Will George Osborne's productivity plan help make Britain a world-beater?

http://www.theguardian.com/business/2015/may/24/george-osborne-productivity-plan-uk-economy

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It’s Monday morning and you arrive at the station to find that your train has been cancelled due to a points failure. You miss an important meeting.

On Tuesday your desktop computer crashes yet again. IT says the problem is simple: the computer is old and needs to be replaced.

Wednesday rolls around and you take your car in to be repaired. Later, you get a call from the garage apologising for the fact that the job cannot be completed that day. A new member of staff has forgotten to send off for a crucial part.

Related: Joseph Stiglitz: ‘GDP per capita in the UK is lower than it was before the crisis. That is not a success’

Come Thursday and you pop out for a coffee. The locally owned business you have been patronising is virtually empty, as it has been since the darkest days of the recession. You wonder to yourself how it keeps going.

By Friday, you have got your car back and head to an out-of-town shopping centre to buy yourself a new fridge-freezer. Wandering around the store, you are taken by how many of the appliances are foreign-made these days.

In their different ways, these five slices of everyday life explain why George Osborne will be publishing a productivity plan before his summer budget in early July. When the chancellor says he wants the economy to find another gear, it’s not so much the speed at which the UK is expanding that concerns him, it is the quality of that growth.

The increases in national output since the economy reached its trough in 2009 have been largely the result of a bigger population and an increase in the workforce. There has been scant evidence of the usual pickup in productivity that normally accompanies an economic recovery, and after almost six years the argument that an improvement is imminent has worn thin.

To make matters even more puzzling, the flatlining of productivity since the crisis is in marked contrast to a strong performance in the years before the recession. In the late 1990s and early 2000s, the UK’s record was on a par with that of the US and a lot better than Germany’s. Had the pre-2008 pattern continued, output per head would be around 15% higher than it currently is, and since higher productivity means higher living standards, the nation would be better off.

There are a couple of factors that help to explain the disparity between the UK’s pre- and post-crisis productivity performance. There has been a structural decline in North Sea gas and oil production – a capital-intensive sector where output per head is high. In addition, work by the Bank of England has shown that the other sector to have suffered in the early years of the recovery was business services. This sector includes the City and real estate, both important to the UK economy. While the long-term trends in North Sea production are clear, it is possible that the decline in productivity in business services will recover as demand increases.

But the Bank of England thinks there has been permanent damage caused by the recession. Its governor, Mark Carney, said earlier this month that productivity growth would return towards, but remain below, pre-crisis growth rates.

That explains why Osborne has embarked on his productivity drive. He is not the first to travel down this path. Barbara Castle was made secretary of state for the combined department of employment and productivity in the 1960s. Gordon Brown set up a productivity unit inside the Treasury when he was chancellor.

The five examples above explain what needs to be done. Firstly, there needs to be action to improve Britain’s physical infrastructure. There are productivity losses from people waiting for trains, sitting in traffic jams and being stuck in a holding pattern over Heathrow. Over many decades and under governments of both left and right, capital spending has been the first to come under the axe when savings have been needed. This does not have to happen.

Secondly, the UK has for many years tended to spend less on investment in new plant and machinery than its peers. Companies have sweated their assets, running machines into the ground rather than replacing them with new and better equipment. With labour cheap and plentiful, and finance dear and hard to come by, companies have expanded output by using more labour rather than by using more capital. The problem here is partly structural – Britain’s flexible labour market and short-termist financial markets militate towards a labour-rich/capital-poor approach – but it is also due to a deep-seated cultural bias against investment. New initiatives in banking – the business bank and challenger banks in the high street – will help, but changing the culture is not going to be easy.

It is not just a question of having the latest kit: the quality of the workforce matters too. The third challenge was outlined by Osborne last week, when he said: “The level of skills in our country is unacceptable – we’re one of only three OECD countries where the skills of our 16-to-24-year-olds are no better than our 55-to-65-year-olds.” The chancellor is right. Britain has too many workers who struggle to read and write, lack basic skills and are not receiving sufficient training. They can find work but only in low-productivity jobs.

The fourth issue boils down to what could loosely be termed creative destruction: whether new dynamic firms are replacing those that are suffering from weak demand. There has been much debate about whether a prolonged period of ultra-low interest rates and forbearance by the banks towards struggling companies has created a generation of zombie companies. This, though, misses the point. As noted above, it is unusual for the UK financial sector to be so merciful and short-termist: business as usual will no doubt be resumed before too long. Britain has never had a problem with the destructive bit of creative destruction. The problem has been with spawning and nurturing the innovation that produces high-productivity jobs – turning good ideas into world-beating products.

This process is not aided by the fifth problem: the lopsided nature of Britain’s economy, where the manufacturing sector makes up just over 10% of GDP and the service sector more than 75% of GDP. Productivity gains are not impossible in the service sector, but in some cases, such as hairdressing, they are harder to come by, and in other cases – think schools – they would not be especially desirable if increasing output-per-head meant bigger class sizes.

That means increasing the share of the economy – manufacturing and parts of the service sector – where it is possible to increase output per hour worked. It also means improving the quality of those services where it isn’t. If it takes the same number of people to produce a meal as it did 20 years ago but it is twice as delicious, that’s higher productivity. It’s just hard to measure.