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The Productivity Puzzle

The UK economy is currently seeing falling unemployment, yet growth in GDP is flat. We seem to be employing more people but producing less. How can this be?

It’s a productivity puzzle which is occupying the minds of many commentators. But in my opinion, the principal reason is a lack of capital investment by companies. Many businesses have unproductive cash sitting on their balance sheets, because they lack the confidence to invest whilst the UK’s economic recovery seems so fragile. Government has been pumping money into infrastructure investment, but this has not been matched by private sector commitments. Two weeks ago, the Institute for Fiscal Studies published a report which tried to explain this productivity puzzle. Among other reasons, the report argued that for many companies, with wages lagging inflation, it has been cheaper to hire people than to spend more expensive capital. So jobs have been created to prepare companies for growth, even though they added little to productivity. But if jobs were to be matched by capital investment, the upgrading of plant and machinery, deferred during recession, plus the latest technology – then productivity and GDP will start to grow.

The KPMG/Recruitment and Employment Confederation monthly survey of recruitment consultants provides a reliable early indicator of employment trends. Initiated over 15 years ago, the survey measures both temporary and permanent job creation each month across the country and across industry sectors. Since last August, there has been an accelerating trend of job growth, particularly in engineering/construction, health care and IT/media. Initially, focused on the Midlands and North of England, with London lagging behind, growth is now spreading to the rest of the country, including London . Reported job vacancies have also accelerated – indicating employers’ intentions and hence future job growth. Vacancies are now rising at the fastest pace for over two years. Companies seem to be employing people ahead of the curve, anticipating growth.

Ultimately this is a confidence call – consumers willing to spend and companies willing to invest. Substantial deleveraging by both companies and households over the past 5 years has left a big hole in budgets and has been a drag on growth. But there are now encouraging signs – in retail sales, housebuilding, share prices and the early stages of recovery in the US and China. Financial markets have recently signaled that maybe the worst of the Euro crisis is over. Having already experienced a double dip since 2008, companies are right to be cautious. But profits are not made by sitting on hands. Policy-makers should do everything they can to prompt business to start investing again. It’s the combination of people and capital that ultimately drives output and sustainable growth.

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