UK Productivity Tracker

Why productivity is critical

Crucially for businesses, higher labour productivity means that they can produce more output for each worker they employ. Firms can increase productivity by improving the skills of the worker, increasing the tools available to the worker, or improving the efficiency of work. This then feeds through into higher profitability, wages and economic growth. For this reason, as renowned economist Paul Krugman put it in his book the Age of Diminishing Expectations, “productivity isn't everything, but in the long-run it is almost everything”.

Recent trends: Back on track or a false dawn?

Over the past two years (2021-22), UK productivity has grown at an annual average rate of 0.9%. This is almost double the annual average growth rate in the previous decade (0.5%). As a result, productivity is now marginally higher than pre-pandemic levels (see chart above). Productivity is a structural part of the economy, so generally we focus on the long-term trends, but it is possible that a significant event like a pandemic can result in a step-change in productivity levels or a different path for productivity growth.

In our view it is more likely this recent growth in productivity has been driven by exceptionally high consumer demand as we emerged from the pandemic in 2021 than a long-term structural improvement. At a time when firms have struggled to attract enough staff, many may have asked their people to work harder than normal to meet the higher demand. Though higher-than-expected productivity growth should be welcomed, we believe this will start to unwind as demand and worker availability normalises over the course of 2023. This will be one of the key themes our team will be monitoring throughout the year.

Sector trends: Identifying the star performers

Looking beyond the economy-wide figures for productivity growth, the sectoral story is much more varied. Manufacturing productivity levels have essentially flatlined since the pandemic started (1% growth). Over the last year, the sector has struggled with higher energy prices and shortages of critical inputs. This may have disrupted or decreased the use of energy-intensive capital, resulting in weaker-than-usual productivity growth. Though, despite facing similar challenges, the construction sector has fared slightly better, with around 3% productivity growth.

The services sector as a whole has also essentially flatlined (-1% growth), but there have been some green shoots. Sectors that have embraced the working-from-home revolution appear to be reaping some of the benefits, such as information and communication (12% growth) and professional and scientific services (8%). Historically, services productivity growth has lagged behind manufacturing as it has not been automated to the same extent. But this is rapidly changing, with the increased use of automation for routine tasks combined with sharper data analytics, in areas ranging from sales processing to audit. Given ongoing talent shortages, technology investment and automation will be increasingly critical in freeing up employees to focus on value-adding activities.

Unpicking the productivity puzzle

When asked for the main culprit behind the UK’s lagging productivity growth, most economists will tell you that the UK is not investing enough. UK business investment as a share of GDP has been on a downward trajectory since the 1960s. Today, UK businesses invest less than all of the other G7 advanced economies, including its peers in France, Germany and the US, once you account for the relative size of their economies. The UK also lags behind the other advanced economies on R&D spending^[1]. However, recent measures announced by the Chancellor in the Spring 2023 budget, including a temporary 100% capital allowance regime for the next three years, are expected to raise business investment by 3% over the duration of the regime, according to the OBR.

Higher levels of uncertainty provide one explanation for falling investment. The UK economy has been hit by multiple shocks in recent years: the GFC, the withdrawal of the UK from the European Union, COVID-19 and now the Russia-Ukraine war. This makes it harder for businesses to plan for the future. Though there are other explanations. To some extent, it just reflects the fact that it has become cheaper for companies to invest as the relative price of capital goods like computers has fallen over time. It is also partially explained by the reorientation of the UK economy away from capital-intensive sectors such as manufacturing towards less capital-intensive services sectors. 

Softer factors matter for productivity growth too. Empirical research suggests that around a quarter of cross-country productivity gaps can be accounted for by differences in management practices. There is also clear evidence that better-managed firms in the UK engage more in R&D and innovative activity than comparable firms, and generally have higher levels of labour productivity.  This relationship holds for all firm sizes, though larger firms tend to follow management best practices to a greater extent than smaller firms.

Spotlight on manufacturing: Reviving the engine of UK productivity growth

The manufacturing share of GDP may have declined from around 27%^[5] in 1970 to 9% today, but it has outperformed the services sector when it comes to labour productivity growth. In the 20 years prior to the pandemic (1999-2019), manufacturing labour productivity levels more than doubled (106% growth), while services productivity increased by just over one-fifth (21%). This exceptionally high productivity growth in the manufacturing sector, particularly in the decade preceding the GFC, has seen the sector make an out-sized contribution to whole economy productivity growth relative to the size of the sector.

Since the GFC, manufacturing productivity growth has slowed, down from around 7% a year to less than 2%, and this has brought down economy-wide productivity growth. This slowdown was broad-based, with all 10 manufacturing subsectors experiencing a reduction in annual productivity growth. The sharpest slowdowns occurred in the sectors that were growing the fastest in the decade prior to the GFC, such as textiles and leather, and electronics and optical. 

Unlike the rest of the economy, underinvestment has played a relatively minor role in the manufacturing productivity slowdown. Manufacturing investment as a share of manufacturing output has remained largely stable, dipping from 19% over the 1998 to 2007 period to 16% between 2010 and 2019. But there are other factors at play. The decade prior to the GFC was characterised by rapid globalisation. There is a wealth of evidence that increased international connectedness boosts labour productivity, as higher external competition creates a need for manufacturers and other firms to innovate to remain competitive^[6]. Since then, the pace of globalisation has slowed, due to strategic competition between the world’s largest economies and increased emphasis on resilience, and so too has labour productivity growth.

Bouncing back

The past 12 months have been challenging for the manufacturing sector. Rising energy costs and input prices more generally have intensified cost pressures for the sector, while demand has started to slow after the strong rebound in late 2021. Though with energy prices stabilising or falling, and supply chain pressures easing, manufacturers are optimistic about their ability to renew the rapid rises in productivity. In a recent survey by Make UK and PwC, more than one in three (36%) manufacturers told us that they expect to see productivity increases of up to 10% next year, while a sizable 19% expected an increase of between 10% and 25%. This buoyant outlook cuts across all sub-sectors, including the ones which experienced the sharpest slowdown in productivity growth after the GFC, such as textiles and leather, and electronics and optical.

Further gains on the horizon

There are further opportunities for manufacturers to explore new frontiers for boosting productivity through investment outside the factory gates. Just over half of manufacturing leaders (52%) plan to boost their human capital by increasing their investment in upskilling or retraining over the next year. While 43% plan to invest in green technologies or energy-efficiency measures in order to reduce their exposure to volatile international energy markets.

Four ways to fire-up productivity growth

Achieving productivity growth isn’t about working harder so much as working smarter and more efficiently – doing more for less. 

While dealing with the immediate challenges of inflation, supply chain disruption and fragile consumer demand, businesses out in front are sustaining targeted investment in the talent, technology and sustainability needed to secure their long-term future. Looking specifically at productivity growth, we explore four key priorities this quarter: