How boosting household economic security could unlock productivity growth

Britain’s productivity problem is well established: a collapse in productivity growth since the financial crisis that we are yet to recover from. To put how big the collapse has been in context, labour productivity growth in the UK stood at only 0.4% a year in the 12 years after the 2008 financial crisis, less than half the average of the richest 25 OECD countries.

And while recent Office for National Statistics (ONS) changes to measuring productivity have led to some sizeable revisions, the overall picture remains the same: according to ONS ‘following the 2008 financial crisis, the UK experienced a slowdown in productivity growth per hour compared with the historic long-term trend’.

The debate about why has focused on familiar explanations: weak investment, poor infrastructure, skills shortages, a lack of innovation and the incentives facing firms and workers. But there is a question that gets much less attention: how does the economic security of households contribute to productivity growth?

Economic security goes beyond current levels of income; it is financial, social, emotional and physical well-being both in the present moment, and the confidence and capability to deliver this well-being in the future. We tend to think of economic security as something that growth delivers.

A more productive economy creates better-paid jobs, raises incomes and gives households greater financial security. But it is possible that the causal arrow also points the other way: that having greater economic security can itself help people become more productive.

There are good reasons to think it might. When people are struggling to make ends meet, dealing with poor health or worrying about whether they can afford their next bill, they have less financial and mental space to perform at their best. And when households have little buffer against financial shocks, they may be less able to take the risks needed to find a better job, retrain or start a business.

If that is right, then economic security is not simply the reward for a more productive economy. It could be one of the conditions that makes a more productive economy possible.

JRF, Pro Bono Economics, and the Fraser of Allander Institute have just published 3 pieces of research that examine this question from different angles. Together, they explore whether improving the economic security of households could be the key in helping unlock productivity growth.

The 3 pieces all start from the same premise: that economic security may be more than an outcome of economic growth. It may also be one of its inputs. Using data from the Understanding Society dataset, they examine different parts of this relationship, from the ability of workers to make productive job moves, to their productivity within the workplace.

Productivity within the workplace

The Pro Bono Economics and Fraser of Allander Institute research looks at what happens to people’s productivity within the workplace when their economic security deteriorates.

Pro Bono Economics show the impact of 3 different dimensions of economic insecurity: financial strain, poor health and weaker social connections. Entering a period of financial strain has significant and persistent impacts on individuals’ employment and earnings potential, resulting in a 4-percentage point fall in employment rates and an 8% fall in labour income (for those remaining in work).

Those entering poor health also saw a 4 percentage point hit to employment rates and, also showed signs of being less able to work effectively while in a job. Those facing weaker social connections also showed a significant decline in their ability to work effectively. This indicator of in-work productivity is referred to as 'dysfunctional presenteeism'.

The potential economic costs are substantial. Pro Bono Economics estimate that the lost output associated with these effects is around £1,300 for the typical person affected. With 56% of the working-age population, more than 21 million people, living with some form of economic insecurity, the potential drag on GDP could amount to around £28 billion, or roughly 1% of the measured economy.

In fact, this estimated drag has increased by around £9 billion since the beginning of the cost of living crisis, highlighting just how much of an impact a widespread economic security shock can have on productivity.

Isolating the impact of changes in economic security on productivity is challenging. Pro Bono do this by examining how people’s lives at the workplace change as they enter economic security using a dynamic model. This method allows them to follow people as their circumstances change over time, rather than treating their economic circumstances as a fixed characteristic. 

The Fraser of Allander Institute research takes an alternative approach. They look at the impact of changes to economic security that result from an individual’s partner losing a job. In theory these changes in economic security should be entirely independent of the individual’s productivity or earnings capacity, other than through the direct impact of reduced economic security.

Using this approach, they find that a 1-point change in economic security on a 5-point scale, where 1 is ‘living comfortably’ and 5 is ‘finding it very difficult’, leads to a 12% fall in an individual’s real hourly wages, suggesting a negative impact on productivity. But this effect is not felt equally across households. The negative wage effect is more pronounced among low-income households, renters, second earners, women, and people in poorer health. These estimates represent averages across the period when the partner remains out of work, which is most commonly 1 year but can be as long as 13 (the maximum duration within the dataset).

There is also evidence that less disadvantaged households responded differently to the initial shock with the probability of being in in-work training rising by 16% in response to the initial shock — a finding driven homeowners, men, primary owners and people in good health. And so, what look like contradictory results (the real hourly wage and training changes) are partly explained by different people responding differently.

Economic security affects not just the outcomes people achieve, but the choices available to them when circumstances change. Those with greater resources may be able to respond to a shock by investing in training in an attempt to protect their future living standards. Those with fewer resources may instead be more exposed to additional pressures and, as a result, face immediate financial consequences, with lower wages compounding the initial loss of household security.

Taken together, the findings support the case for strengthening household economic security, particularly for those most exposed to shocks. Giving people greater capacity to weather these shocks could help boost productivity and provide a stronger foundation for long-term economic growth.

The nuance of dynamism among economically insecure workers

Productivity is not just about how effectively people perform in the jobs they have, but whether they can find jobs where their skills are used most productively. That brings us to labour market dynamism, and the ability of economically insecure workers to make good job moves.

The JRF research starts with an important feature of Britain’s productivity problem: we have become much less economically dynamic. Before the financial crisis, labour market dynamism, via sectoral reallocation, contributed around 20% of productivity growth, but since 2008 it has contributed nothing. Between 2002 and 2007, 1 in every 37 people move between jobs each quarter. Today, that has fallen to 1 in 50.

This matters for people as well as the economy. On average, those who move jobs see wage growth 4.8 percentage points higher 1 year later than those who stay put, rising to more than 7.3 percentage points after 5 years. But moving jobs involves a short-term risk: movers are 6.7 percentage points more likely to experience a pay fall of more than 10% in the following year than non-movers.

This trade-off is particularly important for economically insecure workers, who have strong reasons to move (low pay, limited savings, insecure housing — what we call the push factor) but are less able to absorb the downside if things go wrong (the pull factor).

Traditionally, efforts to boost dynamism have focussed on middle- and high-income households. On the face of it, this makes sense. Insecure workers move jobs more frequently (10.9% move within a year compared with 6.7% of those living comfortably). However, not all of these moves are productive. Once we focus on moves involving at least a 5% pay increase, the gap between insecure and secure workers is much smaller. In fact, conditional on moving and controlling for background characteristics, we see that economically insecure workers are 6.1 percentage points less likely than secure workers to make one of these positive job moves.

The role of economic insecurity through aversion to taking risks is also an important channel. Workers with a high willingness to take risks are more than twice as likely to change jobs, and greater economic security is associated with greater willingness to take risks. JRF qualitative analysis shows that insecurity does not appear to reduce people’s aspirations, it reduces their capacity to act on them.

Conclusion

Growth and productivity are vital for delivering long-term sustainable living standards. But there is now a growing evidence base that economic security is not simply something that a growing, productive economy delivers to households. It can also be one of the conditions that allows people to contribute to a more productive economy in the first place.

Insecurity can make it harder for people to perform effectively at work, protect their earnings when their circumstances change, and take the risks needed to move into better jobs. Poorer labour market outcomes can then reinforce the insecurity that caused them. Greater economic security, particularly for households with the least capacity to absorb shocks, could help break this cycle, improving people’s lives while also boosting the economy’s productive capacity.

That has an important implication for how we think about policy. Measures to strengthen household economic security should not be viewed solely as transfers from the economy to households, or as a cost to be weighed against growth. Some may also be an investment in the conditions that support stronger productivity: giving people the financial breathing space to take productive risks, the security to invest in themselves and the ability to make the most of their skills.

And the reverse is true. Policies that deliberately leverage insecurity as a way of changing people’s behaviour risk undermining the very outcomes they seek to achieve. If people respond to insecurity by avoiding risks, staying in less productive jobs or struggling to perform effectively at work, then making households less secure may hit productivity growth.

The conventional question is how productivity growth can deliver better living standards. We should also be asking whether better living standards can help deliver the productivity growth Britain needs. These findings suggest that the answer may be yes, and that improving economic security could be not just an outcome of a stronger economy, but part of the route to building one.