The UK productivity puzzle

Last week’s comments from the new home secretary, Priti Patel, on the UK’s post-Brexit immigration policy raised some eyebrows from employers around the country, especially those that rely on cheap labour.

Ms Patel announced plans that will effectively prohibit most businesses from recruiting outside the UK for unskilled jobs requiring qualifications equivalent to below an A-level, or who are to be paid less than £25,600 annually. Does this spell the end of cheap labour for the UK economy? And what impact will this have on productivity?

The UK, like a lot of Western economies, has suffered from a productivity decline since the mid-2000s, with productivity growth rates effectively flatlining since the 2007 financial crisis (see graph below). On the flip side, employment has been a bright spot of the economy despite lacklustre GDP growth. This is a perplexing situation for the Bank of England, whose mandate is to keep prices stable and to some extent maintain low unemployment. These goals have been met over the past couple of years, preventing the Bank of England from raising interest rates.

While the economy has maintained a high level of employment, business investment in capital has been virtually non-existent. Instead, employers have substituted investment for a large supply of cheap labour from abroad. UK businesses are well behind some of their European peers, who deploy nearly three times as many robots according to data published by the International Federation of Robotics.

But the new stance on immigration policy means that businesses will no longer be able to rely on low skilled migrant workers. The obvious conclusion is that they will need to raise wages and invest more instead. The Tories have already shown a willingness to fight employers on this by raising the Living Wage. Current noises from the government suggest that immigration was never envisioned to be an alternative to increased investment in automation. The prime minister argues that he and his colleagues are entrusted to set the rules of the economic game, which for too long has been rigged against the interests of low wage staff. Ironically, this paints Labour as the party backing free movement, and the Conservatives championing workers’ rights.

Whenever automation is mentioned, the instinctive reaction is to anticipate robots pushing humans out of work. In countries such as South Korea and Sweden, however, the bots are not displacing humans entirely, simply pushing them into higher paid work. This is seen by some economists as more than welcome, against a backdrop of UK wages only just beginning to rise above levels seen during the global financial crash.

That said, there are clear flaws in Ms Patel’s thinking. One of her headline arguments is that more than eight million people – or 20% of the workforce aged between 16 and 64 – are currently economically inactive. She argues that the new immigration policy will mean that they will be able to fill the void left by a diminished immigrant workforce. This ignores the critical fact that when those classed as economically inactive are surveyed, only 1.87 million out of 8.48 million say they want to work. Of the remainder, the majority are students, sick, elderly, or caring for others. It is currently unclear how the home secretary intends to persuade such people into employment.

If the government is successful in channelling business investment towards automation and labour-saving practices, it is likely to result in rising minimum wages. This could enhance employee morale and work ethic, as well as reducing turnover of staff. But what this means for businesses and the economy is more of a puzzle.

By Sohail Singal, Associate Director at Chatham Financial