Since the financial crisis, the UK has seen economic growth, coming out of the recession well. However, we are still operating at recession levels of productivity and wages have stagnated.  Could the rise in self-employment and different working arrangements be to blame for this productivity problem?  In the fourth and final part of a series on low pay from Lewis Silkin, Tom Heys discusses the issues.

Financial crisis and economic growth

By some measures, the UK economy has come out of recession well. The employment rate is at an all time high and more people are finding work.

But by other measures, we’ve been doing terribly. Although there are some dim signs of improvement, we are still operating at recession levels of productivity. In all other major recessions, productivity has risen by up to 15% in the years afterwards. Yet UK PLC has seen no real increase, and no one really knows why. At the same time, wages have stagnated. As Robert Chote, Head of the OBR, said “it’s fundamentally productivity growth that determines living standards”.

 Since the recession, the UK's productivity has remained lacklustre. Economists believe solving this problem will help boost growth and living standards.

Since the recession, the UK's productivity has remained lacklustre. Economists believe solving this problem will help boost growth and living standards.

Low pay and employee productivity

Economists have a theory that supposedly explains part of the connection between low pay and low productivity. The marginal revenue productivity theory says that, in a competitive market, owners of resources (like labour) tend to be paid according to their marginal contribution to output i.e. that little bit extra revenue that is produced as a result of their work. So a more productive worker that adds a more valuable contribution to output is paid more than a less productive worker that adds a less valuable contribution.

Of course, this is only part of the story. This only applies in a perfectly competitive market. And that exists in only one place: an economist’s textbook. A perfectly competitive market assumes all workers are the same, firms have no buying power when demanding workers, firm are price takers that do not have to lower the price in order to sell additional units of the good, there are no trade unions, that the productivity of each worker can be clearly measured, and that the supply of labour is perfectly elastic with workers being occupationally and geographically mobile.

The real world is very different to this.

Sometimes businesses need to lower the price to sell more; workers aren't all the same, they can’t go from working in one sector to doing something completely different in another; and, productivity can’t always be measured easily. For example, what does a more productive nurse look like? Do they care for more patients per hour, or provide better quality care for the same number? Moreover, nurses have their pay set by Government, so their level of productivity isn’t actually a factor at all. The marginal revenue productivity theory is probably only useful when restricted to some specific industries, rather than the economy as a whole.

Ignoring economic theory

So, if we leave that economic theory aside, what are the real reasons behind the UK’s productivity problem? The rise in self-employment could be a factor.  The last recession did not see the mass unemployment that could have been expected, but saw larger than expected increases in self-employment. Self-employment typically tends be less productive because there can be economies of scale in pooling resources.

In addition, there are record numbers of people with second jobs and record numbers working part-time. Given that productivity is a measure of value created from hours worked, and there are a lot more people working more hours yet not as much demand to buy things (and therefore for someone to have to produced those things), simple maths tells us that productivity should be lower. There may also be an element of businesses holding back their level of production until demand increases.

The productivity problem is not something that can be fixed at a stroke. There’s no one measure (or even a handful of measures) that can be applied across the board and make UK PLC a productive powerhouse again. The macro problem will only be fixed at a micro level. Individual employers will need to apply new ways of working and embrace new technology and working arrangements. Then, when businesses can get more out of a workforce, they can sell more, make more profit, and so afford to pay a bit more.  

This is the fourth in our four part series focusing on low pay.

Part one: "What next for the Low Pay Commission?"

Part two: "What next for the National Minimum Wage; sectoral rates"

Part three: "National Minimum Wage: would a regional approach to NMW work?"

By Tom Heys, Lewis Silkin

 

How can employers boost productivity? Have you seen any innovative measures be taken in your workplace? Share your thoughts about the UK's productivity puzzle using the comments section below.

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