UK labour productivity suffers sharp relapse in Q4

The UK Office for National Statistics (ONS) has reported that output per hour worked fell 1.2% quarter on quarter (q/q) in the fourth quarter of 2015. This was the sharpest q/q drop since the fourth quarter of 2008. It marked a major relapse after output per hour worked had previously risen by 0.6% q/q in the third quarter and 0.8% q/q in the second quarter. There had also been a gain of 0.2% q/q in the first quarter. The 1.2% q/q drop in output per hour in the fourth quarter of 2015 was the consequence of gross value added rising by 0.6% q/q but the number of hours worked increasing by 1.7% q/q. The year-on-year (y/y) increase in output per hour fell back to just 0.4% in the fourth quarter after rising to 1.5% in the third quarter from 0.5% in the first quarter of 2015 and 0.0% in the fourth quarter of 2014. The ONS reported that output per hour actually rose 1.0% overall in 2015, which was the strongest increase since 2011. This was led by the services sector (up 1.4%). However, output per hour in manufacturing fell 2.1% in 2015, obviously reflecting the sector's downturn.

Output per hour worked is considered the most meaningful measure of productivity. Other measures show that output per worker was flat q/q in the fourth quarter of 2015 and up 0.5% y/y. Output per job actually inched up 0.1% q/q and was up 0.6% y/y. The UK has recorded disappointing overall productivity since the 2008/09 downturn, as is evident from the ONS indicating that output per hour in the fourth quarter of 2015 was "some 14% below an extrapolation based on the trend prior to the economic downturn". The second- and third-quarter 2015 improvements had fuelled hope that productivity was finally seeing sustainable, decent improvement.

Outlook and implications

The crucial question for the UK economy is: did the fourth quarter of 2015 mark a temporary relapse in productivity, or is it evidence that the UK has an ongoing serious productivity problem? How productivity develops is critical to the economy's growth potential. It is notable that when the Office for Budget Responsibility (OBR) significantly downgraded its growth forecasts for the UK economy both for the near and medium term in the March budget, it was because it took a markedly less optimistic view on productivity than in November 2015 when providing the Autumn Statement projections. Specifically, the OBR stated, "The data available in November showed a pick-up in productivity growth in mid-2015, consistent with our assumption that the receding financial crisis would exert less of a drag and that trend productivity growth would return to its pre-crisis average rate by the end of the forecast. But more recent data suggest that this was another false dawn. With the period of weak productivity growth post-crisis continuing to lengthen, we have placed more weight on that as a guide to future prospects – although this judgement remains highly uncertain."

The marked relapse in productivity in the fourth quarter of 2015 is undeniably very disappointing and it does raise serious, justifiable questions about likely future developments. Nevertheless, IHS believes there are good reasons to expect productivity to pick up after the fourth-quarter relapse and achieve sustained improvement over the coming quarters. Despite the fourth-quarter 2015 relapse, there are signs that UK companies have stepped up their efforts in recent months to get more out of their workers, and April's introduction of the National Living Wage gives them added impetus to do so. Notably, the Bank of England's regional agents reported in their first-quarter 2016 survey of business conditions that, "For some companies, capital spending was being supported by R&D [research and development] expenditure, the introduction of higher-margin products, and efforts to improve productivity."

Business investment rose by a healthy 5.2% overall in 2015 after a gain of 4.7% in 2014, which will hopefully increasingly feed through to support productivity growth. Meanwhile, decent credit conditions, low interest rates, and companies' generally healthy cash positions should be supportive for companies wanting to invest to try to lift their efficiency and productivity. Certainly, part of the UK's recent poor labour productivity performance has been due to the fact that employment held up well during the downturn and then picked up markedly. Low wage growth increased the attractiveness of employment for companies. This meant that it was easier for companies to hold onto workers even when they did not really need them in order to retain their experience and knowledge. It is also evident that during the economy's struggles and early stages of upturn, some companies employed more people, or at least retained workers, as they found winning orders more resource intensive in an environment of thin demand. Additionally, some companies may have taken on workers earlier than they really needed them during the upturn to ensure they obtained the best staff possible. In all these instances, there should be scope to get more out of their workforces.

However, there are a number of factors that might have hurt productivity on a more lasting basis. In particular, there is concern that the economy's past prolonged weakness and financial sector problems may have hurt productivity through past under-investment and an inefficient allocation of resources. There is particular concern that an extended inability to access capital has held back innovation and investment by smaller companies. In addition, there has been concern about the impact of "zombie" companies that have essentially been kept alive by low interest rates and banks' reluctance to write off loans. Not only are these companies generally less productive, but there is concern that they are preventing credit and resources from being reallocated to newer companies and backing new products and processes.