Design Trends

Solving the United Kingdom’s productivity puzzle in a digital age

New research explains why the United Kingdom has been experiencing historically low productivity growth and what can be done to return to long-run averages.

Labor productivy growth

Declining labor-productivity growth characterized many advanced economies after a boom in the 1960s, but since the mid-2000s that decline has accelerated. Against that backdrop, the United Kingdom stands out as one of the worst productivity performers among its peers. Its absolute level of productivity has persistently ranked toward the bottom of a sample of advanced economies. Moreover, in the aftermath of the crisis, the United Kingdom, along with the United States, recorded one of the lowest productivity-growth rates and steepest declines in productivity growth, falling by 90 percent. Between 2010 and 2015, UK productivity growth flatlined at 0.2 percent a year, far below its long-term average of 2.4 percent from 1970 to 2007.

Boosting productivity growth is important for all advanced economies as they navigate potential economic headwinds, such as an aging population and an ongoing shift to low-productivity services, but particularly for the United Kingdom, with an uncertain outlook for trade and investment after Brexit.

In a new paper, Solving the United Kingdom’s productivity puzzle in a digital age (PDF–749KB), we identify key reasons for the United Kingdom’s recent weak productivity performance by analyzing cross-country, regional, and sectoral patterns as well as other decompositions of aggregate statistics (see sidebar, “Our methodology”).

We find that four phenomena—financial sector boom and bust, employment growth, investment decline, and uneven digitization—explain the UK’s larger decline in labor-productivity growth. Across all the countries we analyzed, we identify the potential for at least 2 percent productivity growth a year over the next ten years. However, capturing that potential in the United Kingdom will take time and require policy makers and businesses to take decisive action in key areas. These include skill building for the existing and future workforce and managers; accelerating adoption of digital technologies through better information, access to finance, collaborations, and a favorable policy environment; and promoting additional investment and exports.

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What can be done to promote productivity growth in the UK

Productivity in the years to come will be more important for the United Kingdom’s future economic growth and living standards than ever before. Labor supply is unlikely to expand indefinitely, and demographic shifts, specifically an aging population, mean that about 90 percent of future growth will need to come from productivity to keep pace with historical GDP growth rates. Moreover, uncertainty and transition costs due to Brexit and other geopolitical developments may dampen growth prospects. However, based on our analysis of the causes of the productivity-growth slowdown, the United Kingdom has an opportunity to boost productivity growth through a focus on education and skills (to make the most of the high workforce participation in the United Kingdom), further accelerating the adoption of digital technologies (to capture their full potential), and supporting investment and exports to build broad-based resilience for the future (to mitigate against boom/bust cycles and uncertainty).

First and foremost, the United Kingdom needs to put in place an education-and-skills system—for managers, the existing workforce, and young people still in education—that meets the needs of a fast-changing digital economy. Given the unprecedented increase in employment, management skills are more important than ever for productivity. Poor management practices also make it less likely that a firm will invest in and adopt information and communications technology and digital technology effectively. When it comes to existing staff, roughly 80 percent of the United Kingdom’s 2030 employees are already in the workforce today, and around 30 percent of them may need to switch occupational categories in order to remain employed by 2030. This points to the central importance of retraining and skill-building programs for existing workers. And those yet to enter the labor market will need both basic skills, an area where the United Kingdom remains behind comparable countries, and the skills to work alongside machines.

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Secondly, closing adoption gaps in digital and next-generation technologies could boost productivity growth significantly. However, this will require better, trusted information provision, given that a lack of awareness of new technologies has been identified as a key barrier to adoption. Similarly, access to finance for innovation adoption may need reform: there is evidence, for example, that even in the United States, banks are more reluctant to lend money to support investment in intangible capital, including the adoption of technology. Collaborations between academia, IT companies, disruptive start-ups and scale-ups, and existing businesses can also help codevelop and implement digital solutions to problems faced by companies.

Lastly, policy makers can mitigate boom-and-bust cycles as well as uncertainty from Brexit and broader geopolitical developments by actively promoting broad-based investment and exports. For example, research has found that between 10 and 15 percent of UK firms are latent exporters: they share the characteristics of exporting companies but are not currently exporting. Identifying and actively supporting these firms to start exporting could further boost the country’s productivity growth and economic resilience.

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To be sure, designing policies in these areas is challenging, and successful productivity-boosting initiatives require careful thought, research, experimentation—and persistent execution. For example, it is well understood that enhancing employees’ skills is critical for driving productivity growth and maintaining high levels of employment in an era of rapid technological change. Yet what is less clear is the most effective way to achieve that. What kind of education system better equips young people for the workplace of the future? When retraining workers, are government or private-sector programs more effective? How can reskilling and upskilling be delivered affordably and at scale? How can firms overcome change resistance and inertia in adopting new practices and technologies? While detailed answers to these questions are beyond the scope of this discussion paper, we provide examples of policies that have worked in the United Kingdom and other countries as well as steps companies have taken that merit further consideration in the quest to accelerate UK productivity growth .

 

The United Kingdom’s poor productivity performance since the financial crisis has raised alarm, particularly at a time of heightened uncertainty and changing demographics. However, we find that advanced economies like the United Kingdom have the potential for at least 2 percent productivity growth a year over the next ten years if policy makers and companies provide supportive action. In particular, we believe that a focus on improving workforce skills, accelerating digital adoption, and promoting investment and exports is key and, indeed, in some areas, relevant initiatives are already underway. A united and sustained commitment by business and policy makers to accelerate productivity growth is necessary to boost the odds of the United Kingdom realizing its full productivity potential.

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About the author(s)

Jacques Bughin is a senior partner in McKinsey’s Brussels office; Jonathan Dimson is a senior partner in McKinsey’s London office, where Vivian Hunt is a senior partner and Louis Chambers is a consultant; Tera Allas is a senior fellow of the McKinsey Global Institute, where Mekala Krishnan is a senior fellow and Jan Mischke is a partner; Marc Canal is a consultant in the Madrid office.

MGI-Productivity-in-the-UK-Discussion-paper-September-2018-1

 

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