The UK’s Real Productivity Challenge — And What To Do About It

Forget labour productivity; in the long run, carbon productivity is almost everything.

Between July and December of last year, the UK had its strongest six months of labour productivity growth in ten years. The so-called “lost decade” since the crash of 2007/8 may finally be coming to an end.

Well, hurray. How could this be anything but good news? The Nobel Prize-winning economist Paul Krugman famously wrote in 1994 that ‘[labour] productivity isn’t everything, but in the long run it is almost everything. A country’s ability to improve its standard of living over time depends almost entirely on its ability to raise its output per worker.’ Today, Krugman’s view is the conventional wisdom shared by economists and policy-makers of both left and right.

Unfortunately this conventional wisdom is wrong. Here’s why.

Productivity versus median wages in the UK. Source: OECD Insights

First, productivity has been decoupling from median wages for decades. Almost all of the gains from productivity growth have gone to those at the very top of the wealth spectrum. For most ordinary workers, Krugman’s dictum wasn’t even true when he first published it, let alone now.

Productivity versus employment in the US. Source: Andrew McAfee and Erik Brynjolffson, ‘The Great Decoupling’, MIT Solan Review 2013

Second, productivity has, more recently, begun to decouple from the rate of employment. Almost half of the growth in UK productivity in the second half of 2017 was due to a drop in the number of hours worked — at least in part a result of rising unemployment. Without major reform to the way both welfare and work are structured, declining labour input will closely track the unemployment rate, and the dream of a world in which we all clock off at 3pm on a Thursday, without compromising our material wellbeing, will remain a utopian fantasy.

Third, productivity has not been decoupling from greenhouse gas emissions and resource consumption anything like fast enough to keep us within 2° of global warming. This is not altogether surprising: there is often a trade-off between the productivity of labour and of other inputs, like energy and resources. Nor is it new: replacing manual power with steam power was great for labour productivity, but it was terrible for carbon productivity — the output generated per tonne of CO2 emitted.

Previous industrial revolutions transformed the productivity of labour, but left us with a mountain to climb on carbon productivity

This last is now, arguably, the more important number to track — and to build policy around — if you care about long-run prosperity. A 2008 McKinsey paper argued that, in order to maintain economic growth and meet commonly discussed (and subsequently agreed) climate goals, globally we need a tenfold improvement in carbon productivity by 2050. That equates to about 6% a year for 40 years. In the decade since, we haven’t broken 3% once.

Unfortunately, in this instance, market forces alone won’t deliver the necessary productivity gains. Although science dictates that the amount of additional CO2 we can emit is small and rapidly diminishing, this scarcity is not properly priced by the market.

This is problematic because it’s scarcity that typically drives productivity growth: when cobalt supplies run low, prices go up and battery-makers are incentivised to invest in figuring out how to reduce the amount of cobalt they need; when labour is scarce, firms are incentivised to invest in productivity-enhancing robots. (Indeed, one reason why labour productivity growth has been so sluggish in recent years is because labour is anything but scarce thanks to a mix of globalisation, technology and a welfare system designed to keep as many people working as many hours as possible.)

The UK Climate Change Act of 2008 established a world-leading scheme of five-yearly carbon budgets, but successive governments since then have failed to follow through with robust policies to make these carbon budgets a material concern for companies.

The EU’s Emissions Trading Scheme (ETS) has also been a disappointment: the cost of emitting carbon under the ETS hasn’t broken €10 per tonne since late 2011. Compare this with the $40–80 per tonne (by 2020) recommended last year by the High-Level Commission on Carbon Prices, led by Joseph Stiglitz and Lord Nicholas Stern.

A tax on emissions would certainly help, but there are other levers policy-makers can pull. Increased investment in R&D for next generation renewables and carbon sequestration (whether through new technologies for ‘direct air capture’ of atmospheric carbon, or ancient CO2-sucking technologies like trees and soils) is undoubtedly needed. The £2.5 billion for low carbon innovation from 2015 to 2021, announced in last year’s Clean Growth Strategy, is better than nothing, but not by much.

Bringing forward stricter energy efficiency standards for buildings and vehicles would help drive incentives to decarbonise two sectors that between them account for about half the UK’s greenhouse gas emissions.

Finally, the Government could use its considerable purchasing power — the UK spends more than £200 billion on public procurement annually — to prime the market for low carbon innovation. Imagine the impact if a requirement to improve carbon productivity were written into every single government contract. Now that would get companies — and markets — moving in the right direction.