The Productivity Problem: How can the UK fix it?

I recently read an article in the Economist about the ‘Productivity Problem’ and how the UK’s productivity is 20% below the average of other nations in the G7. It got me thinking about what solutions there are to fix this problem. Productivity is a measure of the efficiency of factors of production. Supply side policies are policies, which are used in order to increase aggregate supply. These can be used to improve or increase the factors of production, hence increasing the UK’s productivity.

One example of a supply side policy might be to improve education and training, as this will result in workers becoming more productive as they have an improved skill set and will hence provide a higher quality of labour. However, it must be understood that this is not a policy that can have an effect overnight, as there will be an inevitable implementation lag for new training and education schemes to be designed and for these to significantly improve the quality of labour, it may take more than one economic cycle. Furthermore this is a very expensive project for the government so you would have to consider the opportunity cost and whether the government spending could be put to better use like an alternative supply side or even demand side policy.

Another supply side policy that can be implemented by the government could be introducing a reduction in income tax. This would be effective in increasing the quantity of labour as this would act as an incentive for potential workers to get into the labour force, as they will be encouraged by the idea of having to pay less tax. This increase in the quantity of workers will result in productivity in different industries increasing as there will be more workers for the same projects. However this policy will be more effective if there is equal attention into fiscal policies that increase aggregate demand in order to keep the level of capacity utilisation high.

Another policy that could be done by the government is to abolish the minimum wage as this can reduce the cost of production for firms as it is argued that minimum wages fix wages in the labour market above the equilibrium wage rate, which causes excess supply and therefore inefficiency. Getting rid of the minimum wage will bring wages back down to the equilibrium wage rates in the economy, which therefore reduces the cost of production for firms, which makes the labour market more efficient and therefore increases the productive capacity of the UK economy. However, although this may increase the efficiency of the labour market, it may result in the quantity of labour being reduced, as the lower wages will put off workers from accepting the jobs as they may feel that they are not being paid enough.

Can fear define an economy?

Behavioural economics is an aspect of economics, where elements of psychology are added to traditional mathematical models in order to better understand decision-making. I have become fascinated by these studies and have recently read many books regarding different behavioural economic researches. Economics is a study of understanding the choices individuals within an industry make and I believe taking into account emotions is a pivotal aspect in making economic predictions.

Lets look into the issue of fear within economics. It can’t be denied that the fear of future global events and economic history influence economic decision-making. A main cause of fear within an economy is uncertainty as handling large sums of money is not made easier when events occurring in the global economy make it hard to predict what will happen. That is one of the main concerns of Brexit, the uncertainty.

Hysteresis is an idea that can show the impact of fear on consumer behaviour. Hysteresis is when people are influenced by events in the past. Even if circumstances are different in the present and there is strong evidence of improvements from past events, this still remains a strong influencing point within people making economic decisions. One study I did which seemed to support this theory is the fluctuation of demand for inferior goods within an economy.

An inferior good is a good a consumer would demand less off if their income level increased. Examples of companies that operate for the sale of inferior goods are Primark and Poundland. Traditionally, companies selling inferior goods would see an increase in sales during times of recession and a fall in demand during strong periods of economic activity. However, recent research I did into businesses that fall under this category suggested signs of continued growth even during this period of recovery since the 2008 recession.

Companies like Primark and Sports Direct have continued to see exponential growth post the recession, which contradicts past trends. I believe the theory of hysteresis can be argued as a cause of this. Consumers who may have lost money during the 2008 recession may be incentivised to spend their money more carefully and purchase goods from these companies in fear of another recession occurring.

The issue of fear is a very real problem in economics and it is one that must be taken into account when studying economic trends. It’s important to view things from a consumer’s view, who may have inadequate information about things occurring in their economy (inflation rates, economy growth rates etc). When fear influences an individual’s decisions, it can contradict any mathematical model that has solely been formulated off past trends, essentially altering the way we have been looking at an aspect of economics.