Free Lunch: Below potential, but how far?

Δημοσιεύθηκε: 14 Μαΐου 2015 - 11:28

Low-hanging fruit that is hard to pick

The central issue in the Inflation Report published yesterday by the Bank of England is not a monetary one at all. It is the poor productivity growth that has burdened the UK economy since the crisis. The productivity slowdown complicates interest-rate setting in a number of ways. Unless productivity growth picks up, monetary policy makers must soon think they are getting close to the point where monetary stimulus leads the economy to overheat rather than pick up slack, and rate rises are in order even if growth is slow. But the fact that the productivity slowdown is so poorly understood creates huge uncertainty around this central determinant of the appropriate monetary stance. The BoE's best guess is that the outlook has got a little worse; it duly downgraded its growth forecast for this and the next two years by 0.3 percentage points.

There is very little a central bank can do about productivity growth; as this morning's FT editorial points out, that is a matter for supply-side policies. The problem is that ensuring a robust pick-up in productivity is not an easy challenge for chancellor George Osborne either. A recent paper by Kieran McQuinn and Karl Whelan - although it is about eurozone productivity - teaches some sobering lessons. One is that they consider the UK the "productivity leader" in Europe in terms of total factor productivity (TFP) - the efficiency with which production is carried out after you account for all the skills, labour and capital put into the process. So when other European countries produce more than the UK per worker or hour worked, it is because they do so with more capital or more highly-skilled workers. The bright side of this is that the UK can improve by investing more and educating its workers better - but that takes a long time and is difficult to do. As for TFP, if the UK is already the leader it is all the harder to improve that aspect of productivity further. Indeed McQuinn and Whelan show that only a rather meagre growth boost can be expected from structural reforms that would close the eurozone countries' TFP gap with the UK. That means it is even harder to get a big growth dividend from structural reforms to push the UK's own TFP higher.

That raising productivity is hard does not mean it is impossible. It is both a puzzle and a promise that despite the difficulty of identifying macro-level policies that will have a strong effect on productivity growth, company-level evidence shows a lot of opportunity for improvement. Once you start looking, the amount of waste - in other words low-hanging productivity fruit - is just astonishing. For a nice anecdotal example, read Peggy Hollinger's interview with John Neill, CEO of the car parts maker Unipart, in today's FT. Neill claims that better practice within companies could amount to £300bn in productivity gains. One particularly nice nugget: his company improved warehouse productivity by some 15 per cent by noticing workers confused "6" with "9" on box labels. A simple line under the figure allowed teams of six workers to do as much as had previously taken seven.

That's a single company, of course, touted by its own chief executive to boot. But state of the art academic research shows the same potential at the micro level. Igal Hendel and Yossi Spiegel studied the detailed production records of a single US steel mill, with a simple product and straightforward technology - the sort of industry where you would think any available efficiency gains would have been exhausted. Not so: after accounting for some additional investment and remuneration changes, the researchers found a large and steady rise in output per worker. In their own words: "Learning by experimentation, or tweaking, seems to be behind the continual and gradual process of productivity growth."

There are some deep lessons to draw for policy thinking from the importance of "tweaking". One is that "capacity is not well defined", as Hendel and Spiegel write. Another is that productivity gains may rely on protecting or putting in place conditions where workers themselves can and want to figure out how to do things better. This complements the conjecture that labour market flexibility may be behind the UK's poor productivity growth. At the very least it should make us question what sort of flexibility works best. High rates of churn and the shorter employment relationships they imply may help reallocate labour from low-productivity to high-productivity sectors, but also impair workers' ability or incentive to improve productivity on the job.