Slowing economic growth, Brexit and the productivity challenge

Recent years have seen steady, unspectacular economic growth. Employment rates have risen to record levels, but average wages adjusted for inflation are no higher than in 2007. This reflects a key development over the last decade: the stagnation in productivity – how much is produced for every hour worked. This remains a serious concern for future growth and wage prospects. In addition, Brexit has had and will have an impact.

Economic growth has been slowing 

In recent years, growth has been steady but slowing. The UK economy expanded at an average rate of 2.5% per year in 2014 and 2015, before growth eased in subsequent years. It is expected to be just over 1% in 2019.

The slowdown is mainly due to consumer spending growth cooling and a reversal in investment – from strong growth to contraction. Both are linked to some degree to the Brexit referendum result: consumers faced rising prices due to the fall in the pound, while uncertainty over the future UK-EU relationship has hit business investment. More certainty over the shape of Brexit and a possible UK-EU trade deal could bolster confidence and boost investment.

In addition, the global economy has been showing signs of stress. A Eurozone resurgence in 2017 proved short lived and global trade tensions have hit international trade.

More people are in employment…

The number of people in employment in the UK has risen almost continuously since 2012. Just over three quarters of working-age people are in work, and this is the highest rate since comparable records began in 1971. Correspondingly, the unemployment rate is low at around 4%.

There are some signs that these trends may be coming to an end. For example, the number of job vacancies has started to fall. Nevertheless, the general employment picture remains supportive of economic growth.

… but average real wages are lower than a decade ago

While the number of people in work has risen substantially, wages have not. Indeed, average real (inflation-adjusted) weekly earnings are no higher than they were prior to the 2008/09 recession. Such a long period of stagnation is unprecedented in modern economic times.

In 2019, wage growth has picked up and inflation come down. As a result, real average wages are growing at a healthier rate again.

In summary, the recovery from the financial crisis a decade ago has been jobs-rich but wage-poor. Why has this been the case?

Longer-term concerns centre around weak productivity

The amount produced for every hour worked is barely higher now than it was in 2007. This stagnation in productivity is arguably the most important economic development since the financial crisis.

Growth in productivity is the essential ingredient in rising living standards over the long term: if we can produce more in the same amount of time, this frees up resources in the economy to do other things.

Productivity rose by 20% between 1999 and 2007 but only by 4% during 2010-2018 (after the 2008/09 recession). The causes of this ‘puzzle’ are not completely understood, but are likely to include the most productive firms not improving as fast as they used to and weak investment in both the public and the private sectors.

As growth in wages and growth in productivity are closely linked, this has led to the poor performance of average wages observed above. Another consequence is that economic growth has been dependent on more people moving into employment (instead of the existing workforce producing more).

This can’t be sustained forever and raises serious concerns about the economic outlook. Most economic forecasters expect that productivity growth will improve in coming years, although only to around half of historical norms.

Brexit’s impact on the outlook

As well as impacting current economic conditions, Brexit will have a longer-term economic impact. This will be determined mostly by the UK’s post-Brexit trading relationships with the EU and the rest of the world.

The vast majority of economic studies from the May Government and others show that the higher the barriers to trading with the EU, the larger the negative impact on the UK economy. Potential trade-boosting deals with non-EU countries are not expected to make up for weaker trade flows with the EU. (These studies show that the economy will still grow, but not by as much.)

There are many uncertainties related to the ultimate economic impact of Brexit. The priorities and policies of this and future UK Governments will play a crucial role in determining it.

What might policy response to next downturn look like?

The UK economy has not experienced a recession for over a decade. Along with death and taxes, we know for sure that there will be an economic downturn at some point. We just don’t know when.

When one does occur, we will be in the unusual situation in which interest rates will already be at very low levels. This constrains the Bank of England’s ability to cut rates sharply, a common reaction to past recessions.

The policy response to a downturn could therefore look different and potentially include a greater role for fiscal policy – government decisions on taxation and spending – to boost growth.

Further reading

• The UK economy, House of Commons Library.
• The productivity puzzle – “The key economic issue of our age”, Office for National Statistics.
• Brexit deal: economic analysis, House of Commons Library.