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Solving the UK's productivity puzzle

Despite the economic recovery, the UK's productivity is still low. We explore why and how can HR help to fix it

"It has been worse than we had expected and worse than we had expected for the last several years. We have been successively disappointed.”

As indictments go, this one made by Bank of England (BoE) governor Mark Carney earlier this year is pretty damning. It refers to the UK’s productivity, which is currently a fifth lower than the G7 average.

What this means more specifically is that while the UK’s economy seems to be recovering nicely, according to a 2.8% growth rate and the highest employment levels ever recorded, its GDP (gross domestic product) per worker, or per hour worked, is lagging seriously behind other developed nations. As a result growth in pay and living standards is also still weak.

However, things haven’t always been quite this bad. Up until the global economic crisis the efficiency of UK workers tended to increase by around 2% to 2.5% a year. Had this trend continued productivity would now be 15% higher than it was in 2007, which suggests the recession played a damaging role.

But, as the enduringly healthy productivity rates of Germany, France, the US and others show, the UK’s productivity problems can’t be wholly attributed to the downturn. What the UK and its government is facing instead is a complex history of underperformance in this area, with many inter-related factors playing their part.

A major contributor is the way productivity is calculated and whether the way we track this, and indeed attempt to boost output, is fit for our much more knowledge-based rather than an older industrial, manufacturing economy.

A complex picture

“In reality no-one knows exactly which factors are at work,” confirms Mark Beatson, chief economist at the CIPD. “The UK has had a productivity problem for decades.”

Duncan Brown, senior manager at UKCES, agrees that in attempting to uncover the causes we can’t just say ‘recession’ and move on, assuming things will now automatically pick up.

“You hear the term productivity puzzle and I think there’s real truth to that, because actually it’s not our experience that productivity always falls in a recession. If you go back to the 1980s and ‘90s recession, productivity actually increased.” The latest recession did however boast a number of unique features that could be argued to be on the path to righting themselves now.

One such feature, most experts agree, is labour hoarding, where firms hang on to staff they don’t need. Martin Upton, senior lecturer in finance at the Open University, says that this was particularly pronounced during the most recent downturn.

“Companies didn’t want to let go of talented people they’d have to replace when things picked up,” he explains. “Because of that hoarding, people tended to be put into areas that weren’t necessarily productive in terms of output – so marketing and business development, things like that.”

What may act as a continued drag even as the effects of labour hoarding diminish, however, are increased numbers of people in work for other reasons. If we calculate productivity as output per worker, it stands to reason that the more people that are involved, the worse productivity will be.

Indeed as part of his recent BBC Radio 4 Today programme warnings about productivity, the BoE’s Carney said that while net migration hadn’t played a significant role in stymying productivity, higher employment as a result of people working later into their lives, and workers of all ages now wanting more hours, had.

Anthony Hesketh, senior lecturer at Lancaster University Management School, adds: “You’ve also got changes to the social security system so a lot of benefits have been taken away. That’s dragging people who wouldn’t have ordinarily been in the labour market into low-paid jobs.”

Another issue unique to this recession has been poorly performing businesses managing to survive. “This recession didn’t lead to as much failure of organisations,” says Upton. “One reason is the banks have been more tolerant of businesses than previously. Secondly, the taxman has also probably been a bit forbearing; there’s evidence they’ve been granting extensions to companies in difficulty. The third reason is interest rates have been at rock bottom.”

Investing for success

These low profit, zombie companies (those unable to pay off their debts) can be expected to gradually disappear once interest rates increase, reports Beatson. What economists are less confident in happening now we’re in recovery is investment, something the UK has historically lagged behind on.

“The blitz spirit is fine but when the war stops you’ve got to do something different,” says Beatson. “There does need to be a changed mindset of doing something new. The question is: are the pressures on businesses quite enough to do that yet, particularly with interest rates still low.”

“The reason the money is still sitting on balance sheets is because people are very stressed about what could possibly happen; so what was going to happen in the general election and what will happen with the EU,” adds Hesketh, explaining that though this might seem sensible, it’s actually short-sighted; conditions could pretty much always be read as uncertain enough to justify a cautious approach, and the results can be dire.

“They talk about the lost decade in Japan, for example, where everyone just sat on their money because they were petrified about where the next yen was going to come from,” he says. “I don’t think we’re quite that bad in the UK. But what you’ve got to remember is today’s investment is tomorrow’s GDP.”

For a lot of people ‘investment’ immediately brings to mind machinery and technology – and certainly reluctance here plays no small part in explaining the UK’s historical productivity shortfall. But UKCES’s Brown says that this element is not as pronounced a part of the puzzle as you might think.

“Last year there was a big revision made to ONS data. Whereas before it looked like investment had taken a hit during the recession – which is quite normal historically – and flat-lined thereafter, the revised data suggests it has gradually recovered so in real terms we’re about where we were before the recession. So though it’s slowing down it’s not as low as we previously thought.”

Brown explains that economists often talk about three factors affecting productivity. The first is investment in equipment, the second is how educated workers are. He reports that the education factor is also no longer playing as significant a role in stifling productivity as it did previously.

“Obviously if you’ve got more educated workers coming through you’d hope they’d be able to do more with the equipment that you give them, and on that side it’s been a good time,” says Brown. “If you compare the educational opportunities of those young people coming through now to those leaving the workforce in the 1940s and ‘50s, they’re far better in terms of the numbers going to university. So actually we think that’s continued to add to productivity.”

The area Brown thinks should be given most attention is his third factor: an area entitled ‘total factor productivity’. But this is where things become even trickier.

Total factor productivity

“This is everything that we can’t really measure that well. It’s about what goes on within businesses; it’s everything they do to turn equipment and workers into products and services people want to buy,” explains Brown.

Within this total factor productivity category are many different but inter-related elements, including investment in R&D within companies, investment in training and all of the other things that will help to create a happy, healthy and productive workforce. These are aspects that perhaps don’t receive as much, or haven’t historically received as much, attention as the above more tangible factors such as equipment investment and economic climate. But we ignore them at our peril.

One part of this category receiving increased attention recently – and not a day too late in many people’s books – is strength of management within businesses. This is increasingly being recognised as key to the difference between the UK and other members of the G7.

“Work here at LSE shows you can explain about a quarter of US productivity superiority by management practices,” reports Anna Valero, research economist on productivity and innovation at the London School of Economics (LSE), adding: “The example that’s always given in the UK is family firms, which aren’t well managed.”

“In other countries such as Germany there’s much more of a pattern of family firms hiring external managers,” adds Brown.

Growing recognition of the important part total factor productivity has to play within overall productivity paints a picture of even greater complexity. Which begs the question: how exactly should we as a nation be tackling the productivity puzzle? How much of a role can government play and how much should businesses themselves be doing?

Certainly there are numerous things the government can do to help create the right economic and operating conditions for business’s productivity rates to thrive. And, despite a worrying absence of much talk explicitly about productivity pre-election, the government seems to be honing in on this debate now, with George Osborne promising a “productivity plan” in July’s emergency budget.

Infrastructure, namely transport, energy and broadband, is an obvious area for government. “We’d say the chancellor needs to make sure transport and broadband infrastructure isn’t squeezed unnecessarily just to get us through the next few years,” warns Brown.

Research and development

“Another key government policy is the science budget. That’s the money government puts into universities and research centres,” says Valero. “That’s really important in terms of having the ideas in the first place, but also there’s been loads of evidence that government funding of R&D then spills over into the private sector.”

She adds: “In this age of austerity we haven’t done very well at protecting that budget. So it was ringfenced by the last government in nominal terms but then because of inflation it actually fell in real terms. Other countries have done a lot better with that.”

Linking business with universities is important as well says Valero. She adds that government can also do a lot in terms of incentivising investment and innovation in businesses through financial structures and regulation.

She praises the UK’s record on R&D tax credits but says more needs to be done to readjust the banks’ emphasis from tolerating so-called zombie companies, to providing finance for innovation.

Education, education, education

Of course education lies firmly within the government’s remit too. “We’d like to see more joined-up thinking at a national level, so between BIS and the Department for Education, but also at a local level too,” says CIPD’s Beatson.

David Frost, group HR director and organisational development director at produce grower Produce World, adds that a much greater focus on equipping tomorrow’s workforce with technical skills is needed. “The UK for far too long hasn’t really gotten behind that whole area of education,” he says. “We just don’t have many specialists out there that can operate technical equipment and design manufacturing systems.”

Talk of education brings up the issue of immigration, and the ability of companies to overcome skills shortages by recruiting from overseas. The recent news that the skilled non-EU workers cap was reached for June and indications of planned crackdowns on immigration are causing concern.

“The UK, because of our demographics, needs immigration. We wouldn’t have a business without it,” Frost believes.

Referring to the Conservatives’ pledge to hold a referendum on EU membership by 2017, Frost adds though that he’s “more concerned about Europe”. He says: “We’ve got to be very careful. We’ve got people who have come from eastern Europe to work here and I think if we disaffect individuals that feel very committed to the UK that could become a problem. We need those skills.”

Even trickier for government to address though is that slippery area of total factor productivity. Clearly greater incentives to innovate, for example, will have an impact on how businesses, in the words of UKCES’s Brown, “turn equipment and workers into products and services”. But can government really exert influence over management styles and health and wellbeing policies for example?

Martin Mason, group leadership and talent development manager at Halfords, is one of an increasing number who feel in fact there is a certain role for government to play here. “Government doesn’t invest much in the behavioural and certainly nothing in the HR and L&D space. I think it’s a very undervalued area. I think if they gave that support it would be a real game changer.”

But there is still perhaps a limit. “Most of the work will come down to what happens in those companies,” says Brown.