DOI: https://doi.org/10.58248/HS100

Overview

Contributors to the horizon scan identified several issues related to the UK’s economic growth and productivity, including recent trends in, and influences upon, growth and potential policy interventions.

Economic and productivity growth are key elements of material living standards. They are also determinants of fiscal and monetary policy. However, UK economic growth and productivity have slowed markedly in the last decade and a half. Over this time the economy has faced several shocks,[1] including the financial crisis, Brexit, COVID, the energy crisis, and international conflicts.[2] Other advanced economies have also seen slowdowns in growth, but in comparison, the UK has experienced more long-standing shortfalls in productivity.[3]

In its October 2024 forecast the Office for Budget Responsibility (OBR) anticipated UK productivity growth will reach 1.25 per cent by 2029.[4] Total potential economic output is projected to grow by an average 1.5 per cent over 2024 to 2028 – slower than the period between the financial crisis and pandemic.[5]

The Productivity Institute points out that, as ageing demographics reduce the working-age share of the UK population, labour productivity growth will need to increase to maintain the current rate of improvement in average living standards.[6] It calculates that productivity growth over the next 12 years would need to double compared to the previous 12 to maintain the pace of growth in average living standards.[7]

In the July 2024 King’s Speech, the government described “securing economic growth” as a “fundamental mission”.[8] The background briefing paper[9] listed 15 bills under “economic stability and growth”, including those relating to transport, employment rights, pension schemes, corporate governance, a ‘National Wealth Fund’, and devolution. The government has also promised a new industrial strategy and the establishment of a new industrial strategy council.

Challenges and opportunities

Opportunities to improve economic growth and productivity include the adoption of artificial intelligence and machine learning technologies, but there are also challenges, such as the UK’s ageing demographic profile. Even if successful, structural reforms intended to enhance growth may work only gradually, and as in the recent past, unforeseen shocks may provide significant influences on growth.

Recent trends in growth

Excluding the pandemic, the 2007-2008 global financial crisis prompted the UK’s deepest post-war recession,[10] with recovery protracted and incomplete. The economy did not rebound to the point of catching up with the pre-crisis trend in the level of GDP, as was the norm in earlier recessions. The period since the financial crisis has seen lower levels and growth of economic output and productivity.

The shortfall in economic growth between the financial crisis and the pandemic was driven by a sustained slowdown in productivity growth. UK labour productivity (defined as the quantity of economic output generated per hour worked by the UK labour force) grew at a rate of only 0.6 per cent per year from 2009 to 2023, compared to a 2.2 per cent rate of growth per year from 1971 to 2007.[11]

GDP fell by a record ~20 per cent for Q2 in 2020, during the first national lockdown.[12]. Most of this decline was recovered over the following year, but recovery slowed as global prices began to rise and energy prices spiked with the invasion of Ukraine in early 2022.

Over 2022 and 2023 the economy broadly flatlined and slipped into a technical recession in the second half of 2023 (when GDP falls in two consecutive quarters). By 2024, measured signs of recovery were emerging.[13]

The sustained slowdown in productivity growth has become known as the ‘productivity puzzle’[14] and defies easy explanation. The UK has a long-standing gap in labour productivity compared with some other major advanced economies, including the US, Germany and France.[15] These economies have also experienced productivity slowdowns since the financial crisis, but the UK has seen a slightly greater slowdown and lost further ground, particularly against the US.[16]

The UK also has significant shortfalls in productivity levels between regions and nations. In London, output per hour worked is 26 per cent above the national average, while in Wales it is 17 per cent below.[17] This has led commentators to define productivity as “the key economic issue of our age”,[18] which makes the lack of movement around productivity more puzzling since it comes in a period of technological innovation.

While it has been volatile, average growth in labour productivity during the pandemic and recovery period has been similar, albeit lower, than the post-financial crisis pace. The further shortfall in economic activity versus the pre-pandemic trend has been driven in part by a fall in the participation rate (the proportion of working-age people either in work or looking for work). This increased between the financial crisis and pandemic, which partially offset the impact of the fall in productivity growth. However, since the pandemic, the economic activity rate (the ratio between the number of people aged 16 to 64 in work and the total corresponding population) has fallen to 75 percent.[19]

Trends in investment

While UK investment in the economy has remained lower than most other OECD countries since the financial crisis,[20] private non-residential and government fixed investment reached the highest level in a decade in 2023, at 19% of GDP.[21]

A unique factor affecting lower business investment in the UK has been uncertainty following the Brexit referendum of 2016, since this raised ambiguity about the UK’s regulations and how this might affect the cost of exporting, as well as the future of the UK-EU trade relationship.[22] This was followed by an energy price crisis, with the OECD documenting a period of relatively high policy uncertainty over this period.[23]

Key uncertainties/unknowns

Since the causes of the UK’s shortfalls in productivity and investment are uncertain and contested, so are the appropriate remedies. Structural reforms aimed at improving growth and productivity may have only a gradual impact that could be easily masked by the short-term business cycle. Market regulatory reforms can have little effect compared to the impacts of shocks such as the financial crisis, pandemic and global energy price shifts.

The development and take-up of artificial intelligence and machine learning technologies is widely cited as an upside scenario for productivity growth, together with concerns about the associated impacts on existing industries and jobs.

Key questions for parliament

  • How can government facilitate greater investment in the economy, specifically in infrastructure, pensions, and SMEs?
  • How can knowledge about productivity-enhancing practices be shared more effectively?
  • How can policy be designed in a way that better supports productivity and growth?

References

[1] Harari, D.  Low growth: The economy’s biggest challenge, July 2024

[2] Coyle, D., van Ark, B., and Pendrill, J. (eds) The Productivity Agenda. Report No. 001. The Productivity Institute, 2023

[3] van Ark, B. and O’Mahony, M. What explains the UK’s productivity problem? February 2024

[4] Office for Budget Responsibility, Economic and fiscal outlook, 30 October 2024

[5] Office for Budget Responsibility, Economic and fiscal outlook, 30 October 2024

[6] The Productivity Institute, A “UK-wide research organisation exploring what productivity means for business, for workers and for communities [and how it] contributes to increased living standards and well-being.” See ‘About us—The Productivity Institute’, accessed 14 August 2024

[7] van Ark, B. and O’Mahony, M. What explains the UK’s productivity problem? February 2024

[8] Gov.uk, The King’s Speech, July 2024

[9] Gov.uk, The King’s Speech 2024: background briefing notes, July 2024

[10] IFS, Ten years on – have we recovered from the financial crisis?, September, 2018

[11] ONS, Productivity flash estimate and overview, UK: April to June 2024 and January to March 2024, August 2024

[12] ONS, Gross Domestic Product: quarter on quarter growth: CVM SA%, 15 November 2024

[13] ONS, GDP first quarterly estimate, UK: April to June 2024, September 2024

[14] Heys, R. for the ONS, The productivity puzzle: “The key economic issue of our age”, December 2017

[15] Van Reenen, J, and Yang, X. Cracking the Productivity Code: An international comparison of UK productivity. POID Special Report. June 2024

[16] The Conference Board, Total Economy Database, April 2022

[17] ONS, Regional and subregional labour productivity, UK: 2022, 17 June 2024

[18] Heys, R. for the ONS, The productivity puzzle: “The key economic issue of our age”, December 2017

[19] ONS, Labour market overview, UK: November 2024, 12 November 2024

[20] OECD, OECD Economic Surveys, United Kingdom 2024, 2024

[21] OECD, OECD Economic Surveys, United Kingdom 2024, 2024

[22] Bank of England, The impact of Brexit on UK firms, 2019

[23] OECD, OECD Economic Surveys, United Kingdom 2024, 2024


Photo by: Benjamin Elliott on Unsplash

Horizon Scan 2024

Emerging policy issues for the next five years.