What’s so puzzling about the productivity puzzle?
How to cross the bridges of Königsberg in a non-overlapping path was a real puzzle - mercifully now solved. The UK productivity puzzle is not in the same category. The decline in UK productivity, which Martin Wolf writes about in his latest column, is certainly puzzling from the standpoint of classic economic analysis. But the list of the sectors most affected may give us a first clue: banking, telecommunications, utilities, management consultancy, and legal and accounting services. As Wolf writes, these sectors comprise 11% of the UK economy, yet account for two-thirds of the slowdown.
Our own observation is that these sectors have two things in common: they are the most regulated of all economic sectors, and most belong to the category of EU single passport sectors. The regulatory crackdown on mortgages, for example, has reduced the amount of lending per worker employed in the UK banking sector. Banking and exportable services have been the UK’s party trick in the EU, a business model that generated a steady flow of income for parts of the UK economy - in London mostly - but little productivity growth of late as the eurozone itself has been through a long period of economic stagnation. We have argued for some time that it was unsustainable for the UK to maintain what must be one of the strangest large-country business models in existence - which is that of playing financial centre to a monetary union it refuses to join. By getting rid of the single passport, Brexit will in the long run lead to a different domestic specialisation, and thus address the productivity puzzle if accompanied by a loosening of regulation.