New analysis of the UK's 'productivity puzzle' demonstrates that poor productivity performance across most sectors of our economy, more than a compositional bias towards low-productivity sectors, explains why we are so far behind both comparable economies and the upward trajectory we were on before the financial crisis.

The UK has a productivity gap of between 23 and 32 per cent between it and the otherwise comparable economies of Germany, France, the Netherlands and Belgium. It also has a gap of 17 per cent between its current level of productivity and what it would have been if trends in the 25 years to 2007 had continued during and after the 2007–2008 financial crash.

This report presents new evidence on these two aspects of the UK’s 'productivity puzzle', providing a comprehensive review of previous analysis on the topic and systematically examining every factor that may have contributed towards this poor performance. It demonstrates that the productivity gap between the UK and other similar countries can be wholly attributed to relatively low productivity within sectors, rather than it being the result of an overall compositional bias in our economy towards low-productivity sectors. For example, manufacturing in the UK is 27 per cent less productive than in France, and 33 per cent less productive than in Germany, and a similar picture emerges in many other sectors.

Similarly, it also finds that the productivity growth that was ‘lost’ in the UK between 2007 and 2015 was wholly the result of developments within sectors, with productivity growth since 2008 across almost all sectors of the economy remaining lower than it was prior to the crash.

However, we find that over the last seven years there were two distinct phases of productivity weakness that need to be analysed separately, and which pose two distinct questions. First, why did employment not fall further during the recession, given how much output fell? Second, why did productivity not increase over the last three years, despite economic recovery becoming firmly established?

During the recession, poor productivity performance was a wholly within-sector phenomenon, the result of labour-hoarding and a shift in the capital–labour ratio facilitated by falls in real wages. But afterwards, between 2012 and 2014, while within-sector effects remained a drag on productivity, around half of the weakness in productivity growth can be attributed to an unfavourable shift in the structure of the economy. Jobs growth may have been strong over these three years, but it was disproportionately in low value-added – and low-paid – sectors of the economy, and a larger proportion of the labour force now works in relatively low-productivity sectors.

The key to restoring vital productivity growth is, therefore, to shift job-creation towards higher-productivity sectors, while encouraging firms to invest more in order to boost the productivity of their existing workforces. This means the government needs to change its focus, most importantly by:

  • supporting lower-productivity sectors, particularly service sectors which account for a growing share of our economy, to raise productivity, rather than concentrating support on high-end manufacturing industries
  • reconsidering cuts to capital spending on infrastructure, further education and (in real terms) the science budget.