The shock of the Covid-19 crisis has caused permanent change to the UK economy and could be the catalyst for ending a long period of low investment and weak productivity growth, the governor of the Bank of England has said.
Andrew Bailey told a CityUK conference in London that the uncertainty caused by the pandemic and Brexit had meant investment decisions had been put on hold but that the recent vaccine announcements signalled “light at the end of the tunnel”.
While predicting that the structural change to the economy would be less painful than the shift from manufacturing to services in the 1980s, the governor said the crisis had changed how people worked and shopped.
Bailey added that nobody was sure how permanent the changes would be but said his “best guess” was that they would last.
“I will add two further views, one is that we may see a reversal of the period of low productivity growth. Covid may be the spur – the change agent if you like.
“Second, we must now focus and push ahead hard with the changes necessary to support changing the direction of our climate. All of this will require investment on a much larger scale than we have seen in recent years, and that investment will need to be financed.”
What is productivity and why does it matter?
Productivity is an economic measure of the efficiency of a workforce. It typically measures the level of output per hour of work, or per worker.
A more productive workforce signals stronger growth and healthier public finances. Productivity gains are vital to economic prosperity because it signals that more is being achieved by workers in less time. Gains are typically achieved through advances in technology and increased skill levels within a workforce.
In the UK, productivity growth has stalled since the financial crisis, putting it behind international rivals. The UK ranks fifth out of G7 leading industrial nations, with Canada and Japan having weaker levels of productivity. Germany is the most productive nation per hour, while the US is top for output per worker.
Weak productivity is problematic because it signals weaker economic growth, therefore eroding the public finances. Without an improvement in productivity, economies miss out on increases in wages and living standards, putting further pressure on the welfare system and depressing tax receipts.
Some industries are more productive than others. In the UK, manufacturing firms are among the most efficient, whereas the services sector operate at below average productivity.
Bailey said the recent reluctance to invest was due to companies being unsure about the future, but that the financial sector was in a much better position to bankroll capital spending than it had been a decade ago.
“Economic theory indicates that heightened uncertainty about the future tends to have a negative effect on investment; it increases the attraction of waiting to see how the uncertainty is resolved. Both Covid and the process of setting the future relationship with the EU have increased uncertainty – we see this in surveys – and this has restrained investment.”
The news from Pfizer and Moderna on vaccines had been “encouraging”, Bailey said. “Of course there is a lot to do, and important steps to take and evidence to gather, but this is a big step forward, and it will play a major role in lowering the level of uncertainty.”
He added: “If we can now see some light at the end of the tunnel, we need to focus more on important questions about how our economies will look in the future, how we want them to look, what will be the legacy of Covid, and what we can do to support and prioritise any necessary more structural changes.”
The 1980s and early 1990s saw long-term unemployment rise rapidly in the UK’s industrial heartlands as factories and coal mines closed, but the governor said it was unlikely that history would repeat itself.
“We saw deep and painful structural change in the economy in the 1980s and into the 1990s, with a transition from heavy industry and mining to a more services oriented economy. That was a much more painful process, with very difficult consequences, including a sharp increase in economic inequality. I don’t believe that Covid will lead to the sort of inter-sectoral change that we saw in the 1980s and 90s.”
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