Brexit May Shock U.K. Firms Into Fixing Productivity Malaise

Updated on
  • UBS sees investment pickup as labor supply curtailed
  • Persistent weakness has implications for BOE, fiscal policy
Porter Says the U.K. Is 'Swerving' Amid Brexit

Britain’s productivity malaise may find a solution from the unlikeliest of places -- Brexit.

Poor productivity has long been the bane of the U.K., with output per worker far below the Group-of-Seven average and successive predictions for a recovery since the financial crisis failing to materialize. Still, according to UBS Wealth Management economist Dean Turner, Britain’s exit from the European Union could be the catalyst that triggers an improvement.

His argument? While firms now have access to an almost unlimited supply of labor from the EU, tougher immigration rules will force a change in behavior. If the costs associated with each employee increase, companies will be more likely to invest in technology and machinery that improve productivity.

“There will be a deadweight loss to leaving the EU but it’s not as bad as the doomsayers suggest,” Turner said in an interview. “Immigration won’t come to an end, but it will become more difficult, and expensive. At the margin, the decision is: do I buy a piece of machinery for a plant or do I hire someone? If there’s a change in the plentiful labor supply, that could prompt an increase in investment.”

While there’s logic in the idea that firms may ultimately have no choice but to invest in productivity-boosting technology and resources, such measures would only filter through the economy slowly. They would also merely offset the potential negative effects of leaving the EU, such as reducing trade and discouraging foreign direct investment. 

Bank of England Deputy Governor Ben Broadbent made that argument this month, saying Brexit could trigger the type of “sharp step down” experienced after the financial crisis.

Budget Hit

The long-term weakness is already suppressing the economy’s potential and holding back wages. The country’s fiscal watchdog is also preparing to cut its productivity forecasts, which with repercussions for Chancellor Philip Hammond in his Budget this week. 

Even data last week showing a bounce in the third quarter hasn’t dispelled concerns; the BCC’s response was to say the U.K. is still “hampered” by deep-rooted structural problems.

The Confederation of British Industry says that U.K. firms are lagging behind many other European nations in the adoption of new technologies. Being more open to tried and tested innovation and management practices could add 100 billion pounds ($132 billion) to the economy and help reduce income inequality, it said this month.

At the other end of the spectrum, there’s evidence companies are still using outdated technologies.

An Amazon Inc.-commissioned report showed that more than 20 percent of small and medium-sized businesses said faxes play a role in their sales processes. There are also vast regional differences to contend with. R&D spending in Wales, for example, is about half the U.K. average, according to KPMG.

With the economy close to full employment -- the jobless rate is the lowest in more than four decades -- others also say there must be a tipping point for investment. Holger Schmieding and economists at Berenberg said last week that the heavy reliance on labor and a reluctance to make big fixed-capital investments “cannot go on indefinitely.”

But whatever sparks a change, the need for a solution to the productivity puzzle is becoming more acute.

The economy is already struggling to keep pace with its international peers, with growth this year forecast to be 1.5 percent, below that of the euro area and the U.S. The Bank of England was forced to raise interest rates because it’s worried that the weakness means the economy’s capacity to grow without generating inflation pressures has diminished. That lower speed limit is being exacerbated by Brexit, which is restraining companies’ willingness to invest.

There’s no agreed answer to the issue, with possible explanations including the U.K.’s reliance on services, which lag manufacturing in efficiency growth, “zombie” firms kept alive by low interest rates, and limits in the flow of workers between firms since the recession. With such varied causes, Hammond said recently that he doesn’t have the “magic bullet.”

Despite the years of disappointment, the BOE still expects a modest pickup next year, and Governor Mark Carney’s explanation echoes some of the theory behind Turner’s argument. Speaking on Nov. 2 after the bank’s rate hike, he said cited better investment and a “shift between labor and capital.”

“We’ve had a jobs-rich growth model,” Turner said. As that changes, firms have to decide: “Do I pay for the immigration process or make the investment elsewhere?”

— With assistance by Jill Ward

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