News, Reflections and Ideas

Introduction

In the last couple of blogs we have looked at the changing nature of the world economy and inflation. In this blog we look at the important issue of productivity – the lack of productivity is plaguing the UK and is intertwined with the two previous topics. Quite simply, if we don’t get on top of the productivity issue, we will continue to struggle with inflation in the long term if we want to consume at the present rate, and our place in the world economy will decline. There is a myriad of economic forces at play here but consumption has to be paid for by activity unless we keep inflating the money supply…..

News – How Bad is the UK Productivity Issue?

No matter who you talk to, or what you see – something seems to have gone badly wrong with UK productivity. We all have anecdotal examples of the slippage of UK productivity from the gangs of men staring into holes while one man digs, at least two men being needed to change light bulbs in public sector organisations, the endless waiting on phones trying to resolve simple matters, tradesmen being glued to their mobiles for most of the working day, etc. For a lot of us, it is difficult to accept this creeping attitude of not doing much (especially as it seems to have worsened dramatically post Covid) and we are increasingly having to shrug our shoulders if we want to keep our stress levels in order.

While there is a lot of academic debate about how to measure productivity (issues of defining output and the labour denominator), on one commonly accepted measure it is 10% of GDP in the UK as compared to 13% in the US, Germany and France. From a value-added per worker, perspective, a German worker adds $70 to the nation’s GDP per hour worked, compared to $55 for the UK – quite a difference and important in terms of what can be consumed from activity rather than monetary impetus.

For those of us of a given age, it is clear that this has not always been the case, with fathers and grandfathers working long hours in successful companies to produce outputs for the world. In the 1950s, Britain had the highest productivity in Europe. This slipped in the 70s and 80s (“the sick man of Europe”) but recovered between 1980 and 2008. However, since the global financial crisis, Britain has slipped down the rankings once again. And while productivity is not everything (see the next section on work-life balance), in terms of raising general standards of living (measured in consumer terms), it is the most important factor by quite a margin.

There can be little doubt productivity has stalled across the globe and the UK has been particularly hard hit. Somewhat worryingly, if productivity had continued its pre-financial crisis trend, we would be approximately 25% better off.

While the weakness in the UK is widespread (most productive companies have lost momentum), the UK has a long tail of companies with poor levels of output per hour. In addition, the slowdown has been especially apparent in the computer programming, energy, finance, mining, pharmaceuticals and telecoms industries. Combined, these make up about 20% of the UK economy, but account for 60% of the productivity decline.

Finally, the picture in the UK also contains huge regional differences with productivity in London being 40% higher than the UK average.

Reflections – What are the Causes of Declining Productivity and What Can We Do about it?

There is not one single issue driving the productivity crisis in the UK but the various commentators seem to pick the ones which suit their political perspectives. There has been a focus on the banks’ lack of willingness to lend post the crisis and the impact of zero interest rates on struggling companies – i.e. the economy has not been allowed to restructure because a large number of zombie companies have been kept on life support because it is cheaper for the banks to do so. This is consistent with banks not be willing to lend – in both cases they are effectively sitting on their hands. We have not explored here the lack of productivity in the banking sector but this may yet be another example – it is simply easier to let matters run.

Another argument often forwarded is the skills shortages in key industries. In 2016 the OECD noted that 30% of 16-24 year olds in the UK have low levels of literacy and numeracy, compared to an OECD average of around 18%, and less than 10% in Japan, Holland and South Korea. Anecdotal evidence suggests these skills are now particularly acute with many organisations struggling to fulfil vacancies and having to pay very high starting salaries to attract young graduates, etc.

The skills shortage argument is rather irritating as the UK has not invested at many levels in the skills it requires – it has been cheaper to import the skills rather than invest locally. This applies to the NHS, universities and many other sectors. In many ways, we have ended up with a low skill/low wage economy and this is now coming back to bite us as global restrictions in labour/product movement increase. Many pundits blame Brexit, and while this has clearly not helped in the short term, it may be just the ‘shock’ we need as a nation to drive us to reflect on the output mix we want as a nation and how we will produce across the longer term. We may even have a return to proper apprenticeships, etc. but we need to decide on what kind of economy we want in terms of the mix of services and manufacturing.

A further argument is concerned with low business investment, too little innovation and weak management. There is clearly some truth in all of this but we cannot ignore the impact of the ‘business environment’ in the UK. Given the various laws and implicit rights of employees, there is an increasing feeling that the balance has swung too far to the employee and away from the employer, and we are seeing this playing out at the moment with the whole WFH debate and whether the employer has the right to ‘demand’ a full-time return to the office.

And, we want to develop this argument further in terms of how society and its aspirations (or lack of) drive the productivity of the economy. Over the past decade, we have had an increasing focus on work-life balance, the welfare of citizens and less and less discussion on the production needed to provide what the citizens want. Since the beginning of industrial society, competition coupled with a strong work ethic has driven societies forward, both of these are now being questioned. As an aside, when housing can provide wealth increases greater than active work, it may be rational at the individual level not to spend too much time agonizing as to whether we have got our focus right at the societal level.[CX2] When the national fixation on housing seems to continue to pay dividends via price rises, there is little drive/incentive to reflect on whether this is a sensible way to run an economy? We have grown used to notional increases in wealth (via housing) fuelled by an ultar loose monetary policy and this seems to have masked some startling facts – for example, what we produce in 5 days, the French produce in 4 and the Americans in little over 3.

We have an economy that is badly balanced (heavily dependent on financial services and London) and focused on consumption – which does not quite work as we drift ever more to a low skill/low wage economy. Without the continuance of a debt build up and the chimera of housing wealth, it is difficult to see how this ‘economic model’ can survive. Essentially, there will be a day of reckoning and it might just be getting closer.

Essentially, what is being proposed is that our productivity issue reflects a deeper malaise of not being bothered and not needing to be bothered. If this is true, then the productivity problem will not be solved by govt schemes just focusing on innovation, investment, etc. It may need to start at a deeper educational level – i.e. the benefits of striving, competition and hard work.

Finally, to give some balance to our perspective, we need to consider whether labour productivity is the correct measure by which to judge advanced economies (consider how we should measure success if we had a totally robotic means of output production/delivery?) All of the previous discussion has taken labour productivity and its measurement (output divided by some measure of labour input) as important and a given. There is a huge literature on labour productivity but from many perspectives, it might be the wrong measure of the economic success of a nation – especially as we move to higher-tech environments. Let me give a simple illustration of the problem. Take two economies with the same output of 1,000 units each. Both economies have 100 people. In economy A, the output is produced by 1 person = 1,000 measure of productivity; in economy B it takes the whole population of 100 = a measure of 10 for productivity. From the labour productivity perspective, economy A is a lot better. But this raises some simple issues. First, both economies produce the same outputs that can be shared across the population (big assumption of sharing). Second, economy A has quite a large unemployment problem – are the 99 people not producing happy sitting around? Perhaps, people would be happy playing their part in the production of the output. The counter-argument being that the unemployed in economy A could be producing more if they were employed, etc.

What is being driven at here is that emphasising labour productivity takes as a given view of the economy, how society is made up and of the means of production. None of this is to undermine the above discussion but just to make readers aware of some of the issues of taking measures at face value. Some of the limitations of measuring GDP, labour productivity have fed into the discussions of happiness indices, etc. We will discuss these in a future blog.

Ideas – Value enhanced by productivity

Issues with global supply chains, inflation shooting up and productivity in decline leads to the simple conclusion that we are in a changing (changed) situation as regards the markets. Remember not all cost inflation can be passed on to consumers and this will impact corporate earnings. The various US markets are down between 10% and 20% this year. However, not all stocks are falling in the same way and some intelligence will need to be applied to active stock investing – for example, mining stocks have done well, while a number of the tech stocks supplying retail have bombed for obvious reasons (we have had enough of looking at screens..). Warren Buffett believes in investing in well managed but under-valued companies. One measure we could use to measure well managed is the sales to employee ratio normalised by the industry norm.

We construct a high productivity strategy backtesting in a similar style as those we have done in the book. We select the stocks that fall in the top quintile of the FTSE 350 when sorting by their industry adjusted “sales per employee”. We use an equal-weighted portfolio and rebalance every year for the past 20 years. The following figure presents a stunning outperformance of such a portfolio over the FTSE 100 over the 20 years. The accumulative return is 1180% which is more than 6 times that of FTSE 100.