Forget productivity – the most important thing is wages

The most important problem facing the UK government in 2018 is that wage growth has stalled. Mrs May needs to give ordinary people hope of a wage rise in the New Year.

The Productivity conundrum revisited

Productivity is the output recorded per hour worked by the workforce. Successful manufacturing nations like Germany boast high levels of productivity. There is a positive correlation between high levels of productivity and high GDP per capita – so it is evidently something desirable. But we shouldn’t get obsessive about it – for reasons I shall explain.

The conventional wisdom is that the main reason why wage growth has stalled in the UK is that the growth of productivity in the UK has declined. As we know, the Office for Budget Responsibility (OBR) revised downwards its estimates for the growth of productivity going forward in November. The realistic sustainable growth rate in the UK economy was revised down to just 1.5 percent per annum. This had massive knock-on effects for projections for the government’s finances, as revealed in Mr Hammond’s budget of 22 November. The long-term trend growth rate for the UK until the financial crisis of 2008 was 2.4 percent. To move from 2.4 percent to 1.5 percent may not sound dramatic: but it is the difference between getting government finances back into good health and falling into an ever-deepening pit of debt.


If the UK could recover its growth mojo that would not only transform government finances. There are also massive political consequences in a society where most of the population has no – or very little – prospect of a pay rise. The rise of Mr Corbyn is at least partly the result of stagnant wages in both the public sector (thanks to “austerity”) and the private sector (thanks to modern labour practices such as the gig economy with widespread zero-hours contracts, self-employment and declining union membership).

In my analysis of Mr Hammond’s budget I tried to explain that comparisons in productivity can be odious. I pointed out that the French enjoy high levels of productivity but that they also suffer from much higher levels of unemployment than les rosbifs across la Manche. I posited that there is a trade-off between the two – although it turns out to be an imprecise one. Basically, in more flexible labour markets there will be more low-paid workers, and that will tend to drag down output per head. The unemployed, remember, remain outside the labour force, and therefore do not impact the productivity statistics.

If we think that last sentence through, we begin to realise that there is something a bit funny going on here. A society in which everyone was unemployed except for one super-efficient worker (perhaps the sole human being supervising a slew of factories powered by robots) would be a super-productive one. But, such a society could not be said to maximise social utility (where utility is the economist’s term for well-being or social happiness).

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Of course, we might envisage a society in which, on account of universal robotisation, levels of productivity are unimaginably higher than today and human beings do not need to work at all. Instead they will receive a Universal Basic Income (UBI) from the state. (I discussed the idea of UBI in these pages back in February this year, since when I note it has become the subject of a Labour Party discussion paper. The poor old Tories, mired of necessity in the minutiae of Brexit, have not even got round to thinking about it as yet).

But that prospect, even if you think it feasible, is extremely distant; and whether it is even desirable is debatable. In the meantime we inhabit a world in which we shall continue to encourage our children to get good qualifications so that they can get a good job…

Damned lies and statistics

Wages in the UK have stagnated since the Credit Crunch. According to the Institution of Fiscal Studies (IFS) (which I recently described as the Provisional wing of the OBR) we are in danger of losing, not just one, but two, decades of earnings growth. Falling real wages were experienced by most UK workers between 2008 and 2014. This was followed by modest growth in 2015 and 2016. But this has now gone into reverse as real wages have once again started to fall. This is the result of the post-Brexit referendum devaluation of the pound which has pushed up consumer price inflation to a level of 3.1 percent currently. The prices of basic foodstuffs have been most impacted so one can say that it is people on the lowest incomes who are worst affected.

This takes us into uncharted economic territory. The entire economic model which took shape post-Great Depression and post-WWII was that skilled workers and managers could look forward to modest increments in their wages and salaries every year – regardless of promotion. This idea is implicit in pension forecasts: pension providers still assume that contributions will increase smoothly over time.


In the UK we have some of the most productive firms in the world but a very long tail of small and medium sized enterprises (SME), many of which are chronically under-productive. In the aftermath of the financial crisis most economists assumed that the halt in productivity growth was a temporary effect induced when companies tried to hang on to labour at reduced wages rather than making large numbers of people redundant. And indeed, unemployment after 2008 did not increase to levels experienced in previous recessions. And yet, even after the recovery finally came around 2013, productivity growth never recovered.

Yet there are reasons to suppose that the productivity statistics produced by the OECD are misleading. According to their figures the UK, on the basis of GDP per hour worked, comes out at the bottom of the league behind Germany, France and Italy[i]. Interestingly, on the basis of these figures, the far-and-away productivity superstar is the Republic of Ireland – so maybe we should seek advice from our Irish friends.

But let’s leave the OECD statistics to one side for a moment and, instead, let’s look at the average return a private sector business makes on an employee who is paid the Minimum or Living Wage. Remember that employers must pay not just the Living Wage but social charges in Europe (National Insurance Contributions in the UK) which count towards employees’ state benefit and retirement pension entitlements. Note that these levels of charges vary widely. In France social charges amount to about 40 percent of wages whereas in the UK NICs are about 12 percent of wages. Calculated on that basis, the UK now comes top of the league with a return-on-wages of 15.8 percent, followed by Italy at 11.5 percent, Germany at 6.4 percent and France at a paltry 0.4 percent[ii].

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So, again working this through, if you were to place a factory in Europe which paid essentially the Minimum Wage, you would much prefer to locate it in the UK than to locate it in France. And indeed levels of foreign direct investment (FDI) in the UK have consistently exceeded those in France over a long period of recent history, despite the so-called productivity gap. The OECD figures do not tell this story; but then the OECD is a Paris-based institution staffed largely by French economists who are overwhelmingly Énarques trained to think and express themselves in the idiom of the deep French state. Basically, their job is to talk to themselves.

This is not to be complacent and to say that Britain does not have a problem – though I have tried to inveigh on my readers over a number of years now that academic economists and businessmen view the world in very different ways – and often draw quite different conclusions from the same sets of data.

Britain does have an economic problem in that so many workers are at the same time low-paid, insecure and poorly trained – and this problem must be addressed by the politicians. There is also insufficient investment on the part of the private sector in new productive capacity and too much regional inequality which skews new investment disproportionally to the South East of England.

There is, however, in my view, no productivity crisis.

Productivity in services

I also pointed out in my article on the budget that the UK economy is split 80:20 as between services and manufacturing and that the measurement of productivity in services is notoriously subjective. Famously, you can see the impact of information technology across our society – and Britain is one of the most connected countries on Earth barring South Korea and Singapore – but this communications revolution does not show up in the productivity figures. Take our ubiquitous smartphones, for example. These devices have become immeasurably better over the last ten years in terms of their design, functionality and size; and yet they have also become cheaper thanks to economies of scale and improved production technology. So these advances are not captured in the productivity data which measures output as volume multiplied by unit price.


The share of digital media in our economy will only increase going forward. As it does so, so we move into a world of intangible rather than tangible assets. I mentioned recently that Apple Inc. (NASDAQ:AAPL), which is the largest company on the planet by market capitalisation, holds almost exclusively intangible assets – near-cash, capitalised R&D, goodwill etc. – on the assets side of its balance sheet. You could argue that Apple’s great strength resides in its outstanding technology; but you could also argue that its real competitive advantage is its brain. Both are intangible assets.

We know that productivity growth has been declining across the OECD area, though it is not entirely clear why. Technology is powering ahead but it is not being diffused or adopted by small and medium sized businesses. This is probably because small businesses are not making sufficient returns to invest in such technology.

Specious arguments from the Left

A new generation of left-wing economists have been arguing that low productivity in the UK is the outcome of poor corporate governance. In particular, they argue, Anglo-Saxon capitalism prioritises shareholders above employees and therefore dividends above wages. This, they say, is reflected in huge – and widening – pay differentials between CEOs and board members and ordinary workers.

Such people advocate worker representation on boards – as happens in Germany. They want to tackle “insecure work” – which usually means to abolish zero-hours contracts and so forth. This kind of analysis is not unsophisticated and is likely to become more main-stream, so I will confine myself to just a few comments here.

Firstly, you do not stimulate new productive investment by penalising shareholders. Dividends are already unfavourably treated by the tax system and any attempt to restrict dividend payments would have negative consequences for investment.

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Second, many workers actually appreciate the flexibility and convenience of zero-hour contracts and the gig economy. I do not believe that the army of Uber drivers are oppressed; rather I believe that they enjoy the lifestyle. In a sharing economy, which has the potential to boost both productivity and return on assets hugely, people are more likely to have “portfolio” careers in which they do many different things in the course of a day. Interestingly, that is exactly what Karl Marx foretold in Das Kapital. He rightly regarded the worker condemned to performing a repetitive task in a 19^th-century mill as a form of slavery. How much more liberated (and stimulated) are the workers of today!

The real problem: declining Return on Capital

Taking a step back from the productivity conundrum it strikes me that the main cause of under-investment is that returns on capital (ROC) are insufficient to justify the risks. So I would turn the focus away from productivity and towards ROC. There is little question that ROC has declined over the medium term and substantially so since the Credit Crunch. This is curious since one would have expected that, in an era of near-zero interest rates, return on capital would have increased (because the firm’s weighted average cost of capital or WACC, as financial economists call it, is also lower). Moreover, in an economy with near full employment, you would expect labour rates to be bid upwards.

That’s going to be another of my 2018 themes: why ROC is falling. If ROC is falling, so will stock market returns over the medium-term. I suspect that it is something to do with near-zero interest rates, but there is very little analysis of this issue in the mainstream media.

Five ways to increase productivity

Firstly, UK businesses must increase investment in capital equipment – including IT. But small and medium sized businesses cannot invest in top-of-the-range IT systems unless they make decent returns. Chicken and egg.

Secondly, training is critical. As machinery replaces workers so workers need to be up-skilled. I am not persuaded, however, that all training is equally beneficial. Most professional training, in my experience, is box-ticking. These days teachers in the UK have to undertake x hours of Continuing Professional Development (CPD) which could be anything from first aid or equality and diversity awareness training to study of their own subject specialism. How much of that training makes them more productive teachers?


Then, thirdly, there is the issue of job design. According to some reports, about one third of all workers in the UK are working sub-optimally in the sense that they are doing jobs which are beneath their abilities. Ideally, workers and managers should be challenged by their work – though not to the extent that they are out of their depth. Promoting people tends to motivate them; when people do the same old job year-in, year-out, they become de-motivated and thus their productivity declines. That is another argument for economic growth: in a growing economy, new opportunities open up; in a stagnant economy, people flat-line in the same old job.

Fourth, if you look after your workforce they will repay you with better productivity. Therefore, people give more if they perceive they have job security. But there has been a cultural shift. The very flexibility of our labour market means that employees are less loyal and employers less patrician than in the days of old.

A fifth factor – this is not a frivolous point – is quality of life and well-being. In a perfect world all workers would have happy and fulfilling private lives and would skip to work smiling. Alas, this is not always the case. One issue is that, as a nation, there seems to have been a decline in the quality of our sleep – as well as the amount of sleep we get. People who sleep well work much more efficiently and productively than people who are run ragged by insomnia. One reason for declining sleep quality, amongst others, is our addiction to our wretched smartphones. Hands up those readers who woke up in the wee hours today to check their messages. You know who you are.

New Year’s resolutions, anybody?

Diversity of labour wage rates in Europe

According to Eurostat, in 2016, average hourly labour costs (excluding agriculture and public administration) were estimated to be €25.40 in the European Union (EU) as a whole and €29.80 in the eurozone. However, this average masks massive diversity between EU member states. The lowest hourly labour costs were recorded in Bulgaria (€4.40), Romania (€5.50), Lithuania (€7.30), Latvia (€7.50), Hungary (€8.30) and Poland (€8.60). And the highest were in Denmark (€42), Belgium (€39.20), Sweden (€38), Luxembourg (€36.60) and France (€35.60)[iii].

One significant factor is the debate about wages and productivity in the UK should be immigration. When a worker migrates from Bulgaria to Denmark obviously there must be a tendency to under-price his or her hourly rate so as to gain a competitive advantage vis-a-vis indigenous workers. This was particularly apparent in the UK which has the most flexible labour market in the EU. Migrant workers from low-wage economies were able to arrive in the UK and immediately to register as self-employed and set up shop as plumbers, decorators, builders or whatever. They could not do that in France or Germany where even such casual trades are tightly regulated and where there is no direct equivalent status to self-employment.

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I had wanted to complete this piece without mentioning the dreaded word Brexit. But the fact is that the overwhelming reason why we are where we are now is that the New Labour government under Mr Blair chose not to restrict entry to the UK by Eastern European migrants after the accession of the Eastern European countries in 2003 – as they could have done.

It is probably too late to be of use but, in a just world, Messrs Blair, Brown, Blunkett, Straw, Mandelson and Campbell would be given school detention and denied the right to go home until they had written out the following line one thousand times:

Unrestricted unskilled immigration from low-wage economies drives down the wages of indigenous workers…

Post-Brexit we should close the door to low-skilled immigration completely. That will be good news for our own low-paid.

Last words

Talking of productivity, it seems that the elves have been working overtime at 22 Notting Hill Gate. The Master Investor Christmas tree is heavy with shiny gifts – containing lots of exciting plans for 2018.

I must away. Swen has just arrived driving a splendid ornate sleigh adorned with bells, drawn by a troika of sturdy Lapland elks. I can see Evil, resplendent in red velvet, and James and Nick reclining behind with steaming goblets of hot spiced wine. For we have business in the Far North with a big-hitter, whose joviality is legendary…

As we glide jinglingly across the frozen lakes, it remains for me to bid all our readers a merry holiday and a prosperous New Year 2018. May all your positions perform!

Until next year, then… Your most excellent health! Cheers…

[i] See: https://data.oecd.org/lprdty/gdp-per-hour-worked.htm#indicator-chart

[ii] Reported on Money Box Live, BBC R4, 29 November 2017. See: http://www.bbc.co.uk/programmes/b09gbn9p

[iii] http://ec.europa.eu/eurostat/documents/2995521/7968159/3-06042017-AP-EN.pdf/6e303587-baf8-44ca-b4ef-7c891c3a7517