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Britain's productivity crisis is biting hard – and the Bank of England is powerless to stop it

Britain’s economy has a “new, lower speed limit”. Growth can only get to even modest levels before inflation takes off, forcing the Bank of England to “ease our foot off the accelerator”.
So says Mark Carney, the Bank’s Governor.
This is not a new problem – rather, it has been building for years but has only now forced action from the Old Lady of Threadneedle Street.
Ever since the financial crisis, says Ben Broadbent, one of Carney’s deputy Governors, “productivity growth has slowed in just about every advanced economy, but it has been more severe in this country than in others". 
Mr Carney says poor investment and productivity growth is “the biggest part of the story”, but that Brexit has had an impact too.
Productivity growth has crashed - contributions to GDP growth
“It has been reinforced over the course of the last year by some of the Brexit effects and they are two-fold,” he says.
“One is just less investment. Basically, if you look at our May 2016 forecast for investment relative to our August [2017] forecast it is about an 18 percentage point difference in investment [by 2019].”
The other is the effect on cross-border supply chains, depending on the results of the Brexit negotiations.
It is difficult for the Bank to deal with this, given its main tool is interest rates.
Low interest rates can be used to prop up demand.
For the past decade – until this rate rise – rates have been pushed down to stimulate growth.
Households are cushioned as the low rates keep their mortgage bills down. Savers are encouraged to spend as measly returns make cash deposits unappealing. Businesses can fund investments more cheaply.
But it has not boosted investment to any high level, nor prepared the economy for a great rebound into a new business cycle.
Britain's productivity crisis is biting hard – and the Bank of England is powerless to stop it

Bank of England Governor Mark Carney explains interest rate rise
02:17
In the long-term, economic growth and prosperity, and higher wages, are created by increased productivity. That is, getting more value out of every hour of work.
Much of that comes from technology as new inventions combined with extra investment result in workers churning out more goods or services each day.
This has not happened since the financial crisis.
In previous decades productivity improvements accounted for most of the UK’s economic growth.
In the Seventies this was practically the only source of GDP growth, which averaged 2pc per year.
From the Eighties and much of the Ninetiess, productivity accounted for 2.5 percentage points of the average 2.6pc annual growth.
And in the decade to 2007 it was 2.2 percentage points of the 2.9pc GDP growth each year.
In stark contrast, the years since the crisis have seen average growth dive to just 1.1pc per year – and almost all of that was made up of a rise in hour worked.
Just 0.2 percentage points, less than one-fifth of all growth, came from productivity improvements.
Unemployment has fallen to a 42-year low of 4.3pc and the Bank of England thinks it will fall to 4.2pc in the near future.
Unemployment is at a record low
That indicates this source of growth – working more hours – has almost run out of road, leaving the UK with an uncertain future.
“This issue has accumulated since the crisis – [the UK went through] a long period of lower investment and it didn’t really matter for the speed limit for the economy because we had so much spare capacity in the labour market,” says Carney.
“We’re getting to that point with much less labour supply, so these longer-term factors are starting to bite.”
As a result, inflation is coming through despite moderate GDP growth, hence the rise in interest rates.
The historical precedents for this do not bring much hope that any particular policy steps can be taken to fix the problem.
“There has been a 10 year period in the UK when you haven’t had any productivity growth, but you have to go back to some time in the 1860s or 70s to see this,” says Broadbent.
“Even 150 years later, as far as I can see, economic historians are still squabbling about what caused that, so the idea that we can diagnose it and cure it in real time, right now, is maybe too much of an ask.”
He said that previous lost decade of productivity growth is sometimes seen as “a pause between two big technologies – we were moving away from steam, to electricity” and “it wasn’t anything to do with government policies”.
“It is not evident that policymakers can flick a switch and change this.”
The deputy governor lists policies which are sometimes offered including tax cuts, deregulation, good education and openness to the world, but believes those would only be a modest help rather than a fix for poor growth.
Mr Carney added: “The last time we had a decade of negative real income growth was that period, the 1860s. So there is a corollary there. It does require sustained effort on a variety of fronts and all of those issues are away from the Bank.”
“All we can do – price stability, financial stability – are foundational, but the big issues are for others.”
That the move to electricity did spark a resurgence in growth would provide reassurance if only we knew that the next technological revolution was sure to bring the same benefits in the 21st Century.
For now we have to hope the Bank’s forecasts are right and productivity growth will pick up a little in the coming years. At least that should allow the economy to grind out a bit of growth even without any extra workers to be found.
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