Why a nation’s productivity isn’t a ‘one size fits all’ matter

The outlook for UK productivity is hardly encouraging. The Office for Budget Responsibility is suggesting only anaemic growth over the next five years while a recent survey by the ONS points to the lag between the UK and most of its G7 peers.

Before we lament our lot, it is worth considering some of the differences between the UK labour market and those of its contemporaries.

UK labour force participation is very high and unemployment is low. This would illustrate that the UK has been successful in getting as many people as possible into productive employment, which is not the case in most European countries.

The main reason for this is the UK’s flexible labour market where employer costs are relatively low, such as national insurance, social security taxes, and so on. This encourages business creation and hiring.

In most of Europe, potential employers are deterred from hiring on the grounds of onerous taxes. Plus, where there are high levels of unemployment (with associated costs) and unfavourable demographics it makes it unlikely that these countries would look to reduce these business costs.

The downside for the UK here is that hiring people has proven easier and/or cheaper than investing in machinery and technology, not least because employers have had access to a large number of unskilled, lower cost workers from the EU.

The situation is worth comparing with Germany where low-skilled labour is expensive to hire. Instead employers have opted for machinery which has supported productivity. 

This is underlined by the fact that Germany’s economy has higher exposure to manufacturing, especially when compared with the UK, which is heavily geared towards service industries. Thus, German productivity has support as gains are easier to achieve in manufacturing than in services.

Germany’s high exposure to manufacturing is partly a function of its underdeveloped service sector, and the expansion of some service industries is constrained by industry regulation. For example, restricted retail opening hours, without which retailing would be able to expand to employ more people in lower productivity service roles.

Many of these roles could be sought by people looking to work part time, especially working mothers. However, there remain obstacles to encouraging women into the workforce, despite offers of increased parental leave. Germany has a socially conservative labour culture. For women, there remains the stigmatisation of working mothers as ‘Rabenmutter’ (‘raven mothers’).

A further limitation to the development of Germany’s service sector is its labour market regulation. For example, Germany imposes strict and rigorous requirements on anyone wishing to qualify in a trade. This restricts supply, and enables tradesmen to charge very high prices. Consequently, many Germans choose to do their own DIY rather than hire someone. 

This contrasts with the UK which welcomed, with minimal regulation, those with trades from EU accession countries, particularly Eastern Europe. Again this expanded the labour force through lower productivity service roles.

It is not clear that Germany’s ‘high productivity’ model results in a better outcome for its citizens when compared with the UK’s ‘lower productivity model’. Germany has the most unequal distribution of wealth in the Eurozone. This is also tied to Germany’s low unemployment rate. In 2003, after a decade of being labelled the ‘sick man of Europe’, Germany undertook a series of labour reforms. Part of these reforms included unions agreeing to below-inflation wage increases in order to avoid job losses. From 2001-10 German wage growth was flat in real terms.

We don’t yet know what Brexit will look like, but if it results in reduced low-skilled net immigration from the EU then it is likely that UK businesses would need to respond to any related shortage of workers by investing in automation or raising the productivity of a smaller workforce, as has already been the case in countries where labour is more expensive. Investing in and attracting higher-skilled talent would also lend support to more productive segments of the economy.

Separation from the EU could also encourage UK businesses to increase their competitiveness as they seek out wider export markets. As ever, though, much will depend on the outcome of Brexit negotiations.