It’s all about productivity

If you have followed this blog for a while you will know that, like a broken record, I have been banging on about digitalisation, the 4th Industrial Revolution and the productivity conundrum. I have often referred to Tim Harford’s article about electrification and how long it can take to make a transition.

Recently, I’ve started to add the “Energy Transition” into my thinking on the topic. The outcome remains the same but I keep finding more and more reasons why it will inevitably happen.

One of my go-to reads is Ian Stewart, Deloitte’s chief economist. If you’ve not signed up for his Monday briefing then you really should – it’s excellent. Today I have lifted most of his post (available here: https://blogs.deloitte.co.uk/mondaybriefing/2021/06/the-looming-capex-boom-.html) not only because I’m being lazy but also because it talks to many of the points I’ve been trying to communicate to my clients over the last 7 years (since I started Bestem).

Throughout history economies have been shaped by shocks, from recessions to technological shifts and energy transitions. The Great Depression helped change thinking about the role of government, paving the way for a permanent expansion in the state. The switch from steam power to electricity triggered a vast reorganisation of manufacturing.

The pandemic and the drive to net zero are similarly epoch-making events. The pandemic has driven technology adoption and changes in business practices. The energy transition involves an overall of energy production and distribution.

The structure of the economy will change. The sectoral balance of the economy, the skills needed, the uses of capital, the allocation of capital, will shift, creating winners and losers. It will also bring opportunities to rethink organisations, invest and raise productivity in ways that had not previously been considered viable or necessary.

The unlocking of the economy has unleashed a surge of pent-up demand into an economy operating with reduced capacity. That is creating inflation and bottlenecks, and incentivising investment. Meanwhile large corporates are flush with cash, capital is cheap and institutional investors want businesses to step up investment.

The global semiconductor shortage has spurred a flurry of investment announcements in new factories. Automakers are building new battery plants to meet demand for electric vehicles. Rising freight rates have prompted a surge in new orders for container vessels. And the move to ‘hybrid’ working and the growth of online shopping require a reconfiguration of office space and an ever- rising volume of warehouse capacity.

Labour costs play a role in investment decisions too. As countries emerge from lockdowns labour shortages have started to appear in sectors including manufacturing and construction. In the UK increases in the minimum wage continue to outstrip inflation, raising costs for firms and sectors reliant on lower-income work. An exodus of some 650,000 foreign-born workers from the UK last year, equivalent to 2.0% of the workforce, and a reduced flow of less skilled labour from the EU, create new pressures. More expensive and scarcer labour would sharpen incentives to invest in productivity-enhancing equipment and skills. Machines, for instance, could readily substitute for labour in washing cars and coffee preparation (I was in a motorway service station last weekend where the queue for Starbucks led me to get the same product from a self-service machine in the next-door Waitrose. I couldn’t tell the difference).

In the UK government policy has set out to boost investment with the capital-allowance ‘super-deduction’ targeted at plant and machinery. The Bank of England estimates that this will have its greatest effect in raising investment in some of the most capital-intensive sectors including manufacturing and transport.

A surge in private sector capital spending is likely to coincide with rising levels of public infrastructure investment, particularly related to ‘green’ projects. So, with private and public investment likely to grow, this recovery is looking very different from the one that followed the global financial crisis. Then UK business investment took six years to climb back to its 2008 peak. Today the Bank of England sees investment snapping back quickly, ending next year almost 10% above pre-pandemic levels. A similar story is likely to play out globally. Morgan Stanley believes that global investment will stand 20% above pre-pandemic levels at the end of 2022, a remarkable recovery from last year’s downturn.

This sort of surge in capex could help shift the dial on productivity, especially if, as seems likely, it is accompanied by organisational changes and the application of technology. (While business investment fell in the US and the UK last year, spending on IT and computers rose as firms investing in remote working and new ways of doing business.)

Much of the problem of poor productivity in the UK is concentrated in the long tail of medium- and smaller-sized businesses. The pandemic may, paradoxically, have had some positive effects here, as businesses of all sizes adapted and used new digital practices to weather the downturn.

One encouraging sign comes from the retail and administrative services sectors. Both sectors have registered strong productivity growth over the past decade, defying the characterisation of these as labour-intensive, low-productivity parts of the economy. Online shopping, self-service and use of IT in administrative tasks seem to have played a big role. It may be that other labour-intensive sectors, such as healthcare and education, might in time achieve similar gains in productivity.

It won’t be plain sailing. In some important respects the pandemic and the energy transition could act as a drag on productivity. It’s not, for instance, clear how significantly increased levels of homeworking will affect productivity. A recent study of a large Asian tech company found that increased communication and coordination costs more than offset gains from reduced commuting times and reduced overall productivity . Ben Broadbent, a member of the Bank of England’s Monetary Policy Committee, cautions that lower use of offices and transport infrastructure imply a less productive use of the capital stock . Nor is capital spending rising everywhere. Some fossil fuel companies and airlines are cutting capex in anticipation of lasting weaker demand. Structural shifts in the economy risk creating mismatches between supply of and demand for labour. The interruption to education and rising youth unemployment could leave lasting scars.

The pandemic and the energy transition represent the greatest structural change since the shift to electrification and the Great Depression in the inter-war period. The question is how these changes can be harnessed to build a better future. The years after the financial crisis were marked by weak investment, productivity and wage growth. We should be able to do better this time

Here are a selection of earlier articles that talk to the same themes.

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Gareth Davies

Innovation Expert with 30+ years of experience living and working across the world. I apply an engineering approach to helping companies innovate and achieve commercial success.

2 thoughts on “It’s all about productivity”

  1. Thank you I try. To be fair credit for the writing is due to Ian Steward of Deloitte, but he’s saying the same thing that I’ve said for a while so I agree with him. Not that this is confirmation bias of course. Or echo chamber.

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