Mon, August 24, 2026 at 6:14 PM UTC
Increasing productivity has been close to an article of faith for successive chancellors and one of the few economic ambitions that crosses party lines.
Jeremy Hunt saw boosting it as fundamental to growth. His answer was to make full expensing, allowing companies to write off qualifying investments against tax immediately, permanent. He argued that it would “improve the UK’s capital stock, help close the productivity gap, and drive sustainable growth”.
Rachel Reeves inherited the same obsession and put it to different use. In her final Budget, she told the Commons that the Office for Budget Responsibility (OBR) was cutting its productivity growth forecast by 0.3 percentage points, to 1pc by the end of the forecast, meaning “£16bn less in tax receipts by 2030”.
She was careful to attach the blame directly to her predecessors, saying: “These forecasts are the Tories’ legacy, not Britain’s destiny.”
This downgrade was a central justification for her second round of tax rises. But what if it gave a misleading impression of just how badly Britain was performing? The Resolution Foundation thinks that is plausible. It has said that Britain’s productivity performance has been meaningfully better than the official statistics suggest.
The details behind this finding are intriguing. They don’t think our economy has switched from traditionally unproductive sectors to more productive ones. Hospitality, for instance, employs no smaller a share of the workforce than in the late 2010s. Nor do they say it is an early AI effect, as the gains are spread broadly rather than concentrated where AI exposure is greatest.
As Simon Pittaway, the Foundation’s principal economist, puts it, the recovery has been “achieved by the same workers, doing the same jobs, and working in the same sectors”. If that is right, the interesting question is why.
One possible explanation is capital. Hunt deliberately made investment cheaper through full expensing, encouraging businesses to put more machinery, software and technology behind each hour of labour. The productivity recovery appears to have begun before Reeves increased employment taxes, but her policies may have reinforced the same incentive from the opposite direction.
The employer National Insurance rise from April 2025 made labour considerably more expensive, while employment regulation added to the expected cost and risk of hiring. Faced with a higher relative price of labour, businesses have a greater incentive to economise on it and invest in capital instead.
The OBR itself pointed to this capital deepening in its March forecast this year. It noted that “capital deepening – proxied by growth in the capital stock per worker – adds modestly to potential output growth, by around 0.3 percentage points a year”.
It also noted that this contribution was slightly higher than previously assumed because of “lower employment growth, and higher business investment”.
That does not prove capital deepening explains the productivity recovery. But the pieces fit sufficiently well to warrant attention.
Imagine a company producing £10m of output using 200,000 hours of labour. It invests in machinery, software or better processes and can eventually produce the same £10m using 180,000 hours. Output has not moved. Labour input has fallen by 10pc. But output per hour, which tends to be the productivity measure economists care about, has risen by 11pc.
This has an uncomfortable implication. Britain has spent years demanding higher productivity without thinking very hard about what the adjustment might look like. Higher unemployment is not the price Britain must pay, and historically, the two certainly do not require one another. But weaker demand for labour may be a symptom of how some businesses are becoming more productive.
That is consistent with what we are seeing. Vacancies are at their lowest outside Covid-19 since 2014, payroll employment is falling, and graduate vacancies have hit a record low. It is worth considering whether a bad jobs report and a good productivity report may be the same report, read two different ways.
This is why John Healey should be careful in his first Budget. Banks already fear being taxed more, and a Chancellor short of money will inevitably look closely at corporate profits. But if British businesses are finally putting more capital behind each hour of work, policy should encourage that process rather than make investment returns less attractive.
Successive chancellors have promised a productivity revolution would make Britain richer and rescue the public finances. They have said rather less about a journey that might involve companies substituting capital for labour, vacancies disappearing and unemployment rising before the benefits fully arrive.
That may or may not be what is happening now. But if it is, Healey’s job is not to panic at the painful part of the adjustment and tax away the conditions producing the beneficial part. Britain has waited far too long for a productivity recovery to kill it before it has properly begun.
