Don't believe that Brexit is the cause of our productivity slump — our problems go back decades

The UK certainly has an acute productivity problem — but blaming it largely on Brexit, as the Governor of the Bank of England has recently done is, may pander to people who would like this to be true but in truth Brexit is only a relatively small, and recent, part of the story. The UK’s dismal productivity performance goes back at least to the 2008 crash and arguably far further back than that.

Nor is there any great mystery about why the UK’s productivity record is so poor. It is the direct result of the combination of two crucial factors. One is that we invest far too little in our future and the other is that, of what we do invest, far too little goes into the sort of investment that really makes a real difference to productivity.

The average percentage of national income spent on investment across the world is 26%, producing an average rate of growth of 3.5%. In China, they invest 45% of their GDP, producing an increase in GDP per year which has recently averaged about 9%. In the UK, we devote only 16% of our national income to investment and for the last dozen years our growth rate has averaged 1.4%.

But the much better growth performance in other parts of the world than ours is not just due to the total amount they spend on investment, compared to us. It also has a lot to do with what types of investment which they spend the money on. The key factor here is that some types of investment are much better than others at raising productivity.

The huge rise in living standards since the Industrial Evolution got under way is due very largely to only three new key types of investment. These are clustered round mechanisation, technology and power — and very little else. This is because most other types of investment have nothing like the same capacity for enhancing value added. Think of a combine harvester replacing a sickle, a bulldozer instead of a shovel, a large truck replacing a wheelbarrow or a new machine which produces twice the output from the same inputs as the one it replaces.

Other types of investment cannot do this, at least not to anything like the same degree. However desirable they may be in social terms, expenditure on new hospitals, schools, roads, rail, public buildings and housing does little to increase GDP. The same is true in the private sector of new office blocks, shopping malls, restaurants and IT installations. None of them has to any extent the same capacity as technology, machinery and power to diffuse enhanced value added on such a major scale through the economy in the form of higher wages and salaries, better and cheaper products, higher profitability and a bigger tax base.

This being the case, why does the UK spend so little on investment of these key types? There is a simple reason. Most of this type of investment takes place in manufacturing, primarily in the part of the light industrial sector which produces internationally tradable goods. It therefore has to be both internationally competitively priced and sufficiently profitable to attract the investment needed — and this, in turn, depends on the exchange rate being in the right place. Around two thirds of UK manufacturing costs are incurred in sterling and it is these costs which need to be charged out internationally at a competitive rate.

Unfortunately, in the UK this condition is a long way from being fulfilled because we don’t bother about the exchange rate being much too high for industry — largely because those who call the shots in the UK are tied in with the service sector which is not nearly as price sensitive as manufacturing. In services, we also have substantial natural advantages in our language, geography, our universities and our labour force, which are completely lacking in manufacturing.

While services can, therefore, flourish in the UK with an exchange rate against the dollar of $1.30 or even $1.50, these levels are lethal for manufacturing. This is why manufacturing as a percentage of GDP has fallen from almost one third as late as 1970 to less than 10% now — and still falling.

So here is the problem: if we want to get our growth rate up from its currently pitifully low level, the only way to do so is to increase productivity. The only way to do this is to spend a lot more on mechanisation, technology and power. And the only realistic way of making this happen is for us to have an exchange rate which makes these kinds of investment both internationally competitive and profitable. Until we realise this and do something about it, expect productivity to stay in the dumps, whatever happens to Brexit.