How has Covid-19 affected UK productivity?

The latest ONS data suggest that labour productivity – previously seen as the UK economy’s weak spot – has been revived. It appears this has been driven, in part, by less productive sectors shrinking and more productive sectors adopting new technology.

Productivity is one of the big economic questions in the UK. The amount workers can produce – their ‘labour productivity’, is a major driver of economic and wage growth. The 2007-2009 financial crisis saw UK labour productivity plummet. We would expect Covid-19 to cause a similar drop. But according to the latest data from the Office for National Statistics (ONS), labour productivity, despite dipping initially, has been rising over the past year, mirroring pre-pandemic trends. In the first quarter of 2021, productivity rose by 0.9%, around twice the pre-pandemic rate.

Figure 1 shows how each crisis affected labour productivity growth over time. Both downturns led to an initial drop in output per hour of almost 2%. But in the following quarter, 2008 saw a sharp drop in productivity (blue line) while 2020 saw a sharp rise (pink line). Despite 2020 productivity dipping slightly at the nine-month point, the fall is insignificant compared with the record-low drop of almost 5% at the equivalent point in 2009. One year after the start of each crisis, 2021 productivity grew while 2009 productivity fell by 3.4%. But what caused this disparity?

Figure 1: Quarter-on-quarter productivity growth, 2007-2009 versus 2019-2021

Source: ONS

Government restrictions introduced to control the spread of Covid-19 meant that hospitality venues like pubs, cafes and restaurants were forced to close, and dramatically reduce their capacity even as measures eased. Industries such as food/beverages and public services were typically less productive pre-pandemic – Covid-19 further restricted activity in these industries. This left the more productive industries, such as legal and accounting services or IT, with a larger share of the economy.

This type of change is referred to by economists as an ‘allocation effect’. As such, although only half the industries saw a rise in productivity in the first quarter of 2021, the fact they were larger industries caused overall productivity to rise. According to the latest data, the allocation effect contributed 2.7 percentage points to overall productivity growth, almost five times larger than the contribution from any industry (see Figure 2).

Figure 2: Productivity growth by industry (including allocation effect)

Source: ONS

This is only half the story. Changes in productivity are not only caused by shifts in the mix of each sector, but also by within-sector changes. Covid-19 has sped up technology adoption. Remote working and digitalisation of the customer experience have given many industries a much needed boost. For instance, following the shift to online shopping, the wholesale and retail industry contributed to rising productivity more than any other industry.

While the resilience of UK productivity is encouraging, its 0.9% growth pales in comparison to its rapid growth in the decade leading up to the final crisis, which averaged 2.2%. This so-called ‘productivity puzzle’ is a global phenomenon: the United States and many European countries have suffered from stagnant productivity since the financial crisis, with productivity in Italy flatlining for the last 20 years.

The allocation effect and the acceleration of digitalisation have led to a modest increase in short-run productivity. But as the government lifts restrictions, the allocation effect will likely revert. It is unknown whether the digital economy will continue to expand, and how much this could increase productivity.

Other long-term effects of Covid-19 on productivity remain unknown. We are yet to see how school and university closures, and permanent remote working plans, will affect productivity in the long run. In addition, the surge in government lending may have kept less productive, so-called ‘zombie’ industries afloat. This could increase their prevalence in the economy, leading to a negative allocation effect.