Of course, productivity has been falling for some time; it was 4.5 per cent lower in Q1 that at its peak at the end of 2007. But these latest figures are in a sense more disturbing than earlier ones. Economists had hoped during the recession and flatlining phase of the recovery that productivity had fallen because firms were hoarding labour in the hope of an upturn, and so it would rise when the recovery came and labour utilization rose. This hope now seems misplaced. We’ve got a strong recovery, now but productivity is still falling. This suggests that something else is to blame for the productivity malaise than mere labour hoarding.
Here, there are several suspects.
One is that the composition of output has shifted from high-productivity to low-productivity sectors of the economy. The ONS estimates that since the end of 2007, the output of financial services has fallen more than 13 per cent whilst that of retailing and care homes has risen. With productivity being higher in financial services than in the latter, this means aggregate productivity has fallen; productivity here is measured by wage levels rather than social utility.
A second theory blames the financial crisis in a different way. It says that a lot of productivity growth traditionally comes not from existing establishments becoming more efficient, but from “external restructuring” – from inefficient offices and factories shutting and newer ones opening. However, with bank finance less available (or thought by firms to be so), there’s been a slowdown in entry rates and hence lower productivity, as inefficient incumbents are no longer displaced by better ones. With bank lending to non-financial firms still falling, this looks unlikely to change much soon.
A third idea focuses upon secular stagnation. Years of low investment and a lack of technical progress mean that workers have little new equipment or ideas to work with - which naturally means less productivity growth.
Whether this is a temporary or longer-lasting problem is hotly debated by economists; Robert Gordon of Northwestern University says the latter, but Erik Brynjolfsson and Andrew McAfee say the former. Other economists, such as Laurence Ball of Johns Hopkins University, fear that the financial crisis itself has “had dire effects on economies’ productive capacity.”
There is, though, a more optimistic possibility. Carleton University’s Christopher Gunn says that productivity growth depends upon animal spirits; if bosses are pessimistic about the future or fearful for their jobs, they’ll not be so keen to invest in difficult jobs of training, investment and workplace reorganization which are productivity-enhancing in the longer run. If he’s right, the fact that business optimism is now rising should lead to faster productivity growth.
You might wonder why all this matters. It does so enormously, for two reasons. The near-term one is that a productivity stagnation, if accompanied by decent output growth, might well lead to higher interest rates. This is because the Bank of England would worry that higher unit wage costs and increased demand for labour will lead to higher inflation.
The longer-term worry is that without productivity growth we’re unlikely to see rising living standards. Paul Krugman’s famous quip “productivity isn't everything, but in the long run it is almost everything” is a cliché because it is true. If our children and grandchildren are to be better off than us, productivity will have to grow.
