Britain has a productivity problem

First the good news – the fall in living standards may be coming to an end, with wages starting to run ahead of inflation. Now the bad news: it is as much because wages are rising than inflation is falling – which suggests that high inflation is beginning to become embedded in workers’ expectations. Capital Economics is forecasting that next week’s inflation figures will show the Consumer Prices Index (CPI) at 6.8 per cent, down from 7.9 per cent last month. Average earnings figures, it predicts, will simultaneously rise to 7 per cent – up from 6.9 per cent last month and up from 6.1 per cent a year earlier.

This matters because the Bank of England’s strategy for tackling inflation has been based on the premise that the inflationary surge of the past two years is a one-off reaction to the economy’s re-emergence from the pandemic and to the Ukraine war. It has assumed that wages will not simply follow inflation upwards. Indeed, its Monetary Policy Report published last week forecasts that regular pay in the private sector will fall to 6.0 per cent by the end of the year, down from 7.7 per cent now. But will it? Now that regular pay rises have become an expectation there is every reason to suspect that workers will become more, not less, bold in their wage demands. The only thing that might change would be a recession with rising unemployment, making workers keen to hang onto their jobs at any wage.

The trouble is that with productivity growth non-existent in Britain at present there is no room for real-term wage rises. In the year to the first quarter of 2023 labour productivity per hour was down 0.6 per cent. It is now just 0.6 per cent higher than it was in 2019. In terms of output per worker, productivity is exactly where it was in 2019.  

Workers might think they deserve a real-terms pay rise because that is the way things have always been. But if they are not producing more, then sustainable real-terms pay rises simply are not possible – they will inevitably be eaten away by inflation as prices rise to reflect consumers’ extra purchasing power. Monetary policy might succeed in keeping a lid in inflation – although the Bank of England has failed miserably in this department over the past couple of years – but it cannot on its own generate real-terms wage growth. Britain’s problem is very much in the productivity department.

But to tackle that is going to require some hard questions about working practices. Since the pandemic there has been a concentration on work-life balance, with many workers now demanding the right to work from home if not to enjoy a cut from a five day to a four-day working week. Advocates of these measures often claim that working less improves productivity, but the evidence of the past four years hardly supports that assertion. If we want to return to real-terms wage rises productivity is going to have to dominate the debate.