Month: March 2025

Why productivity growth is important – Spring Statement 2025 edition

Last Wednesday saw the UK Government’s Spring Statement on the economy: essentially a response to a new forecast from the Office of Budgetary Responsibility. This was politically painful – a deteriorating forecast means that the government needs to either reduce public spending or increase taxes in order for the forecasts to meet its self-imposed constraints on public borrowing and the deficit. Those forecasts are always uncertain, and highly dependent on what assumptions are made about the future. This set of forecasts underline how important productivity growth – or the lack of it – is for the ability of the government to meet its commitments.

First, where are we now? Here is the latest productivity data. To recap, as I have been discussing for some time now, for much of the postwar period, productivity in the UK grew at a steady rate of 2.1% a year. That changed in the mid-2000s, in the run-up to the global financial crisis; the growth rate rather abruptly dropped to about 0.5% a year. The cumulative effect is that the productivity of the UK economy is now some 28% below what it would have been if earlier trend had continued.

UK Labour Productivity index, quarterly data. The solid blue line is a best fit to a function which assumes two periods of exponential growth continuous at a break point. See my post When did the UK’s productivity slowdown begin? for details of the fitting methodology. The best fit parameters are: pre-break growth rate: 2.1%, post-break growth rate: 0.48%, break at year 2005.2. Data: ONS, Feb 18th 2025 release.

Taking a more close-up look at the last twenty years, one sees that there is no sign of any recovery of productivity growth. On the contrary, the last few quarters seem discouraging. I think it is probably too early to conclude that we are moving into a period of even lower productivity growth – one needs to wait a while to see the long-term trends, and data is often revised. In addition at the moment there is a worry about quality of the survey data ONS uses to estimate total hours worked, which adds further uncertainty.

UK Labour Productivity index, quarterly data. Data: ONS, Feb 18th 2025 release, fit as in the plot above.

What is the OBR predicting for the future? It’s central forecast is based on the assumption that productivity growth increases by 2029 to a value which is more or less the average of the pre-break and post-break values – 1.25%, with an increase of 0.2% to the growth rate attributed to planning reforms leading to more house-building. It has also modelled the effect of an upside scenario, where productivity growth of 1.2% is achieved in 2025, and a downside scenario continuing recent lower trend growth of 0.3% a year.

UK Labour Productivity index, annual data, together with the OBR’s March 2025 scenarios for productivity growth up to 2029. Grey is the main March forecast, yellow & green are high and low productivity growth scenarios.

The next plot, from the OBR report, shows how much difference assumptions about productivity growth make to the fiscal projections. Without the assumption that productivity growth is about to increase significantly over the trend it’s followed for the last 15 years, the government’s fiscal targets for the debt and the deficit can’t be met. In this scenario, the government would need either to cut public spending further or increase taxes to meet those targets.

Effect of the different productivity growth scenarios on the OBRs fiscal forecasts. From the March 2025 Economic and Fiscal Outlook.

So, big decisions about the UK’s fiscal policy are being made on the basis of predictions of future productivity growth, and the question of whether the government will meet its fiscal targets are very sensitive to the assumptions being made. How much credence can we place on these forecasts? It does have to be stressed that the OBRs record on predicting productivity growth has been consistently overoptimistic since its establishment, as the plot below shows. I think this reflects a wider failure by the UK’s economic and policy-making community to appreciate the scale of the change to the UK economy in the 1990s and 2000s and its long term effects. There is no more important economic policy question than to understand the causes of the productivity slowdown – and to find policies to reverse this.

Successive OBR forecasts of productivity and outturn. Source: OBR

The end of wage growth in the UK

I’ve been writing about the UK’s slowdown in productivity growth for about a decade, as I discussed here. I think it’s fair to say that this issue is well-understood amongst economists and some policy people, but productivity is an abstract concept. So, it’s perhaps unsurprising that, even now, the seriousness of our economic situation isn’t fully understood by commentators and journalists, let alone the wider public.

But there’s one way in which our productivity slowdown has very visible everyday consequences – and that’s in the end of wage growth. As my plot shows, wages have flatlined in the UK over last 15 years. This long period of stagnation is unprecedented in living memory, & marks a decisive & unwelcome break from the UK’s postwar economic trajectory.

Average real weekly UK wages. Green: Composite Average Weekly Earnings series, corrected for inflation using consumer prices index. Thomas, R and Dimsdale, N (2017) “A Millennium of UK Data”, Bank of England OBRA dataset. Brown: ONS, Real Average Weekly Earnings, total pay, using CPI (seasonally adjusted). 18/2/2025 release.

The period from the end of the Second World War right up to the mid 2000s shows a remarkably consistent record of wage growth. There are moments of economic turbulence that are reflected in deviations from the trend of continuous 2.8% pa growth; a short-lived period of more rapid growth in the late 60s and early 70s – the Barber boom – with the excess growth unwinding in the mid-1970s crisis. And again, more rapid growth in the late 1980s Lawson boom, with the excess gains lost in weaker wage growth in the subsequent recession.

But nothing compares to the stagnation that we’ve seen since the global financial crisis. By the economic measure that arguably matters most to people at large – how their wages grow – the last decade and a half is by far the worst period since the war. In comparison, the economic turbulence of the 1970’s looks like a golden age.

UK labour productivity, index 2022=100. Data: ONS, 15/11/2024 release. Line: non-linear least squares fit to two exponential functions, continuous at the break point, which occurs at 2005 for the best fit. See When did the UK’s productivity slowdown begin? for more details of the fitting approach.

The end of wage growth in the UK is a direct consequence of the end of productivity growth. It’s worth making a couple of points about the link between productivity growth and wage growth. In the USA, that link is weaker than it was. But the UK is not the USA; while in the USA the labour share of GDP – the share of overall economic activity that goes to wages, rather than rewarding the owners of capital – has significantly fallen, this is not so in the UK. For whatever reason, in the UK, over the last decade, the labour share of GDP has actually increased.

Of course, my plot of wage growth presents a single average, and it’s a fair question to ask how the distribution of wages has changed with time – has this become more unequal, with more of the benefits of productivity growth going to higher earners? It turns out that, while there was a substantial increase in inequality in the 1980s, overall measures of income inequality have been relatively steady since then.

The wage growth plot explains so much about state of UK politics today. Few people have an intuitive feel in the abstract for what productivity growth – or its absence – means, but the sense of stalling living standards, and worse prospects for young people, is all too palpable.