And why the costs of austerity and Brexit may be bigger than we imagined
UK productivity per hour increased by 0.9% in 2017Q3, and is estimated to have risen by 0.8% in 2017Q4. Numbers like that would not have caused much excitement before the financial crisis, but they sound great compare to what has happened since. However, if you put them in a graph you would quickly put the champagne back in the cellar.
UK output per hour, % change on a year earlier
As I have suggested before, once you allow for the likelihood that productivity improvements depend on expectations of future demand growth (as you should), this graph is very easy to read. Productivity always falls in a demand led recession (2009) because firms are slow to lay off workers. However once output stops falling (2010,11) firms initially continue to lay off workers and then begin to invest in productivity improvements because they anticipate a recovery, which means we see strong productivity growth.
However the UK economy was hit by two big shocks after the financial crisis. First, the economic recovery failed to happen in 2011 or 2012 because of austerity, so firms stopped investing in productivity improvements. That is why there was no productivity growth in 2012 and 2013. However once the recovery of sorts in 2013 looked like it would be sustained, those productivity improvements began to be made, and we saw positive growth in the second half of 2014 and the first half of 2015. But then the second shock happened: the Conservatives won the 2015 election and the possibility of Brexit meant firms put productivity improvements on hold.
Does the recent growth at least suggest the Brexit shock is over? It is too soon to come to that conclusion. You would expect growing external demand and a tight labour market to encourage productivity growth, so maybe this is the first sign of that. But in the last two quarters it is a fall in hours rather than a fall in employment that is giving the growth, which may suggest the productivity improvement is temporary. It really is too soon to tell.
If my reading of UK productivity growth is correct, and I’m increasingly convinced it is, then the policy implications are dramatic. The austerity mistake did not just give us a temporary hit to demand and incomes, but has led to permanently lower productivity and therefore permanently lower output and incomes. Brexit started reducing productivity, and therefore output and incomes, before the vote even happened (as I suggested it would back in 2013). The costs of governments or voters ignoring what the majority of economists recommend is even greater than we imagined.