The Productivity Puzzle

In 2008, there was a global financial crisis. Almost no part of the modern world was unaffected. But after a year or two, though things weren't entirely back to normal, they were pretty close. Well, they were for most countries.

In the UK, producitivity never properly recovered. What's weirder: economists don't really know why. It's known as the Productivity Puzzle, and this is a quick exploration of it, mostly for my benefit. I wanted to learn how to use D3.js, and I also wanted to clear my mind by making a project using just Vanilla JS & CSS, no reactivity or UI frameworks. I don't know anything about economics at all, so this is just me having a prod around, idk what I'm talking about 🙏.

The IPPR puts it nicely:

"Two key statistics about the UK’s recent productivity performance are now common currency. First, there is a productivity gap of between 23 and 32 per cent between the UK and otherwise comparable countries: Germany, France, the Netherlands and Belgium. Second, there is a productivity gap of 17 per cent between the UK’s current level of productivity and what it would have been if it had continued to increase, at the average rate for the 25 years up to 2007, both during and after the 2007–2008 financial crash."

It's clear that apart from Italy (which has a visibly smaller growth rate before the crisis anyway), the UK is doing pretty badly compared to other countries.

First question: what does productivity even mean? Productivity is measured here as GDP per hour worked. What's strange is that if we take a look at these metrics in the UK, they were all doing just fine after 2008.

GDP Employment Total hours Productivity

So that's pretty interesting. Since productivity is GDP / hour worked, and the GDP and hours worked are both rising at a pretty similar rate, the productivity in red stays pretty much constant.

So is the problem with GDP being lower than before, or hours worked being higher than before? Here's a graph of UK labour over time

It's clear that labour grew pretty fast after the crisis - perhaps faster than it was growing before. And though part of that is due to "recovering" the jobs that were lost during the downturn, it's still significant - labour recovered more quickly than output did. It's said that following the recession, some UK firms "hoarded" workers, and so the UK's labour decline during the crisis was in fact not as dramatic as many other countries (source: UKCES).

The other factor here is that real wages in the UK did not stop declining until 2014 (and then only barely). These lower wages allowed firms to retain more workers. In previous recessions, firms laid off their least productive workers, resulting in an increase in average productivity. But lower wages this time around meant this did not happen.

Ultimately, wages might well have played a part, and the that labour grew rapidly after the crisis is interesting, but it doesn't answer the whole question.

Since this is a story of the UK vs other countries, we have to look at what makes the UK economy different to others. There are two relevant answers: the UK Finance sector, and government investment in the economy. Let's talk about the finance sector first. Here's a comparison of how much the G7 economies depend on financial services.

It's obvious that the UK is one of the most dependent economies on financial services. This underlines the longer term shift in the UK from an economy based on manufacturing and physical exports to one heavily reliant on consumer credit and financial services.

Though most economists regard the finance sector as creating value, some such as Mariana Mazzucato argue that finance is in the business of extracting value rather than producing it. By extension, a growing proportion of the UK GDP depending on the financial sector is probably not great. It's a sweeping generaliation, but the larger the domestic reliance on finance, the more leveraged the economy is, and the harder it is hit in a crisis.

So let's look at the second way the UK is different to many other countries: investment. The graph below compares Gross Fixed Capital Formation (GFCF, a macroeconomic measure of investment) in the UK with the other 36 OECD countries.

It's worth noting that more developed nations such as G7 members tend to have lower than OECD average investments. But still, the UK consistently ranks pretty low compared to other countries. The ONS notes that

"The UK economy is yet to see the strong recovery in fixed investment that is necessary for sustained GDP growth – with the level of investment 16.2% lower in 2013 when compared with 2008"

Well I'll leave it there. This hasn't been very coherent but I've found it interesting and now know the basics of D3. If you want to read more about this, I found a good starting place is the McKinsey institute report.

Feel free to contact me through my website if you want to chat!