The race to be the next leader of the Conservative Party and Prime Minister comes at a time of genuine national crisis on a number of fronts – with soaring inflation and war in Europe against a backdrop of pandemic recovery and the impacts of Brexit.
The leadership race has quickly focused on a number of key economic issues, particularly the wisdom, or otherwise, of immediate tax cuts in an effort to stimulate growth. Or indeed how one squares the circle of funding tax cuts when the UK’s prospects for economic growth and funding public services, levelling-up investments, and greening the economy continue to be a matter of real concern.
One word in particular has re-emerged in recent days. It is the ultimate constraint facing policymakers, and one which is crucial to growing, rebalancing, and optimising the UK economy: productivity.
The UK economy has performed much worse in terms of productivity growth compared to other advanced economies since the great financial crisis in 2008. This is the economic battlefield on which not only this leadership election should be fought but on which much of the political debate in the next few years should centre.
The productivity conundrum does not lend itself to a snappy political slogan or dividing line. There is no silver bullet and no easy answer to what has now been a central, structural problem in the UK economy for many years.
But this is an issue that simply cannot be ignored and is wrapped up in so many of the other issues which are currently giving policymakers sleepless nights, not least the cost-of-living crisis.
Increased productivity is a key enabler for higher real wages, and thus improved living standards. Indeed, in the recently published first report of the UK Productivity Commission on which I serve, the Office for National Statistics makes clear that if productivity had grown at two per cent over the past ten years, this would equate to £5,000 per worker per year.
As we were told by Andy Haldane, a former Bank of England chief economist, “productivity is what pays for pay rises”.
Put in these terms, the productivity problem in the UK is difficult to ignore. But what should the next prime minister actually do to solve this problem?
Consistency is crucial
The first thing to accept is that this is not an issue that will be solved with one single, “big-bang” policy.
Instead, it will require a measured and consistent set of government interventions, close-working with industry and universities, and an assumption that delivering productivity growth should be at the heart of policy development across Whitehall.
Consistency is a crucial point in this regard – the Productivity Commission heard much evidence in bringing together our first report that the UK has suffered from short-term policy making on industrial policy over the electoral cycle.
A number of other OECD countries have developed either statutory bodies to monitor productivity or advise governments in this area (e.g. Australia, Denmark, France, Germany). Consistency, the fostering of experience and expertise, and institutional memory are all required if government is to meet its goals.
As we highlight in our first report as a Productivity Commission, the UK’s malaise has many potential causes.
Investment and immigration
A key driver of productivity growth is investment in Research and Development – necessitating an effective and long-term subsidy for private R&D spending through tax incentives. Some of them potentially differentiated by region or technology, reflecting the UK’s latest innovation strategy which highlights the technologies where we can be genuinely and globally competitive.
It is these incentives that will prove much more effective than cuts to headline corporation tax.
Public investment in research and development through the research base is just as important, however.
Last year, my own institution, the University of Glasgow published an analysis of its economic impact and found that the productivity spillovers from public investment in research were significant.
For every £1 million invested in research at the University of Glasgow, there were £6.9 million in productivity spillovers across the UK economy – meaning a total of over £1.73bn in productivity spillovers from just one university’s research in 2018-19.
An impact on this scale should demonstrate the necessity of a consistent and increased public investment in the research base by the next government.
Beyond the core investment through UKRI and departmental R&D budgets, there are further catalytic public investments in the UK innovation and skills infrastructure which could be made through the UK Shared Prosperity Fund.
Another factor holding back productivity growth in many parts of the UK is one that is unlikely to be much discussed in the current race for Downing Street – but it is undeniable that if the UK is to reach its full economic potential, the real and significant benefits of immigration will need to be accepted.
Innovative companies and universities rely on skilled labour from across Europe and the world to help drive forward the change and innovation which productivity growth relies on.
Finally, there must be a recognition of the very stark regional disparities at play in this discussion, with the over-centralisation of decision-making in this area being keenly felt.
As we recognised in our Productivity Commission report, it is evident that the UK is atypical in the OECD in having a highly unequal inter-regional economy. London and the South East of England are significant outliers in terms of productivity, and this demonstrates the need for differentiated national and regional policies across the UK.
As an example, in 2019 I was tasked by the Scottish Government with producing a report on how to drive innovation and productivity in Scotland. While I focused on the actions that could be taken in the devolved context, I was forced to highlight that very few of the policies necessary to drive innovation and productivity to the levels of comparable European nations were currently devolved to Scotland, including tax incentive schemes to boost business investment in R&D and immigration policies.
Similar stories will be told across the nations and regions of the UK, and it will require flexibility and commitment from the government in Westminster to ensure that regional disparities are tackled by the specific solutions most appropriate to their situation.
It would be a mistake to consider the UK’s productivity problem is just a matter for economics seminars and think-tank reports. At a time of wage stagnation and huge increases in the cost of living, productivity growth and the wage increases which arise would have a huge, direct impact on people’s lives.
It may rarely be expressed in this way but productivity growth can be the difference between people affording to heat their homes, fill up their car, or put food on the table – and a step change in how government deals with the issue can be a true economic legacy for the next Prime Minister.