Many people, including apparently the Bank of England, are puzzled by the fact that productivity growth in the UK has ground to a halt. There is, however, a compellingly simple explanation. It is that the UK, for the first time since the start of the Industrial Revolution, has virtually stopped investing in the future and particularly in the type of economic activities which are capable of yielding significant increases in output per head.
In 2013, the proportion of UK GDP devoted to gross investment was 14%. This is one of the lowest ratios in the entire world, as a survey in 2012 of 154 countries showed. The UK then ranked at number 142 – equal with El Salvador. By comparison, the world average is just under 24%. In China the ratio is just over 46%.
Depreciation – also called capital consumption – then has to be deducted from the gross percentage. This is currently running in the UK at just under 11.5%, leaving a margin of 2.5%. This might allow some net investment per head of the population if the number of people living in the UK was static, but the UK population is actually growing at about 400,000 people per year. With about £120,000 worth of accumulated assets of all sorts – roads, schools, hospitals, machines, factories, housing, etc., etc. - per head of the population all of this 2.5% and more is needed just to stop this accumulated capital being diluted down. The result is that there is no net new investment per head of the population now taking place in the UK at all.
In particular, there is no significant investment taking place where it is really needed, to increase productivity. Ever since the Industrial Revolution began two and a half centuries ago, output per head has increased because the labour force was provided with capital equipment – mainly machinery of a wide variety of different types – which enabled dramatically more output than before to be achieved per hour worked. It is manufacturing which is very largely responsible for productivity improvements and thus increases in living standards. Services have never been able to do this to the same extent.
The huge importance of manufacturing in making everyone in industrialised countries better off has been partly obscured by the huge falls there have been in the cost of manufactured goods – compared with services whose costs have generally tended to rise. This relative price effect makes the contribution of manufacturing to raising living standards more difficult to see, as in money terms the proportion of GDP derived from industry has trended downwards everywhere. Manufacturing, however, is still very largely the key to economic growth and more and more applications of IT to manufacturing processes are currently providing a further boost to increases in output per head – but only where investment in this type of technology is taking place. It is happening here and there in the UK but on nothing like a sufficient scale.
This is why productivity in the UK is static. There may be a small pick-up in business investment in the UK at the moment but most of it is going into building office blocks and opening new restaurants. Almost none of it is going into where it really needs to go – into light industry, exporting and import substitution. Of course we need to improve our infrastructure and we need investment in services, but the returns to the economy as a whole of investment in these areas is typically quite low – of the order of 10% per annum. Contrast this with the total returns achievable in manufacturing – including higher wages, better products and more tax revenues as well as increased profitability - where the total returns can easily soar to 50% or more per annum. It is only investment on a big scale in this part of the economy which will deliver significant increases in output per head.
There is therefore no puzzle about why productivity is static in the UK. It is because we are not investing in the plant and equipment which can deliver it. Until we do, we are going to be stuck with static living standards and no sustainable growth. Not a great result for the nation which invented the Industrial Revolution in the first place.
This article is part of the There is an Alternative series. An economist and entrepreneur, John Mills is Chairman of JML. He recently established The Pound Campaign to raise awareness of the uncompetitive exchange rate and the effect it is having on UK manufacturing and the wider economy.
John Mills is a donor to openDemocracy.