Hammond’s goal in this Budget should be to restart the productivity engine

Published on Public Finances and the Economy

As a nation, we’re working smarter than we used to. A decade ago, for every hour we worked, we produced about £31.30 of stuff; today each hour of graft generates £31.85 of output. That sounds like good news. If we’re becoming more productive we should be able to treat ourselves to a pay rise, or perhaps some more time off. But the problem is, growth in our output per hour of 1.7 per cent over the last ten years compares with an average of 2.3 per cent every year in earlier times. Average annual growth over the last ten years is the worst we’ve recorded since 1812 – the year Napoleon invaded Russia. We’re working smarter, but nowhere near as smart as we’re supposed to be.

Our response has been to work harder instead. Millions more of us are in employment today than anyone could have expected just a few years ago. And the decades-long downward march in the average number of hours we work has gone into reverse too. Between us we worked more than 53 billion hours last year; back in 2007 the total was 49 billion. But the productivity disaster dominates. If our output per hour had continued to rise at its long-run trend rate after 2007, our economy would be £430 billion bigger today than it actually is. More likely, we’d be a little bit less well-off than that figure suggests, but working a lot less too.

Importantly, our productivity woes are about more than a collapse in output in the immediate aftermath of the global slowdown. Even as economies around the world have started to recover, the amount we produce for every hour we work has remained stubbornly stagnant.

Why? In short, no one really knows; but we do know it’s complicated.

It’s likely that a number of factors are at play: from problems in the financial markets, to low interest rates helping prop up unproductive firms that in other periods would go out of business, to question marks over the quality of the millions of new jobs created over recent years. There may be some issues too with the way in which we measure productivity (though the fact that pay has flat-lined in recent years implies that we can’t be that wrong on our output metric). Low investment is undoubtedly an issue too, with business uncertainty (stemming first from the financial crisis fall-out and more recently from Brexit) acting as a barrier to long-term planning.

Given that productivity growth effectively represents free money, governments are always keen on talking it up. We can expect next week’s Budget to be no different. Even more so given the news the Office for Budget Responsibility (OBR) is set to deliver Philip Hammond before he speaks.

The fiscal watchdog has long been of the opinion that the UK’s productivity stagnation is a temporary phenomenon, with a return to pre-crisis trend rates of growth just around the corner. But it has signalled that it will deliver a different message next week, significantly revising down its forecast for our productive potential as a country. The Bank of England has already done so, assessing that the pace at which we can expand output per hour every year has been halved since 2008. If the OBR follows suit, then it is likely to set out a vision for the UK economy that is £44 billion smaller in 2022 than it had expected it to be when it delivered its last outlook back in March.

That has serious implications for the Chancellor’s public finances, constraining the room for manoeuvre he has relative to the borrowing rules he has set himself. But the OBR’s revisions will also bring the ongoing squeeze on household finances into sharp relief: that £44 billion reduction in the size of the economy would translate into roughly £650 per person.

Faced with such an outlook, it’s important that the Chancellor avoids the temptation to argue that the OBR’s downgrade has tied his hands. Rather he should take it as a prompt to do more to support households.

His ultimate goal must be to restart our productivity engine. That will take significant investment – in infrastructure, kit and people. But it will take time too, meaning he also needs to recognise the difficulties facing families in the here and now. That means revisiting his plans for cutting billions from the working-age welfare bill and putting a halt to expensive tax cuts that disproportionately benefit the better-off. As things stand, the government’s approach to tax and benefits is set to lengthen the squeeze on incomes and underpin the sharpest rise in inequality since Margaret Thatcher was in power.

Britain is working harder than ever before. The Chancellor should do what he can to make sure that hard work is rewarded.

The blog originally appeared on Prospect magazine’s website.