A productivity boast that deflates under scrutiny

Nine years ago, when Gordon Brown unveiled his first spring Budget, he declared that “over the next few years we must seize this opportunity by challenging ourselves to lift our productivity”. Nine Budgets later, Mr Brown is claiming some success, but it is far from clear that Britain really is in the early stages of a US-style productivity miracle.

On Wednesday the chancellor proclaimed that “after decades behind, Britain has caught up with Germany in productivity, is ahead of Japan and has halved the gap with France”.
This is true only on the Treasury’s favoured measure of output per worker. Measured by output per hour, Britain remains far behind France and Germany, though the gap has narrowed somewhat since 1997. The difference arises from the fact that the gap in hours worked per worker has widened since Labour came to power.

Britain’s productivity performance during Mr Brown’s decade as chancellor compares favourably with continental European economies. But that is hardly a stern test. A more instructive comparison is with the US and with Britain’s own historic productivity performance. Office for National Statistics figures suggest that on both measures the gulf between the UK and US was broadly stable between 1997 and 2004; rival datasets are less flattering.

Mr Brown on Wednesday made the bold new claim that trend productivity growth since 1997 has been higher than in previous cycles. This is promising but the evidence is incomplete, in part because of difficulties adjusting for the cycle. While productivity growth from 1997 to 2001 was strong by UK standards, it has been much weaker since, with particularly poor productivity growth in 2005.

By contrast, figures from the Conference Board, a business group, which are not cyclically adjusted, suggest output per hour has grown more slowly under Labour than it did under the Conservatives, rising 2.1 per cent a year from 1987 to 1995, 1.9 per cent a year from 1995 to 2000 and 1.8 per cent a year from 2000 to 2005.

It is still too soon to say whether Mr Brown’s policies have succeeded or failed. There are time lags involved, and to some extent – less than the Treasury would have us believe – underlying productivity growth has been masked by rising employment of lower-skilled workers. Still, it seems fair to say that Mr Brown’s policies have not delivered tangible results as soon as he hoped or expected.

One of his biggest disappointments must be the failure of businesses to respond to improved macroeconomic stability by investing more and so raising capital per worker, one of the main determinants of productivity.

In a rare moment of candour, the Budget report admits that “measured rates of UK business investment as a percentage of gross domestic product have not yet caught up with rates in Germany, France and the US”. If investment remains subdued in the years to come, it is hard to see how output per hour could race ahead.

Mr Brown has focused recent efforts on microeconomic policies, promoting what he calls the “five key drivers of productivity”: competition, enterprise, science and innovation, skills and investment. The big changes have come already, including tougher competition policy and a big increase in funding for education. Wednesday’s Budget contained the familiar annual instalment of extra initiatives. Some of the measures were gimmicky: £50m more for enterprise capital funds. Others were sensible if hardly revolutionary: a consolidated medical research budget, emphasis on science in schools and lifelong learning.

Critics argue that there are serious flaws in Mr Brown’s microeconomic agenda. Research and development spending remains low in spite of tax credits. Transport infrastructure is poor and Britain still has a long tail of low-skilled workers. Proliferating initiatives and a complex tax system carry high compliance costs and a rising tax burden may blunt incentives to perform.

Yet Mr Brown, crucially, does understand the opportunity for Britain to embrace global competition, open markets and inward investment as engines of productivity growth and higher standards of living. His initiative to promote London as a global business centre stands in welcome contrast to the defeatist protectionism in much of the rest of the European Union.

Mr Brown must pray fervently that the current very tentative evidence of rising productivity growth is confirmed. Since he became chancellor incomes per head have risen impressively, with only moderate productivity growth, due to rising employment rates. But employment rates cannot be increased forever, particularly given an ageing population, nor can hours worked.

In the future, a Britain quite possibly led by Mr Brown will have to rely much more on productivity growth to sustain or improve recent increases in incomes. As Paul Krugman, the US economist, famously put it: “Productivity isn’t everything. But in the long run, it is almost everything.”

krishna.guha@ft.com