Labour productivity

Factors affecting labour productivity

  • Skills and qualifications of workers. If workers become more skilled with relevant training, then this can increase labour productivity.
  • Morale of workers. In a period of industrial unrest and low worker morale, productivity is likely to fall. If workers are motivated and happy, productivity is likely to be higher. Morale of workers could be affected by wages, industrial relations, whether they feel they have a stake in the company, non-monetary benefits, e.g. do they enjoy the job?
  • Technological progress. The implementation of new technology is one of biggest factors in improving productivity. For example, the assembly line introduced from the 1920s made huge strides in productivity. In recent years, the development of micro computers and the internet have also enabled improvements in productivity.
  • Substitution of capital to labour. If labour becomes cheap and freely available, firms may have less incentive to spend money on capital and use labour intensive methods rather than capital intensive methods. Labour intensive processes are likely to have lower levels of productivity.
  • Rules and regulations. If it is very hard to fire lazy workers, then productivity growth may  be constrained. Though the absence of any labour market regulations could lead to high turnover and poor worker morale, which could also diminish labour productivity.
  • Capacity utilisation. In a boom, firms may squeeze more output out of existing capacity through encouraging people to work overtime – this increases labour productivity. In a recession, firms may hold onto workers, rather than let them go – even if they are just working at 80% capacity – therefore labour productivity falls.

Why did UK labour productivity fall during the 2008-13 recession?

You might expect workers to work harder in a recession because they fear unemployment, but labour productivity has fallen. Some reasons could include:
  1. Labour hoarding. (When firms hold onto workers). Unemployment has risen by a smaller amount in the ’08-’12 recession – compared to previous recessions in 1981 and 1991, and now unemployment has fallen to 6.2% . This could support the theory that firms are preferring to hang onto workers, despite lower demand. Firms may feel this prevents having to rehire and retrain workers after the recession ends. Though the length of this current recession makes this surprising, and it’s uncertain why it’s happening in 2008-12 more than previous recessions.
  2. Low levels of investment. The credit crunch has held back investment because firms struggle to gain finance or don’t have the confidence to invest in new capital. This could hold back labour productivity growth.
  3. Rising employment / dodgy data.  A strange feature of this recession, is that despite record falls in GDP, employment levels have been rising. Some query whether output figures are understated and employment figures overstated. But, this is unlikely to be happening. The downward trend in unemployment, suggests firms are keen to rehire workers.
  4. Falling real wages. During the recession, the UK has seen falls in real wage growth. If real wages are lower, firms may  be more willing to employ labour rather than capital. In other words low wage growth means labour is relatively more attractive than usual. Therefore with lower labour costs, firms are willing to employ more workers and labour intensive production methods.
  5. More flexible labour markets. In recent years, UK labour markets have become more flexible, with more part-time, temporary contracts (e.g. zero hour contracts) This has helped reduce the cost of labour to firms, and therefore, they are more willing to employ workers, without rising productivity.
  6. European wide fall. The graph below shows that labour productivity has also fallen in other Eurozone economies.
Examples of policies
  1. Increased government and private sector investment on infrastructure e.g. improve telecommunications (broadband) and transport networks to speed movement of people and goods and lower the cost of doing business
  2. Expand the size of the capital stock and reduce the average age of capital by encouraging a higher level of business investment (inward and/or domestic) - for example through lower corporation tax or a sustained period of lower interest rates
  3. Tax and welfare reforms to improve work incentives and increase the incomes from people working more productively
  4. Improving the quality and affordability of education and training will increase its effectiveness at raising productivity - for example an expanded programme of apprenticeship schemes, better management quality, investment in STEM subjects
  5. Improve access to and quality of health care to reduce sickness and absence which should increase output per worker
  6. Facilitating inward migration of skilled labour to improve the quality of the labour force
  7. Deregulation of markets to encourage stronger competition leading to greater efficiency e.g. increased competition in financial services, retailing
  8. Measures to boost business start-ups and research and innovation which could all lead to higher productivity in the long run
  9. Tax breaks on the use of new technologies and low carbon, energy efficient products
  10. Government measures to increase bank lending to further increase investment and productivity e.g. the Funding for Lending scheme introduced by the Bank of England
  11. Encourage the uptake of the living wage or raise the national minimum wage - there is plenty of evidence that paying workers a better hourly wage improves their morale and can lead to improvements in output per hour worked.
  12. Investment in making housing more affordable, this would improve the geographical mobility of labour and help transfer workers from one industry to another over time as the pattern of employment changes
Evaluation arguments
  1. Productivity is determined by a mix of supply and demand side factors
  2. Most productivity gains come from the private sector of the economy - the focus of policies should be on making businesses and markets more competitive
  3. Productivity tends to rise as an economy recovers - so effective demand-side policies needed to sustain a higher level of aggregate demand to keep the level of capacity utilisation high
  4. UK has found it more difficult to raise productivity in service industries - a lack of intense competition may have held the economy back + there are well-known skills gaps in many industries
  5. The UK economy suffers from a low level of capital investment (as a share of GDP) and low research and development spending - this can hold back innovations and technological progress which might boost productivity in future years
  6. A combination of policies may be more effective (e.g. fiscal incentives and supply side interventions)
  7. Inevitable time lags and implementation lags - raising UK productivity closer to rivals will take more than one economic cycle
  8. Possible short run conflict with other macro objectives e.g. capital investment to raise productivity might lead to some lost jobs and perhaps some extra structural unemployment
  9. Real wages have been falling in the UK in recent years - has this been a factor limiting productivity? It might have affected morale of workers and it may have provided an incentive to businesses to use more labour-intensive forms of production.
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