Solving the productivity puzzle

The UK economy has for years suffered from lacklustre productivity, and the latest figures from The Office for National Statistics confirm the trend: output per hour worked grew 0.4% in the third quarter of 2016, after 0.5% growth in the second quarter. ‘Quarterly growth of 0.4% is below the 1994 to 2007 average, which even taken together with recent stronger quarters, provides little sign of an end to the UK’s ‘productivity puzzle,’ the ONS said. With inflation rising and poor prospects of wage increases, British workers could be facing a tough 2017.

But the potentially surprising fact is that the UK’s dismal productivity growth is no puzzle at all. The reasons are not hard to identify but there is no political will to do anything about them.

A report from McKinsey, the consultancy firm, identifies regulation as the major cause of the productivity malaise: ‘Lack of exposure to global best practices and low competitive intensity are often the result of product market barriers such as trade restrictions, price constraints, and land use regulations. In some cases, these barriers constrain competition and so limit the pressure on management to adopt global best practices. In others, they prevent the implementation of best practices or render it uneconomic’.

Also, consider that business deaths in 2014 (the most recent figures) was at the lowest level since 2008, the pinnacle of the Global Financial Crisis. It seems ‘creative destruction’ is not really working in the UK – inefficient companies are being kept alive, indeed ‘the share of loss making companies remains elevated’, BoE says in its February 2016 Inflation Report. To be fair, BoE is aware of the problem: mis-allocation of capital is being perpetuated, they say. For an Austrian economist, this is text-book stuff. Artificial credit expansion creates capital mis-allocation that only the remedial effects of recession can correct. This could ‘come sooner as the result of voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved’, as Ludwig von Mises explains.

Regulation and artificial credit expansion of course have a common source: the state. In the UK, the state institutions of government and central bank are effectively colluding to keep productivity growth and therefore wage growth subdued, consequently being directly responsible for living standards in the UK being below potential.

We know how to solve the productivity puzzle. But the solution requires a showdown with the current orthodoxy. The prospect of that is of course unlikely, so productivity growth will plod along well below potential while the BoE’s monetary munificence distorts capital allocation and government regulation chokes the economy.

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