Centre for Policy Studies: Productivity is Key to Securing UK's Economic Recovery

Yesterday saw the release of another good set of jobs figures. Employment rose and youth unemployment and long term unemployment fell. Nevertheless, to secure the recovery and generate sustainable real wage rises, we need to break the decade long stagnation in productivity which is holding back our economy.

We can effectively raise GDP firstly by increasing the number of people working and secondly by increasing how much each worker produces per hour. So far, we have benefited greatly from the former but not the latter. Employment has significantly increased from 28.9 million at the time of the last election and has well surpassed the pre-crisis peak of almost 29.6 million.

This upswing is also reflected in total hours worked. Between October and December 2013, the total hours worked per week was 966.8 million compared to a low of 904.5 million between June and August 2009.

There must be a cyclical element to this employment growth but the government's welfare reforms, including the New Enterprise Allowance, the Work Experience Scheme and yes, the Workfare scheme, along with changes to benefits have clearly also led to more people being willing and able to work. These increases in employment and hours worked have been crucial in restoring economic growth.

However, at some point the gains to be made from increasing the number of workers and increasing the number of hours will diminish. Education and welfare reforms combined with more robust growth in aggregate demand will cause the pool of available workers to shrink. When we reach that point, productivity will need to rise to support output growth and real wage rises.

Unfortunately, the performance of productivity has been especially poor. On an output per hour basis, it remains 4% below the pre-crisis peak and has fallen back to where it was in Q4 2005. If productivity had continued growing from 2008 onwards at the rate that it had grown on average since 1971, then it would be 20% higher than it is today. Moreover, since 2007 productivity in the UK has performed worse than any other G7 country apart from Italy.

Weak demand and labour hoarding have often been cited as the causes for this sustained weakness. However, stronger growth in demand in 2013 has not led to significant increases in output per hour. Rising aggregate demand must surely lead to some increases in productivity over time but it is clear that other structural reasons are holding back productivity growth.

Firstly, whilst there have been some encouraging signs, business investment remains almost 30% lower than it was in 2008. Secondly, impaired capital allocation has meant that the normal process of new, dynamic companies coming in to replace old business models has slowed. ONS data shows that services sector productivity is underperforming and that companies which export and make better use of IT have the strongest productivity.

So to restore productivity, the government should carry out a series of tax and regulatory reforms to make it easier to invest. Letting lower paid workers keep their performance related pay tax free would promote innovation and creativity. In addition, there needs to be a refocussing on important infrastructure projects for example by making it easier to invest in superfast broadband.

A tougher competition policy in energy, water, banking and public sector procurement would drive up efficiency. Far-reaching patent reform would help boost the commercialisation of intellectual property and help export growth and radical reforms to tear down the barriers between enterprise and education would encourage innovation and a higher skilled workforce.

The task of restoring economic growth has been achieved. The government's next task should be to carry out reforms to increase productivity and secure this recovery.

Adam Memon is head of economic research at the thinktank the Centre for Policy Studies