Britain has a productivity problem

There is some good news and bad news regarding the current state of living standards. The good news is that wages are starting to exceed inflation, which indicates a potential end to the decline in living standards. However, the bad news is that this is largely due to rising wages rather than a decrease in inflation. This suggests that high inflation is becoming ingrained in workers' expectations. According to Capital Economics, the upcoming inflation figures are projected to show a Consumer Prices Index (CPI) of 6.8 percent, slightly lower than the previous month's 7.9 percent. At the same time, average earnings are predicted to rise to 7 percent, up from 6.9 percent the previous month and 6.1 percent a year ago.   

If they are not producing more, then sustainable real-terms pay rises simply are not possible

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 percent by the end of the year, down from 7.7 percent 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 on 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.

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