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Productivity drop in Q4-2020 largely wiped out gains from previous quarter

Professor Bart van Ark is the Managing Director of The Productivity Institute & Professor of Productivity Studies at Alliance Manchester Business School, The University of Manchester.

Key observations for the outlook on productivity after Q4 Flash Estimates of Productivity for the UK

  • The drop in output per hour in Q4-2020 of 4.5 percent over the previous quarter reflects a weak performance in output coupled with a moderate increase in working hours.
  • The annual growth rate of output per hour in 2020 at 0.3 percent turned out to be only slightly below the decade-average of 0.5 percent.
  • We expect output per hour to increase by no more than 0.5 percent in 2021 as sectors and firms will struggle to return to normalcy and regain a path of sustained growth.
  • Bigger improvements in productivity can only be anticipated beyond 2021, depending on the success of a broader agenda for productivity improvements across the economy and the nation through technological change and innovation.

Summary of the data from the ONS

Labour productivity, measured as output per hour, dropped by 4.5 percent in the fourth quarter of 2020, wiping out most of the 5.6 percent gain in the previous quarter, according to the flash estimate of productivity by the Office for National Statistics. The decline in productivity can be directly attributed to continued business and mobility restrictions because of COVID-19 and subsequent lockdowns across the nation, bringing the recovery in Q3 from the first lockdown to a virtual standstill.

The silver lining of the drop in productivity in Q4 is that hours worked improved at 5.8 percent, which was much faster than the growth in output at only 1 percent. In particular, the manufacturing and construction sectors saw large increases in hours worked. However, output growth in those sectors did not catch up sufficiently with the rise in hours, so that the loss in productivity was 5.8 percent in manufacturing and 9 percent in construction. Services sector productivity dropped by less, falling 4.2 percent over the previous quarter, due to weaker recovery in hours worked than manufacturing and construction, and only a small improvement in output growth over Q4 despite the relaxation of the lockdown restrictions in December.

Despite the massive blow of the COVID-19 pandemic to the economy, the annual growth rate of output per hour in 2020 (over 2019) came out just positive at 0.3 percent, only slightly below the average productivity growth rate of 0.5 percent for the full decade, 2010-2019. This needs to be understood as meaning that the drop in output in the economy in 2020 was slightly larger than the drop in hours. In contrast to output per hour, the growth rate of output per worker dropped at 9.6 percent in 2020.  The difference between the improvement in output per hour and output per worker is due to the government’s Coronavirus Job Retention Scheme (CJRS) enabling workers to keep their job but with fewer hours actually worked.

The drop in productivity over 2020 has been cushioned by a strong positive “reallocation effect”, meaning that low-productivity industries, such as part of the retail sector, accommodation and food services lost a significant share in total employment relative to high-productivity industries, such as manufacturing and business services. If it was not for this positive reallocation effect, Q4 productivity would have actually declined by double compared with Q4 in 2019 .

The productivity estimates must be interpreted with more caution than usual, as both the underlying output and labour input estimates are subject to significant revisions because of volatile movements of those variables due to the pandemic, especially for sectors in the economy that are most hurt by distancing measures, temporary shutdowns, etc.

Outlook for productivity

Our outlook for productivity growth in 2021 is not very optimistic as we expect only a modest gain of between 0 and 0.5 percent in 2021 over 2020, which is mainly the result of a recovery in output but a weak response from the labour market once the new roadmap out of the lockdown just announced by the government, gradually opens the economy up.

forecast by the National Institute of Economic and Social Research suggests GDP in 2021 to recover by only 3.4 percent which is less than half of the loss in 2020 (9.9. percent). Much will therefore depend on how the labour market will respond to those moderate output gains. First, while a significant improvement in output and hours worked in services industries is likely in the second half 2021, it may be offset by rising unemployment due to bankruptcies once the government support programme runs out, possibly by July. It cannot be automatically assumed that firms exiting in 2021 will indeed be the least productive ones, because liquidity and solvency issues rather than weak productivity may still be the primary cause for business failures during 2021.

Second, the shift from low- to high-productivity sectors in 2020 is likely to reverse later in 2021, as sectors such as retail, accommodation and food services regain market share. Their lower productivity levels will therefore put a brake on the economy-wide productivity growth rate.

Third, some productivity gains in 2020 which were due to technology and innovation may level off in 2021. Several industries have made a step change in digital technology usage during the pandemic when transitioning to working from home, new models of online delivery of goods and services, and accelerated digital transformation.  However, as firms return to “normalcy” in 2021 it remains to be seen how much of those gains can be safeguarded. For example, work from home and at work location may become more of a hybrid mode that needs to be re-optimised from a productivity perspective. Only once the economic recovery goes into significantly higher gear, which may not be until 2022, incentives for new productivity change form technology and innovation are likely.

Beyond 2021 the productivity trend will depend on other factors related to the structural issues the UK economy has been facing for a considerable time. The level of productivity in the UK has fallen considerably below that of other comparator countries in the OECD, including France, Germany and the United States. The pace of digital transformation, the effects of regional investments as part of the government’s levelling up agenda, and the longer-term impact of Brexit on the sector structure of the UK economy will be critical to a productivity revival in the UK.