Economics

Lessons from Europe: How the UK can solve its productivity problem

BY Ian Stewart   /  23 July 2018

A personal view from Ian Stewart, Deloitte’s Chief Economist in the UK. Subscribe to & view previous editions at: http://blogs.deloitte.co.uk/mondaybriefing/

Britain’s recent record on growing productivity and wages has been lacklustre. In the UK GDP per hour worked, the main measure of productivity, has risen by just 2.2% since 2010, less than a third the rate seen in Germany.

Poor productivity tends to suppress wage growth. On average UK wages after inflation have fallen by 1.6% since 2010. Over the same period good productivity growth in Germany has helped lift real wages by 10%.

Yet there is another, brighter side to the UK’s poor productivity record. The UK has proved exceptionally good at creating new jobs, getting people into work, and reducing unemployment.

The number of people in work in the UK has increased by 10% since 2010, faster than in Germany or indeed most EU countries. At 4.3% the UK’s unemployment rate is lower than at any time since 1975. The UK’s jobs market is relatively accessible and inclusive, with high employment rates for women and younger and older workers. Temporary work is less common than in most OECD countries.

The World Economic Forum (WEF) ranks the UK labour market, alongside America’s, as one of the most flexible in the world. Flexibility is characterised by an efficient matching of jobs and skills through, for instance, ease of hiring and firing. Countries with high ratings for flexibility are strong on job creation and have low levels of unemployment.

The UK’s job-rich but poor wage and productivity performance contrasts with that of other European countries.

France has a less flexible labour market and lower rates of job creation than the UK. But France scores highly on absolute levels of, and growth in, productivity. By close of business on Thursday the average French worker has produced what it takes the average Brit to produce by the end of the working week. It’s harder to find a job than in the UK, but workers are more productive and pay rises faster. High employee costs and barriers to hiring may dampen job creation, but they also encourage an efficient use of labour.

The Brits are good at job creation and the French are strong on productivity. But the Holy Grail of economic policy is job and productivity-rich growth. This is pretty much what a group of north-west European countries – Germany, Switzerland, Benelux and Nordic countries – achieve. They have flexible labour markets, high employment rates and low levels of unemployment. All score highly on productivity and wage growth.

In economics perfection is rare. So, for instance, Sweden has, by Northern European standards, somewhat elevated youth unemployment and Danish job creation has lagged its neighbours. But by and large this group of countries do unusually well creating well paid, high productivity jobs.

All combine labour market flexibility with strong vocational education. Whereas in the UK, university has become the default choice after school, many young people in north-west Europe opt for training in school or college and the workplace. Switzerland arguably leads Europe in vocational education and 70% of its young people take this route.

The experience of Italy is very different from its northerly peers. It has struggled with high unemployment and poor productivity for more than two decades. Italy’s employment rate is among the lowest in the industrialised world with 58% of adults in work compared with rates of 75-80% in north-west Europe. Almost a third of young Italians are unemployed and a majority of those in work are on temporary contracts. Italy ranks at the bottom of the WEF league of labour market flexibility, below many developing economies. Since 2010 productivity has scarcely risen and average wages, after inflation, have fallen by 2.5%.

Yet none of this is set in stone. Careful reform, pursued over years, can create jobs and reboot growth. In the late 1990s Germany’s economy looked increasingly sclerotic and uncompetitive. Unemployment was stuck at intractably high rates. Hard though it may be to believe it now, in the media Germany was dubbed the “sick man of Europe”. Labour market undertaken by Chancellor Schroder’s government in the early ‘00s eased rules on hiring and firing and sharpened incentives for unemployed people to take work. The reforms faced strong resistance, but they played a crucial role into making Germany the high employment economy it is today.

The potential sources of the UK’s slow productivity growth are much debated. What is clear is that on vocational training and education the UK lags well behind the likes of Germany, Switzerland and Denmark.

This is not new. In our researches last week, we came across the report of the Royal Commission on Technical Education from 1884. A meticulous 556 pages analysis of vocational training on the Continent the report counters today’s fashionable ideas of Victorian insularity and hubris.

On the contrary, the authors were hugely impressed by what they saw: “Your Commissioners cannot repeat too often that they have been impressed with the general intelligence and technical knowledge of the masters and managers of industrial establishments on the Continent…They are familiar with every new scientific discovery of importance…They adopt not only the inventions and improvements made in their own country, but also those of the world at large”.

The report urged the UK to emulate the Continental model of rigorous vocational training, both theoretical and practical, coupled with the development of language skills. Looking at the UK’s recent performance it is a recipe that is as relevant today as it was in 1884.

PS: Last week the European Union and Japan signed the world’s largest bilateral free trade agreement, lifting tariffs on nearly all goods traded between the two countries. The contrast that the deal made to the prevailing international mood of protectionism was not lost on the signatories. Donald Tusk, the president of the European council, described the deal as “light in the increasing darkness of international politics” and claimed that “this is an act of enormous strategic importance for the rules-based international order, at a time when some are questioning this order.” Once ratified by parliaments on both sides, the EU-Japan trade deal will eliminate about 99% of tariffs on Japanese goods, while Japanese consumers will enjoy lower prices on the $100bn worth of goods and services the EU exports to Japan every year. While clearly a significant deal in economic terms, it may be at least as notable as a statement of support for free trade and globalisation.