Budget must address fall in productivity

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Britain's Chancellor of the Exchequer to deliver budget tomorrow

Few British budgets have mattered as much as the one that Philip Hammond will deliver tomorrow.

The chancellor of the exchequer must shore up Theresa May's perilously shaky government ahead of a vital Brexit summit of European leaders in mid-December.

At the same time, he has to keep a grip on the public finances. But the gravest challenge he faces is economic: Britain's persistent productivity blight.

Productivity - output per hour worked - is the mainspring of economic growth. In the decade before the financial crisis of 2007-08 productivity was increasing in Britain by just over 2 per cent a year, outpacing the average for the other economies of the G7.

But since the crisis, British performance has been dismal. Although productivity jumped in the third quarter of 2017, prolonged weakness means it is barely higher than its pre-crisis peak a decade ago. The recovery in GDP has been driven overwhelmingly by more labour input, a source of growth that is running dry.

Other advanced economies have also experienced setbacks to productivity growth following the financial crisis. Where Britain stands out is in the severity of its reverse.

The shortfall in productivity is the main reason real wages are now 4 per cent lower than 10 years ago, a potent reason why the leave campaign prevailed in the Brexit referendum.

Early detective work highlighted the impact of the financial crisis itself, which was especially severe in Britain. This held back productivity by throttling bank credit to new potentially fast-growing ventures and by jamming up the usual way in which capital moves from declining to advancing sectors.


Longer-term forces appear to be in play in Britain and elsewhere. Firms at the technological frontier continue to forge ahead in raising productivity.

However, the diffusion of their best practices within economies has slowed. An ageing workforce is now acting as a drag. And the contribution to productivity from improved educational attainment is falling.

One reason the productivity setback has been particularly severe in Britain is that its apparently robust performance before the crisis was overstated and unsustainable.

Banking activities ballooned on the basis of what turned out to be economically and socially harmful practices such as risky securitisations.

Despite making up less than a tenth of the economy, the financial sector has been responsible for nearly a third of the productivity slowdown.

Long-standing weaknesses in qualifications and skills have also become more damaging as business becomes more knowledge-based. Over a quarter of British working-age adults perform poorly in numeracy or literacy or both.

When he presents his budget, Mr Hammond will point to the fall in the budget deficit from a peak of almost 10 per cent of GDP after the financial crisis to 2.3 per cent of GDP in the financial year ending in March 2017.

But what matters now is the future path of the public finances. Britain's poor productivity prospects will box the chancellor in because GDP is the tax base and future revenues will be smaller to the extent that output per hour worked continues to stall.

The harsh reality is that Brexit will blight the public finances by hurting productivity. - REUTERS

Paul Wallace is a London-based writer.