produced by the average working person over a period, is a strange number in that, although crucial, it is always measured indirectly. So, it relies on ourstatistical authorities producing accurate information on both total output and total employment. Putting that issue to one side for a moment, it is obvious that an economy can grow only if those in work produce more (that is, they can improve their productivity) or the number of people in employment rises.

Another important concept is that, to be sustainable, productivity improvements must be brought about without working people having to work ever harder – improvements must be the result either of better technology or of permanent efficiency gains. And one other fact is also worth highlighting: in the longer term, people can only be paid more in real terms if they produce more.

Growing economies

During the decade or so before the recession, the US, German and UK economies grew by average rates of 3.2%, 1.5% and 2.9%, respectively. Within this, productivity gains contributed 2.3%, 1.2% and 1.9% (it is worth noting that numbers for Germany are probably understated due tothe impact of reunification and the introduction of the euro). Making up the difference, all three economies saw growth rates enhanced though an expansion of the numbers in employment.

This reflected both increased workforce sizes and increases in the proportion of people of working age in employment. So, in the UK’s case, output (or GDP) growth averaged 2.9% per annum between 1993 and 2007, of which 1.9% came from productivity gains, 0.6% from an increased workforce size and 0.4% as a result of an increased proportion of the working population actually in work.

We can immediately contrast those numbers with more recent experience. Between 2010 and 2016, GDP growth in the UK averaged a respectable 1.9%per year. Of this, only 0.7% was as a result of productivity improvements, while 0.8% reflected increases in the size of the total workforce and 0.5% came from increased employment.

So, the total rise in the numbers in work has contributed 1.2% to the average annual growth rate in the UK during the recovery from the great recession. In the US, the equivalent percentage is 0.9% and in Germany it is also 0.9%; these numbers can be contrasted with productivity gains of just 1.0% and 1.1%, respectively.

The bigger picture 

While, in international growth terms, it may be GDP numbers that determine who tops the league, in the context of intrinsic economic wellbeing, it is growth in GDP per head of population that is vital. In nations with unchanging population age profiles, growth per capita will be virtually identical to gains in productivity.

For those countries with ageing populations, however, per capita growth will tend to be lower than productivity growth – something that will intensify the issues caused by weak productivity trends. For the US and UK, ageing is not so much of a problem. For Germany, it represents a dark shadow over future growth.

Hidden dilemma 

To an extent, countries like the US, Germany and the UK have been hiding behind the satisfactory growth numbers reported since the recession and have been able to brush off weaker (but more important) trends in productivity. Near-full employment with domestic labour forces and the likelihood that immigration will contribute less to growth mean that this will no longer be so easy to distract attention from. It will be incumbent on policy makers and the wider economics profession to come up with more coherent explanations for recent trends.

If, as I strongly believe, weak productivity trends in advanced economies during the period since the recession are linked directly to very low interest rates and bond yields, then rising rates in the US and, more recently, in the UK, should initiate an improved productivity trend.

In essence, my analysis suggests that low interest rates induce economic laziness.

The challenge of higher interest rates should encourage companies to undertake higher levels of productivity-enhancing investment in new technology.

In the context of the EU, one further observation is pertinent to the position in Germany and the UK. While tapping into the cheaper EU pool of labour may be beneficial at the corporate and GDP levels, it is not beneficial to people already in employment. It is not so much that bringing people into the workforce from overseas forces down wages; rather it is that having access to a supply of cheaper labour discourages companies from undertaking the productivity-enhancing investment that would otherwise lead to real income growth for those already in employment.

One final observation is appropriate for the UK. I estimate that recent annual GDP growth numbers have probably been understated by round 0.25%. While this would boost recent productivity growth to average an annual rate of around 1%, the fundamental problem is only modestly reduced.


Richard Jeffrey

Richard Jeffrey

Chief Economist

Richard Jeffrey was Chief Economist at Cazenove Capital until he retired in January 2018. 

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