UK productivity – output per hour worked – is currently 15% below an extrapolation of its trend over 1998-2008. Productivity rose at a trend rate of 2.3% per annum (pa) over this period; since 2008, by contrast, it has fallen by 1.0% pa – see following chart.


The Bank of England’s Monetary Policy Committee (MPC) forecasts that productivity will recover by 1.8% pa over the next three years. Many commentators regard this as unduly pessimistic, since it implies that 1) the 15% loss relative to the prior trend is permanent and 2) future trend growth will be below the historical average.

The judgement here, by contrast, is that the MPC's forecast is optimistic. This is based partly on an analysis, summarised below, of the last major productivity slowdown, in the 1970s. The weaker productivity performance expected here informs the view that unemployment will fall more rapidly than the MPC expects while “core” inflation will pick up in 2014-15.

The 1970s analysis is based on output per worker rather than output per hour because the former has a longer data history. Inspection of the data reveals a strong productivity trend in the decade to 1973, much slower growth between 1973 and 1980 and a return to faster expansion in the 1980s – next chart.


The change in trend in 1973 coincided with the onset of the “first oil shock” recession, which had similarities to the 2008-09 downturn – it was preceded by extreme monetary / credit laxity and precipitated a financial crisis; a spike in energy costs, moreover, contributed significantly to the 2008-09 recession.

A key difference from the recent past is that productivity continued to grow in the mid to late 1970s. The divergence from the prior trend, however, was substantial. Trend productivity growth slumped from 3.3% pa over 1963-1973 to 1.4% over 1973-1980, a reduction of 1.9 percentage points (pp). This compares with the recent decline of 3.3 pp (i.e. from 2.3% to -1.0%). By 1980, productivity was 16% below the prior trend – similar to the current 15% shortfall.

Several features of the 1970s experience are discouraging to current productivity optimists. First, the period of weakness lasted seven years, which, if repeated now, implies no recovery until 2015. The optimists, presumably, would argue that the larger deterioration in recent years increases the likelihood of an earlier revival.

Secondly, while productivity recovered after 1980, growth was permanently lower than before 1973. There was no catch-up relative to the prior trend. Trend growth over 1980-1990 was 2.5% pa, 0.8 pp below that in the decade to 1973. A similar step down now would imply future expansion of 1.5% pa (i.e. the 1998-2008 trend of 2.3% pa minus 0.8 pp).

The 1980s productivity revival, moreover, occurred only after another – deeper – recession and was at least partly due to economic liberalisation under the Thatcher government. The 1980-1981 downturn forced companies to shed low-productivity workers, whose jobs had been shielded by the loose monetary / fiscal policies of the 1970s. The Thatcher reforms, meanwhile, resulted in a more efficient allocation of capital and labour.

Current and prospective faster economic expansion should allow productivity to recover but the working assumption here is that growth will be 1.0-1.25% pa in the absence of policy changes to improve economic efficiency. If GDP rises by 2.5-2.75% pa, and the labour force expands in line with the MPC’s projection, this would imply a decline in the unemployment rate of about 0.75 pp pa – consistent with it reaching 7.0% in mid-2014.

The optimists believe that productivity growth will “mean revert” without any policy intervention, resulting in unemployment staying high. The 1970s-1980s experience suggests that causation is the other way round – a normalisation of productivity expansion may occur only as a result of policy changes that promote a reallocation of resources and push unemployment higher in the short term.

A scenario regarded as plausible here is that, with productivity performance remaining weak, faster growth will run into capacity and inflation constraints in 2014-2015; an associated tightening of monetary conditions – probably market-led rather than due to the MPC – could then produce another economic downswing in 2015-2016. Depending on its extent and policy choices, this downswing – like the 1980-1981 recession – could act as a catalyst for a more significant and durable improvement in productivity growth.