Twenty-five years ago the economist Paul Krugman wrote that, “Productivity isn’t everything, but in the long-run it is almost everything”. Today as we struggle with the consequences of sluggish productivity growth, these words sound highly prophetic.
Ask any business leader, educator, government official or influencer to pinpoint why productivity growth has slowed and you will get a range of different answers. It is a problem with no single identifiable cause, which in turn makes it hard to tackle.
The reasons given have varied including:
- Lack of investment;
- Less innovation – or at least radical, game changing innovation;
- The transition from a manufacturing to a service based economy – a faster machine can produce more goods but it is more difficult to give more haircuts;
- Rising debt levels, which in turn restricts investment and the potential for future productivity growth;
- ‘Zombie’ companies – by keeping unproductive companies alive, more productive parts of the economy are deprived of capital.
Whatever the reasons, slowing productivity growth really does matter for all of us. Productivity growth matters because without it real prosperity is difficult to achieve. At its simplest, productivity is measured by dividing output by hours worked; increasing productivity means we can produce more from the same inputs. If we want to raise living standards and reduce inequality we need to become more productive. And arguably this will become a more critical issue in Scotland if our working age population flat-lines or even shrinks; if we cannot increase the hours worked, we can only increase output by becoming more productive.
The latest Fraser of Allander Commentary, which Deloitte supports, evidenced that the economic growth we have seen in Scotland over the last seven or eight years has been matched by an increase in hours worked rather than an increase in productivity. If we want to see a rise in real earnings and living standards, we need to see productivity grow.
A consequence of the fragile level of productivity and earnings growth is that devolved tax revenues are forecast to grow more slowly, with a subsequent impact on Scottish Government budgets. Fraser of Allander’s Commentary points to that budgetary pressure, explaining that while Scottish taxpayers are paying £500m more than they would if they were rUK taxpayers, the Scottish Government will only collect £180m more in 2019/20. The difference is accounted for by weaker earnings growth.
Deloitte’s Power Up: UK-Wide Growth report, published late last year, explored how improved productivity can be unlocked across the UK’s nations and regions. It involved reviewing nearly 20 years of Office for National Statistics (ONS) productivity data and 36 years of employment data dissecting it by nation, region and by sector. We then consulted with more than 50 business leaders, educators, local government officials and other influential figures in Scotland, Wales, Northern Ireland and the eight English regions outside London to assess the productivity conundrum.
It found that Scotland has outperformed the UK average in productivity growth over the last 10 years, closing a previous gap, and that Scotland’s output per head was higher than the average of all other UK regions and nations, except for London and the South East. However, the growth rate has declined across the UK as a whole since the financial crash. Slowing productivity across certain sectors and lower levels of investment in high productivity sectors are contributing factors to this decline.
Although each region and nation face challenges, those we met were united in how greater collaboration and investment in skills and infrastructure is key to improving productivity. A very clear message was that in order to grow and attract business, and to embed new ways of working and technologies, infrastructure must be fit for purpose.
Technology and digital transformation initiatives are recognised enablers of productivity improvement. Leveraging advanced technologies can help organisations to do the same things more efficiently. Many of the business leaders Deloitte interviewed said they were therefore looking to capitalise on new AI-based software, robotics and workplace connectivity tools that will help to re-design work and lift productivity.
Adoption of these tools has accelerated – affecting strategy, talent, business models and the way companies are organised. Against this backdrop, there is also a predicted demand for skills beyond technology and digital, such as cognitive abilities and complex problem-solving and social skills.
This raises two challenges for Scotland’s business leaders. Firstly, in order to maximise the value of these technologies and minimise adverse impacts on the workforce, organisations must keep people in the loop – reconstructing work, retraining people and re-arranging the organisation. Secondly, business and educators need to agree on the future skills, including leadership and management skills, and personal attributes that Scotland’s workforce will require in the face of continuous technology change.
Encouraging and supporting Scotland’s businesses to scale up and expand internationally will also be important; businesses exposed to international competition are generally more productive.
Solving the productivity puzzle will not be easy but it is critically important. Investment in people and their skills, a focus on infrastructure investment and increasing collaboration between business, educators and policy makers should all help to increase productivity.
How we all respond to the reality of sluggish productivity growth and develop effective policies to increase it, will largely determine how rapidly our living standards improve over the next 25 years.