Labour productivity measures the output per worker in a period of time. Labour productivity is an important factor in determining the productive potential of the economy. Countries with strong labour productivity growth tend to benefit from high rates of growth, strong export demand and low inflation. Increased labour productivity can enable a higher long run trend rate of growth.
Since the start of the great recession in early 2008, UK labour productivity growth has remained very low – well below the historical average. in Q2 2014 output per hour was some 16% lower than would have been the case had the pre-downturn trend continued.
This is a problem for long term economic growth and is one factor explaining the weak growth of real wages in the UK.
Recent UK Labour Productivity
ONS Labour productivity
Annual Growth in Productivity
In the post war period, UK labour productivity growth was averaging roughly 2-3% a year. However, since the start of the recession in 2008, UK labour productivity has fallen and is at a level close to the rate at the start of 2008 recession.
Labour Productivity since 1987
Factors affecting labour productivity
- Skills and qualifications of workers. If workers become more skilled with relevant training, then this can increase labour productivity.
- Morale of workers. In a period of industrial unrest and low worker morale, productivity is likely to fall. If workers are motivated and happy, productivity is likely to be higher. Morale of workers could be affected by wages, industrial relations, whether they feel they have a stake in the company, non-monetary benefits, e.g. do they enjoy the job?
- Technological progress. The implementation of new technology is one of biggest factors in improving productivity. For example, the assembly line introduced from the 1920s made huge strides in productivity. In recent years, the development of micro computers and the internet have also enabled improvements in productivity.
- Substitution of capital to labour. If labour becomes cheap and freely available, firms may have less incentive to spend money on capital and use labour intensive methods rather than capital intensive methods. Labour intensive processes are likely to have lower levels of productivity.
- Rules and regulations. If it is very hard to fire lazy workers, then productivity growth may be constrained. Though the absence of any labour market regulations could lead to high turnover and poor worker morale, which could also diminish labour productivity.
- Capacity utilisation. In a boom, firms may squeeze more output out of existing capacity through encouraging people to work overtime – this increases labour productivity. In a recession, firms may hold onto workers, rather than let them go – even if they are just working at 80% capacity – therefore labour productivity falls.
Why has UK labour productivity fallen during the 2008-14 Recession?
You might expect workers to work harder in a recession because they fear unemployment, but labour productivity has fallen. Some reasons could include:
- Labour hoarding. (When firms hold onto workers). Unemployment has risen by a smaller amount in the ’08-’12 recession – compared to previous recessions in 1981 and 1991, and now unemployment has fallen to 6.2% . This could support the theory that firms are preferring to hang onto workers, despite lower demand. Firms may feel this prevents having to rehire and retrain workers after the recession ends. Though the length of this current recession makes this surprising, and it’s uncertain why it’s happening in 2008-12 more than previous recessions.
- Low levels of investment. The credit crunch has held back investment because firms struggle to gain finance or don’t have the confidence to invest in new capital. This could hold back labour productivity growth.
- Rising employment / dodgy data. A strange feature of this recession, is that despite record falls in GDP, employment levels have been rising. Some query whether output figures are understated and employment figures overstated. But, this is unlikely to be happening. The downward trend in unemployment, suggests firms are keen to rehire workers.
- Falling real wages. During the recession, the UK has seen falls in real wage growth. If real wages are lower, firms may be more willing to employ labour rather than capital. In other words low wage growth means labour is relatively more attractive than usual. Therefore with lower labour costs, firms are willing to employ more workers and labour intensive production methods.
- More flexible labour markets. In recent years, UK labour markets have become more flexible, with more part-time, temporary contracts (e.g. zero hour contracts) This has helped reduce the cost of labour to firms, and therefore, they are more willing to employ workers, without rising productivity.
- European wide fall. The graph below shows that labour productivity has also fallen in other Eurozone economies.
Historical UK productivity
Implications of falling labour productivity
1. Lower output
This graph by the Bank of England show labour productivity compared to the pre 2008/09 recession trend.
The fall in labour productivity mirrors the fall in real GDP.
2. Lower wages
With falling productivity, firms cannot afford wage increases. This is leading to depressed income tax receipts for the government.
Comparative UK labour productivity
Between 1990 and 2005, UK labour productivity grew at a faster rate than Germany. Since 2005, German productivity has increases slightly more.
The drop in labour productivity of 2008-12 has been mirrored in other Eurozone economies. The US has fared a little better, but still saw poor productivity growth in 2005-08.
Importance of UK Labour Productivity
- Economic Growth. UK labour productivity is a key factor in determining long run economic growth. Improvements in labour productivity enable firms to produce more for lower costs. Without growth in labour productivity, it would be difficult to have strong economic growth. see: causes of economic growth
- Inflation. Rising labour productivity helps to keep costs and inflation low.
- Rising real wages. Rising labour productivity is a key factor in enabling rising real wages. If workers become more productive, firms can afford to pay them wage increases.
- International competitiveness. Improvements in labour productivity can help to boost the competitiveness of UK exports. See also: Factors that determine international competitiveness.
Labour Productivity Growth Selected Economies