Why is the Chancellor obsessing about improving productivity?

Philip Hammond

Arguably the most important judgement we’ll hear in the Chancellor’s autumn statement on Wednesday is the extent to which the Office for Budget Responsibility believes that productivity growth in the UK will be damaged by Brexit.

As I said in my interview with the Chancellor this morning on Peston on Sunday, the OBR will – to the chagrin of the Brexiteering ultras – forecast a Brexit-induced deterioration in the recovery of productivity, or output per hour worked.

That’s because of the friction and costs that are likely to be introduced into our trading relationship with the rest of the European Union: all other things being equal (which they never are, though economists never tire of pretending they might be), productivity tends to improve when companies operate in larger more competitive markets.

But I am also told that Sir Stephen Nickell – the distinguished labour-market economist and relevant member of the OBR’s three-person Budget Responsibility Committee – is forecasting less of a Brexit-induced shock to productivity than many economists.

“Nickell expects a slowdown, but its not as bad as many in the Treasury have been fearing” a senior government member told me.

The point is that in determining the sustainable long-term growth rate of the whole economy – and of wages and tax revenues – productivity matters more than any other variable.

The slower that productivity grows, the more the government’s debts are likely to increase, because tax revenues would be commensurately lower and benefit payments commensurately greater.

And the faster the growth rate in productivity, the richer we become.

So to labour the point, productivity matters.

Apart from anything else, the big reason why living standards for those in work are still lower than they were before the great recession of 2008 – and why it has been such a slog for the government to close its financial deficit – is productivity slumped almost a decade ago and has never properly recovered.

We’d be close to a fifth better off today if productivity had continued to grow at its pre-crash rate.

So some might say the British people about which Theresa May obsesses – the Brexit-supporting, just-about-managing or JAM households – are the pre-eminent victims of declining productivity growth.

And – irony of ironies perhaps – they’ll suffer more if Brexit is a serious blow to productivity.

Which perhaps explains why Philip Hammond said this to me: “I think to the extent that we are able to increase borrowing we should target it on productive economic investment.

Investment in the R&D capacity of our economy, investment in our network infrastructure, the things that will improve the productivity of the UK economy.

“Because as we leave the European Union and we start to earn our living in the wider world, we are going to have to get ourselves match fit in order to compete and we have a long-standing productivity challenge in this country

"We need to build the productive capacity of our economy, we need to close that productivity gap if Britain is going to be able to succeed in the world”.

Now if you’ve bothered to read this far, you’ll probably be experiencing déjà vu, because the UK has had a productivity problem more-or-less since we stopped being the biggest and most powerful economy in the world: output per hour in the US, Germany and France, for example, is between a fifth and a third higher than here.

But here’s the rub: the timing of Brexit both makes the productivity challenge harder and more urgent: we have a record deficit on our trade and investment with the rest of the world, we are more reliant than ever on credit from the rest of the world to fund our lifestyles; but the worse the outlook for productivity, the more our creditors become anxious about our ability to repay those debts.

Let’s be in no doubt, the collapse in sterling since we voted to leave the EU is in large part a judgment by investors that our productive potential has been damaged and we’ve become a lousier credit risk.

That precipitate fall in the pound is significantly increasing the price of imports, which means, as the Chancellor starkly put it to me, that “it’s clear that inflation is back”.

Which in turn means we’ll be poorer next year, when price rises outstrip wage rises by a margin.

This prosperity squeeze could be a blip, a pimple, rather than a trend of course, if – and you’ll by now be able to sing the chorus to this dirge – we work harder and smarter, if we somehow engineer a productivity revival.