Declining productivity is proving to be an issue for chancellors and investors alike.
For seven years, the Office for Budget Responsibility (OBR) forecast that productivity in the UK was on the cusp of recovering from its dismal lows – only to be proved wrong on every occasion.1
In this year’s Budget, Chancellor Philip Hammond was obliged report that the OBR finally gave in and cut its forecast. Having seen productivity growth averaging 2.1% per year before the crisis, annual productivity growth since the financial crisis has been just 0.2%.2
Although several other developed countries face a similar challenge, the UK’s productivity deficit is particularly acute. Government figures show that the UK’s output per worker is 16.6% below the EU average.3 Nevertheless, it is a widespread issue with profound implications.
“There are two fundamental ways to boost your potential GDP growth,” says Megan Greene of Manulife. “In the US, as in the UK, Germany and Japan, we don’t have much productivity growth these days. There is an argument that we just don’t know how to measure productivity anymore, given that we have all these new technologies, we’ve got the gig economy – there is a measurement problem.”
Yet Greene believes that is only part of the reason for the decline in productivity. A more important factor is ‘capital deepening’, namely, the amount of investment allocated per worker. As far as Greene is concerned, companies have simply failed to invest. She sees two causes behind their reluctance.
Firstly, there has been a glut of cheap labour globally, a trend that began with the collapse of the Berlin Wall and USSR, which brought Russia and central and Eastern Europe into the global workforce. It continued with China’s opening up and industrialisation, and continues today with the urbanisation and industrialisation of India. Greene believes the trend still has plenty of road left, as it could continue with the Middle East and sub-Saharan Africa.
“We’re going to have a glut of cheap labour for a long time,” says Greene. “Companies don’t have to hire within their national boundaries anymore, which means there’s a lot of competition on wages from abroad. If a company has the choice between investing in expensive machinery or hiring cheap labour, then it will probably hire cheap labour.”
The result is a relative absence of both capital deepening and high-quality workers. On top of that, due to rapid advances in technology, an increasing number of companies may not need to invest in physical capacity much anyway.
“There are a lot of companies now, like Google and Amazon, which don’t actually require a huge capital stock, especially when you compare them to the old manufacturing behemoths of 40 or 50 years ago,” says Russell Jones of Llewellyn Consulting. “They don’t need big factories or production facilities. That also means less investment.”
In fact, Jones believes that a significant number of different factors have converged to put unprecedented pressure on productivity in the developed world. One of these is shifting demographics.
“Elderly dependency ratios have risen most aggressively in Japan, Korea and Spain, but it’s something being seen right across the advanced economies – and in some of the emerging world as well,” he says. “Another reason is that there is a shortfall in productive investment. There are a lot of zombie companies which can pay the interest on their debt and not much else – they are struggling to invest anything. The other consideration is that governments are not investing in the more productive areas of the economy – education, R&D, infrastructure and training. Governments are not delivering on the recommendations made by entities like the OECD and IMF, and that has fed into productivity weakness.”
Greene is forthright about the outlook: “I don’t think this low productivity environment is going to change significantly any time soon.”
Without improvements in productivity, there is another way to improve the growth rate, however; by increasing the supply of labour. According to Greene, this can be achieved one of two ways. Either governments can invest in childcare, which tends to increase workforce participation considerably. Or they can encourage immigration. On neither score, she says, is the outlook positive.
“No government is fighting for childcare just now, and the developed world seems to be turning against immigration,” she says.
When companies and governments alike choose to invest in future growth, it can act as a fillip to investors. A broad corporate culture that is focused on growing companies – not simply growing dividends or bonuses – has the potential to lift all stocks as companies grow ever more efficient.
Yet neither Greene nor Jones believe these are such times – quite the reverse. As a result, investors need to discriminate more than ever to identify those companies that are truly investing in their own future. Anything else risks being unproductive.
Manulife is a fund manager for St. James’s Place.
The value of an investment with St. James's Place will be directly linked to the performance of the funds you select and the value can therefore go down as well as up. You may get back less than you invested.
The opinions expressed are those of Megan Green of Manulife and Russell Jones of Llewellyn Consulting and are subject to change at any time due to changes in market or economic conditions. This material is not intended to be relied upon as a forecast, research, or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or adopt a strategy. The views are not necessarily shared by other investment managers or St. James's Place Wealth Management.