The Productivity Puzzle - How Has the UK Borne The Brunt of This Debacle?

Productivity - it’s an integral part of any economy, affecting almost every firm, individual and government globally. Hence, economists have been asking the same question for decades: how can we successfully improve the productive potential of an economy? Well, there isn’t a direct answer to the productivity problem. Keynesian and classical economists both understand the significance of supply side policies in boosting the quantity and quality of the factors of production in an economy, the key to increasing the economy’s productivity and achieving long term, sustainable growth. But the UK economy has been suffering a huge productivity problem; ever since the 2008 financial crisis, the UK economy has been sluggish, struggling to pick itself up from where it left off, and a major cause of the lack of growth has been poor economic productivity - something economists term as the ‘productivity puzzle’. 

To delve deeper into the UK’s productivity problem, it's essential that we explore some background context of the general economy before the onset of the financial crisis and how the recovery since has continued. Leading up to the new millennium, the UK experienced strong and sustained year on year growth, with an average annual growth rate of 3% between 1993 and 2007. The key reason for this wasn’t just a strong domestic economy, but a positive political landscape and booming consumer confidence in the global economy as well. Driven by the dot com bubble of the late 1990’s, many businesses were expanding at a rate that the world had never seen before and new businesses with strong sales growth and profits were sprouting up everywhere. Politically, Tony Blair was in Ten Downing Street, George Bush was the newly elected President of the very powerful USA, and the Euro was just a year old with the EU considering its expansion into central Europe. But what followed in the next few years would leave a lasting impact on Britain’s economy and its people, one that is still felt to this day. 

Much like the rest of the global economy, the UK entered a recessionary period during the 2nd quarter of 2008 - the financial crisis had officially begun. It all began with US banks giving out credit loans to poor borrowers, known as ‘subprime’ borrowers. The aim of this policy was to boost the housing market as the US believed it was almost invincible. During the US housing bubble of 2006/7, numerous banks were forced to give out cheap mortgages to subprime borrowers, backed by the government’s initiative of making the ‘American Dream’ a reality for low income families and immigrants.

Low and behold, as many as 25% of subprime borrowers defaulted on their mortgages by May 2008, leading to a credit crunch in the US. This crisis rapidly spread to the UK as many major UK banks had ties to the housing market in the US, and their collapse created a shockwave in the UK financial market. The government had to inject £37 billion into major banks such as Lloyds and RBS, in order to stabilise the financial system. What followed was a surge in the national debt due to the excess government spending, while revenues from taxation had plummeted. 

The deepest recession since the second world war was underway, marked by 2 years (6 consecutive quarters) of negative economic growth. At the height of the recession “GDP fell by 2.6% in a single quarter (Q1 2009) – the same percentage by which the economy

expanded during the whole of 2007.” An even more startling figure is that the UK was the last of the G7 countries to come out of recession after the financial crisis, which set the economy up for its productivity problem. 

There’s no greater example of the importance of labour productivity in an economy than that of the UK’s. Since 2008, the average output per worker per hour (the standard measure of labour productivity) has been growing at around 0.4% annually, compared to the 1.9% labour productivity growth rate the economy experienced between 1993 till 2008.

What’s puzzled economists even more is that even after 16 years since the end of the financial crisis, the economy’s productivity has barely risen above the level at which the financial crisis had begun in 2008. One of the many key factors believed to be at the heart of the productivity puzzle is a lack of investment in the UK economy. Investment is the spending that firms undertake on capital goods in the economy (things like machinery, vehicles, factories, etc) and it makes up about 15% of the Aggregate Demand (AD) in the economy. Theoretically, when firms invest in the economy, it should lead to an increase in productivity levels as the overall output of workers shall be boosted given all the supporting technology and machinery that they have access to. However business investment is also heavily affected by both consumer and business confidence in the economy, as well as their personal finances. Post the financial crisis, the UK’s macroeconomic conditions have largely been unstable, characterised by fluctuating interest rates, government debt being piled on year after year (most recently the debt to GDP ratio crossed 100% in September 2024), and inflation levels being at their highest (11.1%) in October 2022, due to the energy crisis causing cost push inflation to spiral out of control.

Arguably, the most influential factor in affecting the UK’s productivity levels is government spending in education and training, as well as the overall quality of education being provided to children throughout the country. This type of spending done by the government is known as supply side policies, and it affects the economy by increasing its productive potential while lowering average price levels (inflation). However, the real problem stems from a lack of higher education in the UK, especially the regional inequality in academic achievement. Almost 1 in 50 children miss more than half the time they should be in school because families can’t afford transportation costs, uniforms, school supplies, or school meals.

In addition to this, the divide between public and private institutions in the country is immense, resulting in poor quality teaching and facilities for children in many parts of the country. Further budget cuts to education in the past few years have meant that a stark divide has been created in the education system, which means that only the very elite end up going to top universities. In many areas of the country, sixth form education is quite uncommon and pupils usually find work straight after Year 11 (at the age of 16). Here’s an interesting fact: A total of 30 out of 57 Prime Ministers have been educated at Oxford, and 20 have been educated at Eton College, which has a yearly fee of £48,000.

All of this means one thing: a less educated, qualified and trained workforce leads to lower productivity levels! On top of that, youth unemployment has soared to 14.5% in 2024, up by 2.3% from last year which means that more of the youth are finding it difficult to get jobs that they can occupy for the long term; a labour force that is discouraged can be problematic for an economy like the UK, as the threat of hysteresis becomes imminent. Finally, there’s a few major problems with supply side policies that would be hoping to boost the economy’s productivity: time lags and a blow to the already large budget deficit/national debt. These policies can take a really long time to actually work after being implemented. For example, the government recently announced an injection of about £1.8 billion into early years education. It will take nearly 10-15 years before those children leave high school and enter the workforce or go to university, and hence the time lags associated with the investment in education means that short term change shall be negligible. The investment also comes at a cost to the government; one that could further add to the already large national debt or come from the pockets of taxpayers - worsening consumer confidence in the economy. 

A challenge that has piqued the interest of many economists, the productivity puzzle will surely continue to trouble the UK’s economy for the next few years. However, with a few key changes to educational policies, as well as providing extended vocational training for those already in work, the government can try and assuage the painful wounds caused by the stagnant productivity growth experienced by the economy post the woes of the financial crisis.