Capital concerns: slower growth in assets is weighing on UK’s productivity growth

The role of capital in enhancing labour productivity — the output delivered by each worker per hour worked — is a core feature of how economists think about, and model, growth. “Capital” in this context means tangible or intangible things that a society, economy, an organisation or a person has invested in that generate a benefit over a period of time greater than a year. [Note: there are a lot of technicalities involved in what is and is not considered an “investment” or “capital”, which I’m going to side-step in this blog.]

For example, compare a farmer from a few hundred years ago to one today. The latter benefits from all kinds of capital assets: the research and development that went into better crop varieties, the machinery and equipment that makes labourers on the farm more efficient, the storage facilities that help keep products fresh, the information and communications technology that allows the farm to optimise operations according to weather, the software that helps keep track of invoicing, the transport infrastructure and equipment that gets the produce to buyers, and so on.

Of course, labour productivity doesn’t just depend on capital, or even just the quantity of capital, but also the type and quality of capital. Indeed, labour productivity is also driven by the type and quality of labour, and exactly how the labour and capital are put together to produce output (often called “total factor productivity”). In this short blog, though, I wanted to home in on the overall capital stock, mostly because the data is pretty striking and helps shed light on the so called “productivity puzzle”.

Before we get into the detail on capital stocks, let’s just recap what happened to productivity growth in the UK prior to the COVID-19 pandemic — even though the general phenomenon, of a slowdown in productivity growth, has been pervasive in most developed economies. In the 9-year period from 1997 to 2006 (before the financial crisis hit), output per hour worked increased in real terms by an average of 2.6% per year. In the years following the crisis, from 2010 to 2019, this had dropped to 0.5%. Productivity growth slowed down in 44 out of 65 sub-sectors. [Note: all figures quoted in this blog exclude the real estate sector, due to non-comparability.]

In parallel, a similar thing was happening with capital stocks. The net stock of capital at the end of each year is calculated by adding new investment to the previous year’s ending balance and deducting depreciation (deterioration in asset quality) that takes place during the year. Overall, the absolute amount of net capital in the UK has grown in most years, even after the financial crisis. However, when we look at the net capital stock per hour worked — in other words, relative to the quantity of labour —the picture changes.

In some of the years following the financial crisis (specifically in 2012–14), net capital stock per hour worked actually declined. Even though this figure resumed some growth in later years (specifically, 2015–2019), it was at a modest rate: at 0.8% per annum, on average. Overall, the average growth rate in net capital stock per hour worked in the pre-crisis period (1997–2006) was 2.2%; in contrast, the growth had slowed to an average of 0.2% per year in the period from 2010 to 2019. In other words, growth in capital stock per hour worked slowed down by 2.0% percentage points.

The analysis above gives an indication of aggregate figures (note: excluding the real estate sector). The chart, in turn, provides some detail on how much growth in net capital stock per hour worked slowed down in each of the sub-sectors of the economy. The striking feature of this data is that the slow-down was very broad-based: of the 35 sectors shown, the growth in net capital stock per hour worked slowed down in all except three: public administration, arts and recreation, and health.

While there are likely many causes for the slowdown in productivity growth — including that economists’ mathematical models about how growth works may have been incorrectly formulated — this data seems pretty clear: a slowdown in the growth of net capital has played an important role, not just in specific sectors, but across the entire economy.