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A Very British Failure

ritain was the nation fortunate enough to be the starting point of the industrial revolution, which led to an incredible boost of productivity pushing Britain above the growth rates of its past to set it on the path to the modern economy we know today. This innovation, which on top of its world spanning empire, led to the rapid rise of Britain’s economy and living standards that culminated in the hegemonic economic and military status it enjoyed during the “Pax Britannica”. It was to be supersede by its former colony, turned independent state, the United States of America after the First World War due to faster productivity in the US, but the decline of its status was only truly evident after the Second World War. All of this is to underline the importance economic productivity has in the deciding the fortunes of countries and regions.

Britain’s productivity was rising quickly enough that it was able to enjoy some of the fruits of winning the Second World War in a similar fashion to the United States with mod cons becoming more prevalent, and while Britain did face some economic challenges (see here), ultimately Britain was still a place to invest and be in. However, this steep upwards trend was broken by the Great Financial Crisis (GFC) and has affected pay as well setting the growth of pay on a lower average for the last 10 years, than the 10 years before. This shift has seen the worst performance in productivity since the end of the 1700s. Has this trend shift been the result of the brutal austerity imposed post-GFC? A general lack of R&D spending? If not, what else could it be?

This trend break has economists, economic policymakers and even economic journalists worried. Those in the United Kingdom do know that the lower gear for productivity is a problem for future economic growth (see here, here, and here for examples) , and arguably is more important than rising debt loads or deficits. For without faster growth the burden of higher debt loads or a rising deficit become even heavier. This is particularly pertinent given the recent COVID-19 crisis that has caused debt and deficits to explode. Since the GFC, this productivity stagnation has exacerbated income inequality through poorer pay growth on average and arguably exacerbated feelings of left-behind. The austerity measures imposed on the United Kingdom after the GFC could also have stunted any potential productivity boosting measure as the capital was unavailable to be spent.

Austerity measures did not affect gross R&D spending in the United Kingdom, which disqualifies this to be a reason for the lower productivity growth rate. If anything, the UK appears to have shifted gross R&D spending into higher gear. This would lend to the belief that the productivity should be improving as more advanced technologies come out, better management techniques implemented or just further progress.

This has not been the case, as can be seen in the associated chart that depicts the productivity slowdown that has it growing at a lessor rate than before the GFC. The increasing R&D spending yet flatlining of productivity growth demonstrates that there is a disconnect between changes of R&D spending to productivity growth and that something fundamentally had shifted in the British economy post-GFC. This is in line with a paper put out by the Bank of England, and elaborated in simple terms on their blog that the productivity slowdown is a structural issue, not cyclical.

his idea proposed and supported by research that the problem of British productivity is a structural issue leads to more questions, such as:

“What is the exact structural problem?”

“Why did the financial crisis highlight this problem and not previous crises/recessions?”

Well, there is growing proof that the more general economic crises set off by financial crises have deeper, more permanent damage to the overall economy. This phenomena has also been found to be the case in the US (see Kansas Fed Paper), a country that recovered from the GFC faster than others. This is due to the relationship between credit and innovation, which is that tighter credit conditions damage the productivity-improving enterprises and individuals from doing exactly that, producing things that improve productivity. During the Great Financial Crisis, understandably the financial system wanted to deleverage themselves and thus created tight credit conditions. The financial services sector in the UK is also quite large by international standards, contributing 6.9% to total output, with 50% of that being located in London as of 2018 down from 9.2% in 2009, which could indicate a larger proportional effect relative to the economy. This economically-large and important sector experiencing a negative shock due to the global financial crisis roiling markets on top of reducing credit lending to the wider economy, one can see how this could set British productivity on a different path. It is also completely feasible that this crisis had deeper scars due to the growing size of the financial industry in the UK compared to previous banking crises. This lack of private sector spending stifling the productivity of the wider economy was most likely exacerbated by the brutal austerity measures that was imposed by the Government in the aftermath of the GFC to try and balance its budget.

The dual squeezing of public and private funding led to the squeezing felt by all in everything, which can be most directly seen and understood by the halving of pay growth in the UK afterwards. The rate of total pay growth across the entire British economy went from ~4% pre-GFC to ~2% post-GFC. That’s a fairly significant drop in income growth. This fall in terms of income plus the reduction of public services due to austerity measures and a general malaise setting into the wider British economy could have discouraged innovators from taking those risks. This overall reduction in innovation feeds into this lower gear of pay growth as well, ultimately which places indescribable stresses onto workers, managers, graduates as well as their families.

he UK has experienced a nearly unprecedented slowdown in productivity. It has far-reaching consequences and hit families in their wallets with a halving in total pay growth. Austerity is most likely not the only factor to blame, though it certainly did not help much, if at all. The unfortunate combination of a very large financial sector, and a financial crisis has been supported by research to have long-term negative effects on productivity so this may be an area for further research. The evidence as well that this is a structural issue within the UK and not just a cyclical one leads one to be suspicious of what the exact cause could be and why it was not set off before. Regardless, the reduction of public services and the tightening of private credit lending most certainly worsened the environment for innovation against the backdrop of global crisis. Hopefully lessons can be drawn from the last recession to prepare the economy for overcoming the COVID-19 crisis and how to encourage productivity to once again set the path for higher growth in terms of GDP, wages and more.

An economist with musings on interesting parts of economic history/society from the past to the present. Book reviews | Economic History | Current Events

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