UK: DAVID SMITH - ECONOMIC TRUTHS - THE CRUELLEST CUTS PAY DIVIDENDS/UK productivity appears to be catching ... - DAVID SMITH - ECONOMIC TRUTHS - THE CRUELLEST CUTS PAY DIVIDENDS/UK productivity appears to be catching up with Europe as manufacturers retu

by DAVID SMITH, economics editor of the Sunday Times.
Last Updated: 31 Aug 2010

DAVID SMITH - ECONOMIC TRUTHS - THE CRUELLEST CUTS PAY DIVIDENDS/UK productivity appears to be catching up with Europe as manufacturers return to more traditional ways of paring down overheads.

A short time ago I had a public debate on the relative performance of the British and German economies with Bob Bischof, the British-based German businessman. Things were going pretty well from my point of view until, in a wounding thrust, he decided to raise the question of Britain's abysmal productivity performance.

I had one or two answers prepared. Better to have a high-employment, lower-productivity economy, I suggested, than the continental European alternative. Also, Britain's firms were inclined to hang on to labour through the business cycle, rather than slash it at the first whiff of gunpowder, showing a commendable long-termism.

But productivity is a sticky wicket for defenders of the UK economy, not least when the Government itself trumpets the fact that worker output in Britain is 20% behind France and Germany and 40% adrift of the US.

For a long time, we could get away with the fact that, having started a long way behind - sick man of Europe in the '60s and '70s - we were at least catching up. But even that excuse began to wear thin when, as the Treasury pointed out, productivity growth in British manufacturing appeared to have shuddered to a halt around 1994 and failed to come to life since. Where were the benefits of the flexible, deregulated UK model?

Where were the effects of the IT revolution? Certainly not, it appeared, in the productivity statistics.

Meanwhile, to add insult to injury, those stodgy, unreformed economies in continental Europe appeared capable of putting Britain in the shade.

In 1997-98, manufacturing output per worker in the 11 countries which went on to form the euro area (Euroland to you and me) grew at an annual rate of 6%. It was enough to make any patriot hang his head in shame.

Never say never is, however, a useful rule of thumb. After a long slumber, productivity in Britain appears to be picking up as manufacturers have begun to resort to more traditional job cutting in the face of adversity.

It could have been the warnings of an impending global crisis; it may have been that industrialists, believing for so long that a falling pound was around the corner, got fed up waiting and decided to act. Whatever it was, there was a notable shift and manufacturing employment has dropped by 200,000, some 5% of the total. Not only that, but output has started to pick up, with manufacturing productivity rising at a 3% annual rate and set to climb towards that 6% rate enjoyed recently by our European partners and rivals.

This does not mean it is time to call time on all the productivity-enhancing ideas being knocked around by industry and government. We need more investment, R&D spending, a better skilled and educated workforce, better management and so on. And there is still no sign for the wider economy (ie services) of an IT-led productivity revolution, a British equivalent of the claimed new US economic paradigm. But it is a start.

By happy coincidence, this has been accompanied by an abrupt productivity slowdown elsewhere in Europe. According to the European Central Bank, Euroland's manufacturing productivity dropped from the 1997-98 6% rates to -2% in the first half of this year. Whole economy productivity growth in the euro-11 economies, which averaged more than 3% a year over the period 1993-98, appears to have greeted the birth of the euro with a slowdown to 1%.

This, like in Britain earlier, can be explained by cyclical factors.

European economies, except for the smaller booming countries such as Ireland, have experienced a surprise deceleration in growth, and, while unemployment has remained high, employment has not been cut. Something had to give and it has been productivity, although there appears to be slightly more to it. In countries such as Spain where labour-market reforms have encouraged firms to hire more freely, a step-change may be occurring in the level of employment relative to output. That is: European firms are now less inclined to economise on labour.

Related to this, as happened when Britain joined the European Exchange Rate Mechanism (ERM), wage settlements in the traditionally high-inflation euro-member countries have come down sharply. And, as Klaus Baader of the investment bank Lehman Brothers points out, when unit labour costs are rising only slowly there is less incentive for companies to push through productivity improvements. The introduction of the euro, by producing a dramatic convergence of inflation performance, may paradoxically have contributed to this European productivity slowdown.

Finally, while European manufacturing productivity growth has tumbled, it may also be the case that a shift from high-productivity manufacturing employment to lower-productivity service sector jobs is producing a shift towards lower overall productivity, as happened in Britain some time ago.

None of this, of course, means that the productivity battle between Britain and Europe is over. But it is certainly joined.

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