Andrew Willshire is founder of the independent strategic analytics consultancy Diametrical Ltd.
It’s a new year, which can only mean one thing – another 12 months of economic commentators bemoaning the dire state of the UK’s productivity, particularly since the financial crash in 2008. Such articles are usually accompanied by a chart of this sort showing where we might expect productivity to be if the pre-2008 trend had continued.
There are many factors blamed but most of these would take time to filter through; they wouldn’t produce in a step change in the rate of productivity.
For example, a reduction in infrastructure spending in 2008 wouldn’t be reducing productivity by 2009. Business investment was already growing again by 2009, while the post-Brexit freeze didn’t induce a noticeable reduction either. Energy prices nearly doubled between 2001 and 2010 but were mostly flat in the 2010s, and the spike following the Ukraine invasion doesn’t seem to have an obvious effect.
But one question seems to be rarely asked; are people actually incentivised to work harder?
No matter the state of the business environment, there is an element of productivity that is simply related to individuals making the decision to work harder.
Most of us know that there are times when we can focus more on getting the job done, particularly if there’s a deadline approaching. We can set aside distractions, reduce casual conversations, turn our phones off, etc.
There’s a level at which you need to perform to keep your job, although that is often set by the performance of those around you. Then there’s a level above at which you might perform in order to try to secure a pay increase or a promotion from your employer. Ultimately, you work at that level because you believe that you will be better off afterwards, i.e. you will have more discretionary income.
But what would happen if a pay rise or a promotion did not result in greater spending ability commensurate with the additional effort?
Back in 2017, I wrote that many families were massively disincentivised to work harder because in 2003, Gordon Brown implemented a system of in-work benefits which interacted with existing benefits, such as housing benefit, such that claimants could face an effective marginal rate of 97 per cent.
A family with children renting in London might find that that even trebling their income from £20k to £60k would only result in additional income of £130 per week.
This was the trap that Universal Credit was designed to help people escape, although it was only last year that the so-called taper rate was reduced from 63 per cent to the originally-envisioned 55 per cent, allowing people to keep nearly half of their increased earnings.
Many people just getting on with their work up until the crash probably didn’t realise this: you do your job, you get your salary, you get your benefits paid. But when the crash hit, some of those people will have found themselves redundant, or working reduced hours, but – critically – that their post-tax-and-benefit incomes were almost unaffected.
Consider the following chart which shows real-terms spending on Universal Credit and its antecedents against the annual change in real-terms output per worker in the economy. There is an obvious cyclical component to the welfare spending related to recessions, and a trend which will be partly related to population.
But there are also a few obvious steps, abrupt increases in the spending on benefits that are seemingly permanent. There is a small step in 2003, when the new tax credits system was introduced, and another much larger step in 2009 following the crash.
There are also two obvious changes in the rate of productivity increase. Once is around 2003, which pre-Covid was the last time that productivity increase exceeded 2 per cent. The other was around 2009, after which productivity slumped to its recent dismal level.
Are these timings pure coincidence? Perhaps; it is possible that another factor is causing both productivity to be low and the welfare bill to be high. But it would be at least worth examining.
The key problem with in-work welfare is not only that it conditions people to work less hard, but that it disincentivises businesses to pay more to their employees. Why would a company increase its staff wages when the only beneficiary is the Treasury?
That step up in tax credit payments is really just a massive subsidy to employers of low-wage workers. And if companies aren’t forced to pay workers more, then they will be less likely to invest in technology to replace those workers, or even to train the workers they already have. Inevitably, we have become a low-wage, low-skill, high-welfare economy.
But does this really affect that many people? Well, 4.6m households are on Universal Credit. By design, this includes a large number of people working part-time who could earn more if it was worthwhile for them to do so.
Of course, it would be ridiculous to place all the blame for the slow increases in productivity on just those working at the bottom end of the pay scale.
People earning close to £50,000 a year start to lose child benefit if they earn more, a marginal rate of 71 per cent for a family with three children. Those who earn up to £100k per year will be faced with a marginal rate of 62 per cent tax if they earn more. These rates could be higher still if individuals have student loans to pay back: an additional marginal rate of nine or even 15 per cent if they have a postgraduate degree.
Small business owners may be disincentivised by VAT being applied at revenue exceeding £85,000. Why push to expand only to be hit by a huge increase in complexity? Increasing Corporation Tax, slashing the Dividend Tax Allowance, and tying people up in knots over IR35 is also a disincentive for those considering starting their own business.
You might as well stay as an under-productive employee, rather than try to become an over-productive contractor.
Public sector productivity lags the private sector considerably. Thanks to national pay bargaining and regular increments, public sector workers have no particular impetus to become more productive.
Teachers get paid whether children learn or not. GPs are paid by the number of patients on their books, not the number they treat. Treasury civil servants are paid whether the state of the nation’s finances improves or declines.
This isn’t to say that public sector workers don’t work hard. But they aren’t driven to increase the actual amount of output that is created through that effort.
This problem is not front of mind for pensioners’ either: the ridiculous triple lock means that their state pension increases whether the productivity goes up or down. And if productivity-increasing measures like building homes and factories would even fractionally reduce their perceived quality of life, why would they support that?
It’s a modern-day tragedy of the commons – it’s in the collective interest for us to have a more productive economy, but it’s in too few individual’s interest for themselves to be more productive. That’s no way to run a country.
Andrew Willshire is founder of the independent strategic analytics consultancy Diametrical Ltd.
It’s a new year, which can only mean one thing – another 12 months of economic commentators bemoaning the dire state of the UK’s productivity, particularly since the financial crash in 2008. Such articles are usually accompanied by a chart of this sort showing where we might expect productivity to be if the pre-2008 trend had continued.
There are many factors blamed but most of these would take time to filter through; they wouldn’t produce in a step change in the rate of productivity.
For example, a reduction in infrastructure spending in 2008 wouldn’t be reducing productivity by 2009. Business investment was already growing again by 2009, while the post-Brexit freeze didn’t induce a noticeable reduction either. Energy prices nearly doubled between 2001 and 2010 but were mostly flat in the 2010s, and the spike following the Ukraine invasion doesn’t seem to have an obvious effect.
But one question seems to be rarely asked; are people actually incentivised to work harder?
No matter the state of the business environment, there is an element of productivity that is simply related to individuals making the decision to work harder.
Most of us know that there are times when we can focus more on getting the job done, particularly if there’s a deadline approaching. We can set aside distractions, reduce casual conversations, turn our phones off, etc.
There’s a level at which you need to perform to keep your job, although that is often set by the performance of those around you. Then there’s a level above at which you might perform in order to try to secure a pay increase or a promotion from your employer. Ultimately, you work at that level because you believe that you will be better off afterwards, i.e. you will have more discretionary income.
But what would happen if a pay rise or a promotion did not result in greater spending ability commensurate with the additional effort?
Back in 2017, I wrote that many families were massively disincentivised to work harder because in 2003, Gordon Brown implemented a system of in-work benefits which interacted with existing benefits, such as housing benefit, such that claimants could face an effective marginal rate of 97 per cent.
A family with children renting in London might find that that even trebling their income from £20k to £60k would only result in additional income of £130 per week.
This was the trap that Universal Credit was designed to help people escape, although it was only last year that the so-called taper rate was reduced from 63 per cent to the originally-envisioned 55 per cent, allowing people to keep nearly half of their increased earnings.
Many people just getting on with their work up until the crash probably didn’t realise this: you do your job, you get your salary, you get your benefits paid. But when the crash hit, some of those people will have found themselves redundant, or working reduced hours, but – critically – that their post-tax-and-benefit incomes were almost unaffected.
Consider the following chart which shows real-terms spending on Universal Credit and its antecedents against the annual change in real-terms output per worker in the economy. There is an obvious cyclical component to the welfare spending related to recessions, and a trend which will be partly related to population.
But there are also a few obvious steps, abrupt increases in the spending on benefits that are seemingly permanent. There is a small step in 2003, when the new tax credits system was introduced, and another much larger step in 2009 following the crash.
There are also two obvious changes in the rate of productivity increase. Once is around 2003, which pre-Covid was the last time that productivity increase exceeded 2 per cent. The other was around 2009, after which productivity slumped to its recent dismal level.
Are these timings pure coincidence? Perhaps; it is possible that another factor is causing both productivity to be low and the welfare bill to be high. But it would be at least worth examining.
The key problem with in-work welfare is not only that it conditions people to work less hard, but that it disincentivises businesses to pay more to their employees. Why would a company increase its staff wages when the only beneficiary is the Treasury?
That step up in tax credit payments is really just a massive subsidy to employers of low-wage workers. And if companies aren’t forced to pay workers more, then they will be less likely to invest in technology to replace those workers, or even to train the workers they already have. Inevitably, we have become a low-wage, low-skill, high-welfare economy.
But does this really affect that many people? Well, 4.6m households are on Universal Credit. By design, this includes a large number of people working part-time who could earn more if it was worthwhile for them to do so.
Of course, it would be ridiculous to place all the blame for the slow increases in productivity on just those working at the bottom end of the pay scale.
People earning close to £50,000 a year start to lose child benefit if they earn more, a marginal rate of 71 per cent for a family with three children. Those who earn up to £100k per year will be faced with a marginal rate of 62 per cent tax if they earn more. These rates could be higher still if individuals have student loans to pay back: an additional marginal rate of nine or even 15 per cent if they have a postgraduate degree.
Small business owners may be disincentivised by VAT being applied at revenue exceeding £85,000. Why push to expand only to be hit by a huge increase in complexity? Increasing Corporation Tax, slashing the Dividend Tax Allowance, and tying people up in knots over IR35 is also a disincentive for those considering starting their own business.
You might as well stay as an under-productive employee, rather than try to become an over-productive contractor.
Public sector productivity lags the private sector considerably. Thanks to national pay bargaining and regular increments, public sector workers have no particular impetus to become more productive.
Teachers get paid whether children learn or not. GPs are paid by the number of patients on their books, not the number they treat. Treasury civil servants are paid whether the state of the nation’s finances improves or declines.
This isn’t to say that public sector workers don’t work hard. But they aren’t driven to increase the actual amount of output that is created through that effort.
This problem is not front of mind for pensioners’ either: the ridiculous triple lock means that their state pension increases whether the productivity goes up or down. And if productivity-increasing measures like building homes and factories would even fractionally reduce their perceived quality of life, why would they support that?
It’s a modern-day tragedy of the commons – it’s in the collective interest for us to have a more productive economy, but it’s in too few individual’s interest for themselves to be more productive. That’s no way to run a country.