The debate among British economists and politicians about economic prospects for the year has intensified in recent days—but what matters more is the United Kingdom's long-term growth pattern over the next two decades. A drop in the rate of GDP growth from its historic 40-year average of 2.5 per cent per annum to, say, 1.5 per cent for each of the next 20 years would be far more damaging to wealth and jobs in this country than a double-dip recession some time in the next 12 months.
The economy will thrive if it takes bold steps now to drive labour productivity higher, to make itself more broad-based (notably by narrowing regional differences), and to increase its resilience by improving financial stability and reducing pockets of high leverage.
Continued improvements in productivity per hour, which has accounted for more than 100 per cent of the rise in GDP per capita since 1970 and offset falling hours worked per capita, are the key to this sustained growth. Britain's recent record on productivity has been encouraging—outstripping the other G7 economies in the past 15 years. However, our absolute level of productivity still lags behind that in the United States by about 17 per cent and the big European countries, such as France and Germany, by about 10 to 15 per cent.
Two factors make action especially urgent at the moment. First, demographic trends (a falling share of the working population relative to the total population) will restrain growth in GDP per capita by an average of 0.3 percentage points per annum between now and 2030. Second, although productivity in the private sector has grown by more than 2 per cent per annum in recent years, productivity growth in the public sector has been consistently negative and represents a growing drag on our overall national performance.
What matters is the productivity performance within different sectors, not the overall mix. The solution for the United Kingdom is, therefore, not to tinker with the balance between, say, financial services and manufacturing but to lift the specific barriers to competition and growth within each industry.
A good place to start is to look at ways to improve productivity across the diverse service sectors, which represent about 65 per cent of private sector output. Despite Britain's reputation as a strong, service-based economy, our overall service sector productivity lags behind that in the United States by 25 to 40 per cent. We can narrow the gap if we remove barriers to competition and eliminate unnecessary regulations, for example in retailing by easing planning constraints on location and formats of stores. Look at what happened to productivity in the Swedish retail sector after the easing of zoning laws in the mid-1990s: over the next ten years it had the highest productivity growth in Europe, outperforming US retail productivity by 14 per cent.
Improved road infrastructure will help multiple service sectors, as will alignment between the skills produced by our educational system and employers' needs, especially in science and technology. Equally important, we must avoid additional regulation that makes successful sectors, such as financial services, uncompetitive internationally, or measures such as excessive constraints on immigration that hinder U.K. employers' access to essential skills.
Our recent report, "From austerity to prosperity: Seven priorities for the long term," contains many other ideas for improving long-term productivity, notably through better innovation and by unleashing the productive potential of the health and education sectors. It repeatedly demonstrates the correlation between skills and managerial capability on the one hand and productivity, output, and competitive intensity on the other.
Although the near-term economic outlook may be challenging, there is an opportunity this year to accelerate our longer-term growth potential. The experience in other countries suggests that the will to pursue difficult reforms is strongest during the most difficult economic times.
This article originally ran in The Times.
