You get what you pay for: Slump in wages triggers slump in productivity

Workers in the UK are producing 2.6% less output per hour than they were at the start of 2008, according to new research.

A report by the respected Institute for Fiscal Studies (IFS) found the 'productivity puzzle' was a result of low wages, low business investment and misallocation of capital since the financial crisis

"The fall in labour productivity seems to have been driven by low real wages and low firm investment," Wenchao Jin, a research economist at IFS, said.

"Productivity slowdown has happened right across the economy."

Some analysts suggested the fall in productivity was the result of labour hoarding, the demise of financial services or changes in workforce composition, but the IFS found no evidence to substantiate these claims.

Falling productivity is the other side of the coin of robust employment levels, which have surprised analysts given the state of the UK economy.

Tellingly, unemployment appears to have been limited by measures favoured by left and right: a flexible labour market and a tailored benefit system which kept people skilled and in contact with recruiters after they lost their job.

"The labour market seems to have become much more flexible. And successive governments appear to have learnt from some of the great mistakes of the 1980s," Helen Miller, another senior researcher, said.

"Two decades of reforms have ensured that the benefit system is doing a much better job of ensuring that people remain in touch with the labour market."

British workers are producing 12.8% less than if the pre-recession growth in labour productivity had continued past 2008.

Interestingly, public sector labour productivity has risen – a move which runs against long-term trends. This is probably a result of there being fewer workers around, leaving those that remain doing extra tasks.

Some may claim the public sector figures prove that it could have been more efficient if it had cut spending earlier, but researchers warned that the rise in productivity could come with a corresponding drop in quality of service.

The IFS report suggested that with wages getting hit by an excess of labour, firms have employed more workers, leaving each employee producing less per hour than they were before the recession.

Researchers also cited a lack of investment. Business investment remains 16% below the pre-recession high – a much sharper and more persistent fall than in previous recessions, probably as a result of continued market uncertainty.

"If workers have less capital to work with, they will produce less," the report found.

Finally, the report also cited misallocation of funds, which comes as a result of the financial sector lending to established low productivity firms but behaving in a far more risk-averse way when it comes to new projects.