How firms can solve the productivity puzzle

Addressing the UK’s productivity problems has become essential to help businesses fight the challenges of inflation, slowing business confidence and labour shortages.

Productivity growth has been poor in most advanced economies since the 2008 global financial crisis (GFC). The UK has underperformed most major economies since then, and is currently at its worst recorded level.

Our economic report “More jobs but little productivity in the Eurozone” highlights how many countries struggle with productivity. It details how sluggish reallocation of labour since the pandemic has slowed productivity growth and hampered economic recovery, especially in areas with limited labour market flexibility.

Why the UK lags behind other countries

The report highlights that the US and Italy have seen strong productivity growth due to higher output produced per hour, rather than hours worked. But in France, UK and Spain, productivity is still below the pre-pandemic trend, due to lower output per hour and hours worked. In the UK, it’s the result of lower hours per worker.

In Italy and the US, job creation has slowed and companies have ramped up efficiency to make up for labour shortages. By contrast, Office for National Statistics (ONS) data shows the UK’s productivity problems worsened further this year. In January to March 2023, output per hour growth was the weakest since 2013, excluding the pandemic. Output per worker has also barely improved since 2017.

This matters because productivity growth links directly to GDP and incomes – the higher the growth, the better for companies, employee’s pockets, and government tax receipts.

What’s causing poor productivity?

There are many other potential factors behind the UK’s low productivity growth.

Some say the country over-relies on cheap, often foreign, labour while neglecting the capital investment required for strong productivity growth – although others argue a good flow of cheap labour makes businesses more competitive.

Another potential factor is insufficient vocational training and workplace skills. In 2021, the government quickly introduced reforms to technical education and training to improve national productivity. However, a 2022 National Audit Office report cast doubt on the effectiveness of these reforms so far, as indicators were heading in the wrong direction. It said the scale of skills challenges have grown significantly.

However, the UK economy is still resilient. Economic growth has not fallen as sharply as expected in the current downturn. If it continues to ride out the storm and recover strongly, so could investment levels. This would support stronger productivity, growth incomes and tax receipts, potentially creating a virtuous circle.

How to improve productivity – the search for a solution

The role of automation

Automation and artificial intelligence are fast evolving with huge potential to increase efficiency and productivity by, for example, cutting out manual tasks, reducing errors and supporting communication, innovation and creativity. Early research shows a wide range of productivity improvements through using artificial intelligence.

The UK is well-positioned with a high state of readiness to adopt AI.

However, it faces stiff competition worldwide. For example, Japan is another front-runner with a programme for improving productivity that includes accelerating use of AI, attracting researchers, promoting innovation and implementation, and collaborating on research with other countries.

Where from here?

As the report highlighted, there are no “easy wins” when trying to tackle the UK’s poor productivity performance.

According to a 2022 report from the Skills and Productivity Board (SPB), place-based inequalities are greater in England than in most comparable countries. A growing inequality in productivity between regions is driving this, and leading to low wages and living standards, and a vicious cycle.

Solving productivity therefore requires nuanced, localised approaches and long-term planning from successive governments. Constant policy changes cannot help.

But there is some hope in the continuing resilience of the UK economy and its opportunity to use emerging technologies. The existence of high-productivity firms across every sector, shows that with the right management, firms can narrow the productivity gap.

UK companies should look at challenges such as inflation and labour shortages as catalysts for higher productivity growth – and make it a burning priority.