Next week Chancellor George Osborne will deliver the first Conservative Budget since 1996, when he is expected to put some flesh on the bones of the next phase of welfare reform and where he expects to find an additional £10 billion plus of cuts. With almost half the welfare budget ring-fenced, this will not be easy and recent experience illustrates what it means for some “unprotected” departments when the cuts come.
Freezing allowances, for example, may garner an extra billion or two, suggesting the Chancellor will have to look elsewhere – perhaps housing benefit or tax credits – to reach his targets.
Given present difficulties, welfare is likely to dominate the local narrative on July 8, with some risk that the region misses the other key plank of the Chancellor’s package – a plan to address what has been the Achilles’ heel of this recovery - while the UK recovery has been job-rich and output now exceeds its pre-crisis levels , productivity is still some 15 per cent below a continuation of the pre-crisis level, with particular weakness in areas like financial and professional services, agriculture, energy, water and the public sector. In simple terms, why is it taking more labour these days to achieve the same output?
To be clear, it is not about the duration of the working week. The latest data for Northern Ireland, for example, revealed that this region is second only to London in average actual weekly hours worked (33.4) and the highest for part-time jobs at an average 17.8 hours.
Yet, Northern Ireland has a long-standing adverse variance in productivity to the UK average that is stubbornly around 20 per cent, a reflection of the size, scale and mix of the private sector that results in a proportionately larger number of lower value/skilled jobs.
Of course, the UK is not alone in wrestling with this challenge. It has become a global issue troubling policy-makers in the US, Japan and Europe - recent data has confirmed that average labour productivity in mature economies slowed again last year to 0.6 per cent from 0.8 per cent in 2013.
Furthermore, it seems the weaker trend pre-dates the financial crisis. Research published earlier this month by two academics Ken Coutts and Graham Gudgin – familiar to many in Northern Ireland – of the Judge Business School in Cambridge – suggests the decline in UK labour productivity has been generational, falling from an average 2.9 per cent for 1950-1980 to 1.8 per cent in the period to 2008 and minus 0.2 per cent since.
Various explanations have been advanced in an effort to unravel the productivity puzzle and here’s a flavour…
• The last decade has seen a huge expansion in the global labour force putting downward pressure on rates of pay.
• The financial crisis was marked by greater forbearance and lower levels of insolvency than might have been expected, perhaps resulting in capital not being re-cycled quickly enough to more productive use.
• The really big transformational innovations around technology, IT and automation have already happened and economies are struggling to match the “white heat” pace experienced during periods of the 20th century.
• Levels of business investment have dropped off the pace. Post crisis, the UK has seen a greater incidence of the substitution of (more cost-effective) labour for capital and what some regard as an inherent trade-off related to the flexible labour market model. France for example might demonstrate higher output per worker per hour than the UK but can also demonstrate higher unemployment.
• The measurement may not be accurate enough. As economies mature and become more service-orientated, gauging productivity in, for example, labour-intensive areas such as health and education is generally more complex.
• Perhaps patience is required – this seems to be the message of the Bank of England – If so, a productivity renaissance might be just around the corner.
Unravelling and understanding the productivity challenge matters and shouldn’t be an area reserved for esoteric discussion among economists in a dark room. In the medium term, productivity growth is the most important driver of prosperity and without it, an economy is destined to remain trapped in a low growth rut even as unemployment falls.
The Chancellor is aware that in the absence of a productivity rebound, wage growth will lag, average living standards will stagnate and income tax receipts will fall short of expectations, upsetting fiscal calculations. Furthermore, if the recent acceleration in earnings growth is not supported by productivity improvements, the timetable for an interest rate rise will be accelerated and economic growth may lose momentum. The imperative is even greater for economies with ageing demographics and slowing employment growth.
So expect more initiatives next week relating to super-charged Northern powerhouse cities with increased fiscal powers, new measures to strengthen education, skills & science and renewed efforts to boost entrepreneurship and capital/infrastructure investment.
Northern Ireland needs to be engaged on such matters too.
- Alan Bridle is UK economist at Bank of Ireland UK
