Should productivity be a public policy target for Northern Ireland?

Introduction

Northern Ireland (NI) recently launched its consultation on a draft Programme for Government (PfG). The document is a wide ranging framework to achieve a better society in NI containing a range of economic, social and policy objectives. One noticeable absentee from the list of 14 strategic outcomes and 42 supporting indicators is a commitment to reduce the productivity gap between NI and Great Britain. The 2008 programme for Government included a failed objective to halve the private sector productivity gap with the UK average (excluding the South East) by 2015, and increasing productivity growth is a central component in the framework for the current economic strategy.

Recent performance

Productivity is a prerequisite for long term economic growth. It reflects our ability to produce more output by better combining inputs, owing to new ideas, technical innovations and business models. Recent data for productivity, measured as GVA per hour worked, highlights that the productivity gap has widened since 2008 and now stands at 82% of the UK average. That is bad news for many wage-earners, as ultimately only increases in labour productivity can support real wage increases. Employers are reluctant to push wages up against a backdrop of poor productivity performance.

Productivity

It is worth drawing attention to the fact that in international terms the UK is a relatively poor performer with regard to productivity. The UK would need to increase its GDP per worker by 15% to match the G7 average. NI falls further down the international rankings and records a productivity level 63% of the equivalent figure in Ireland (in 2014).

international productivity

Productivity is clearly important for economic growth and is an area where NI under-performs. In the consultation responses to the PfG it is likely that a number of stakeholders, particularly from the business community, will highlight the lack of a productivity target as a gap in the Government’s framework outlining their vision for a better society. To assess whether productivity should be included in the PfG with a specific target requires firstly a consideration of whether reducing the productivity gap is an appropriate target for NI, and secondly, whether it can be accurately measured.

Appropriateness

A significant factor which explains ‘productivity gap’ which NI experiences with the rest of the UK is the structural composition of the local economy. Even if NI was to close the productivity gap in each sector of the economy NI would still have a sizable overall productivity gap as NI industry is weighted towards lower value sectors.

Although NI outperforms the UK in a small number of sectors, these tend to either be quite small (e.g. utilities) or in the public sector. In the latter recorded productivity does not reflect superior labour performance. NI’s relative performance in the public sector is an outcome of a different occupational mix and imputed rents recorded within the national accounting framework – not more productive employees.

In a number of the sectors in which NI has recorded below average productivity performance, the sectors also represent a higher proportion of private sector employment relative to the UK. For example, in agriculture there is a sizeable productivity gap and the sector accounts for 6% of private sector jobs in NI compared to 2% in the UK. NI also has higher shares of workforce jobs in lower productivity sectors (e.g. retail), these contribute towards a higher overall productivity gap due to their greater relative size. Aligned to this is a relatively lower number of jobs in high value added sectors. For example, in NI the high productivity professional services sector accounts for 6% of private sector jobs compared to 12% in the UK.

NI nominal productivity

Another important factor to consider is that NI has become an important ‘cost centre location for inward investment. Many of NI’s recent successes in attracting investment in recent years would not be reflected in productivity statistics. Although many of these jobs are good, professional high wage jobs, the companies’, in many cases, do not declare their profits in NI. Therefore, these jobs would not appear as ‘high productivity’ jobs within a GDP accounting framework.

The differences in the structural composition of the NI economy compared to the UK, highlight the scale of the challenge for NI to close the productivity gap. To place this in context the local economy would requires 90,000 additional jobs with a productivity level of £90,000 per job to reach 90% of the UK average level. To find the year in which NI had 90,000 less jobs than today you would have to travel back to 2001, and the latest officially published statistics indicate NI’s average productivity level to be less than half of the £90,000 productivity level required to get within 90% of the UK average level.

Considering the skills profile of people who are workless within NI, moving people into work in a huge volume and into high productivity jobs would appear to be an unachievable objective. Therefore, it may be more appropriate for the NI Executive to concentrate on alternative measures of economic performance such as the employment rate, unemployment rate, economic inactivity rate and wage growth to ensure that citizens benefit from economic growth, and ensuring that public policy creates the conditions for a higher productivity economy rather than focussing on an explicit productivity target.

Measurement

Productivity is measured by dividing the total output of the economy (i.e. GDP/GVA) by the total labour input (number of workers or the number of hours worked). There are measurement problems with both aspects of this equation.

(i) Labour: On the labour input side NI has two main measurements. One is a measure of the total number of people in employment, and the other is a count of the total number of jobs (reflecting the fact that some workers have more than one job). Both measures tell a different story. One measure indicates that employment in NI has already recovered to its pre-recession peak. The other measure indicates that NI has some distance to go to reach the pre-recession peak number of jobs. The self-employment portion of ‘total employment’ is estimated using the labour force survey. This survey can produce volatile results for self-employment, which mean the data should be treated with some caution.

(ii) Output: There are many problems in measuring output at an international level. The GDP framework was developed in the 1930’s to measure the output of economies largely based around manufacturing. Measuring service sector output has been much more difficult within the GDP framework, and today most economies are heavily structured towards services. There are two major problems with measuring GDP in services.

  • Firstly, it only values goods and services based on their ‘market value’. For example, take Google’s search engine. Within the GDP framework the value of Google is quantified largely by the advertising that is sold on the site, no value is attributed to the search engine itself which is used freely by workers and consumers across the globe. There are numerous examples of companies where their economic contribution is undervalued within a GDP accounting framework.
  • Secondly, unlike manufacturing the output of the service sector is not tangible and is much more difficult to quantify and causes the data to be subject to frequent revision. One example of measurement difficulties is in quantifying the GDP contribution of the financial services sector. Typically, financial services are not paid for directly in fees: banks make a large part of their income from charging more interest on loans than they pay on deposits. To capture the value being added, statisticians use an imputed figure, the “spread” between a risk-free interest rate and a lending rate, and multiply this by the stock of loans. The problem with this method is that the lending spread is a measure of the risk banks take. For this reason, its use in GDP figures can have perverse results. For example, at the turn of 2009 Britain’s financial sector was close to collapse. However, because fear of bank defaults was driving spreads up, GDP figures recorded a spike in the sector’s value added, and thus its contribution to GDP. Other examples of measurement difficulties include the recent addition to the national accounts of the income gained from selling recreational drugs and paid sex work which are estimated using dubious statistical techniques based on proxy data. The effect can be significant, when this illegal activity was added to the national accounting framework it boosted UK GDP by 0.9% – equivalent to the GDP contribution of agriculture to the UK economy.

Finally we should consider NI’s economic strategy, which is focussed attracting new, and retaining existing, investment. The policy of the NI Executive has long been to secure a rate of Corporate Tax in NI of 12.5% to compete with the rate in Ireland. However, if NI is successful in achieving higher levels of investment resulting from a lower Corporate Tax regime, it may overstate the productivity impacts. This is evident in Ireland’s own GNP statistics for 2015 which recorded an enormous increase of 19%. This huge increase has been driven by a number of multi-national firms declaring profits in Ireland as part of the global game of corporate tax avoidance, availing of Ireland’s 12.5% (and lower for some firms who negotiated special deals with the Irish Government) Corporate Tax rate.

ireland - corporate tax

The performance of Ireland’s economy recorded in their national accounts has clearly been distorted by a group of corporate behemoths and their tax planning strategies. As a result Ireland will rocket up the wealth league tables (measured as GDP per person) and its productivity will have surged, yet few Irish people will actually notice any difference. Earnings growth and employment growth are small in comparison to the national accounts figures, reflecting the fact that the GNP growth figures largely represent a corporate accounting exercise which has little material impact on Irish people.

If NI is to realise its aim of achieving a 12.5% Corporate Tax rate equivalent to Ireland’s, it will not be immune from such accounting peculiarities distorting the statistical portrait of economic performance. Therefore including productivity as a target within a PfG framework would not only appear fraught with measurement difficulties, it also appears to be an inappropriate measure for a region with ‘low tax’ aspirations.

Monitoring drivers of productivity

Productivity remains important, and is key for workers to achieve wage increases. Although measurement of productivity itself is difficult we can effectively measure many of the drivers of productivity – Innovation (via R&D expenditure); Internationalisation (via export sales); Skills (via qualifications); Entrepreneurship (via business start-up rates); and infrastructure improvements. Therefore, it is recommended that the NI Executive be held accountable for providing the most effective conditions for productivity growth by concentrating on the drivers of growth rather than the outcome of productivity growth itself.

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