If productivity can be raised, more services can be provided to the public for any given level of spending, writes Paul Ormerod
Pre-election blows are being traded with increasing ferocity by both the main parties. Do the costs of Labour’s energy policies bear scrutiny? And can the Conservatives really afford to cut taxes?
All of these questions relate back to the state of the public finances. Taxes are already at a post-war high relative to the size of the economy. Public sector debt is already some 100 per cent of GDP and, as the Liz Truss experiment showed, markets might not take too kindly to any announcements of further increases.
Both parties seem to be operating under a very tight constraint. The electorate seems to want more public services but is very reluctant to pay more taxes for them. And it is difficult to fund them by increased borrowing.
But there is a massive prize on offer which would go a long way to solving this conundrum. It is indeed a prize, though we could equally think of it as the huge elephant in the room because virtually nobody is talking about it.
The prize is to increase the stagnant productivity in the public sector of the economy. Obviously, if productivity can be raised, more services can be provided to the public for any given level of spending.
There is huge potential. Last month, the Office for National Statistics (ONS) released their latest estimates for public sector productivity. Incredibly, in 2022, the latest available figure, it was 0.4 per cent lower than it was in 1997.
Over a period of 25 years, the public sector has seen basically zero growth in productivity. Over the same period, the cost of all the inputs to the sector rose by 88 per cent. But output grew by only the same amount so productivity was unchanged.
In contrast, productivity in the economy as a whole rose by 27 per cent over the 1997-2022 period. There has been a slowdown since the financial crisis of the late 2000s, but overall there has still been growth.
To be fair, there are challenges in any attempt to measure public sector output for the simple reason that much of it does not take place in a market setting. It is therefore not straightforward to assign a value to its output. The inputs, such as the wages and salaries of the staff, can be measured easily enough, but not the output.
The most extreme example of this is in how to measure the value of the output of the armed forces. The ONS looks the problem squarely in the eye and dismisses it. By definition, they simply assume that productivity growth is zero.
The ONS does construct what they call a “quality adjusted” productivity index. The latest data for this only goes up to 2019 (well, 2020, but the pandemic distorted everything). This does show a rise since 1997 of seven per cent, but it is still a very small number.
But even given the difficulties, the ONS estimates are the best we have got. And it almost defies belief that a big chunk of the economy has shown little or no improvement in efficiency over a 25-year period.
The public sector does many good things. Yet at the same time it is riddled with the sorts of restrictive practices which were driven out of the private sector from the 1980s onwards.
Both the major political parties appear to have accepted – or the leaderships have – the severe constraints which financial markets are now placing on increased spending. But with a few conspicuous exceptions such as Labour’s Wes Streeting, they seem almost paralysed by this realisation.
The whole debate around public services needs to be reframed. By focusing on and delivering higher productivity, we can have better services without paying more tax.
Paul Ormerod is an economist at Volterra Partners LLP