Policymakers should keep an open mind on productivity

This is not a column about the wisdom of having an OBR with that much influence on UK fiscal policy. As important as that debate is, the rules have been set - and the pitch has been laid - for November’s Budget. Today’s column explores whether the OBR are about to throw in the towel on UK productivity at the very moment things are about to improve.

Economic forecasters are rarely accused of making dramatic changes. The OBR is no different. When it changes its view, it does so with caution. And for good reason. Every decimal point in its productivity forecasts carries with it a multi-billion-pound consequence for UK fiscal headroom.

Since its creation in 2010 the OBR has been too bullish on productivity. It clung initially to the pre-financial crisis trend that never returned. Then it moved to a more anaemic, but still overly generous, trajectory. Since the COVID-19 pandemic the reality for UK productivity has been worse still. Output per hour has barely moved, squeezed by a ballooning labour market inactivity, and stubbornly high inflation. From a purely rear-view mirror perspective, a downgrade to potential growth is the easy, defensible call.

But good forecasting is not about extrapolating the past. It is about judging turning points. And here lies the problem. By treating the post-pandemic slump as the “new normal”, the OBR risks missing forces already reshaping the economy – and in doing so, risks hard-wiring a fiscal doom loop. For every 0.1 percentage point shift in productivity assumptions, £9 billion in borrowing capacity is created or destroyed. If the OBR insists the future looks like the recent past, it effectively condemns the Treasury to hairshirt economics.

There are at least three reasons why this view could prove unduly pessimistic: generative AI, energy policy, and shifting population dynamics. None of these guarantee fiscal salvation. But together they represent a plausible case for optimism amidst what is a dispiriting economic picture.

Let us start with AI. Scepticism is understandable: Silicon Valley’s boosterism outpaces sober economic analysis. Yet real-world evidence of its additive impact is emerging. Call centres report 14% faster resolutions when AI copilots assist staff. Coders report time savings of more than 50% on certain tasks. Knowledge workers across industries self-report productivity gains equivalent to the entire compound growth in UK productivity since 2011. These are not trivial increments.

Of course, firm-level transformation is harder than individual task automation. AI adoption remains patchy, integration requires redesigning processes, and time saved does not always flow into measured GDP. Nor are gains evenly distributed – the “winner-takes-all” tendency of the digital economy risks concentration of AI’s benefits in a handful of firms. Yet for the OBR not even to factor this into the productivity horizon seems curiously myopic. At the very least there is stark contrast between the enthusiasm amongst investors surrounding AI, and the more sober stance of economic forecasters. One of these groups will be proved spectacularly wrong.

Second, the UK’s energy policy. Over the last two decades Britain has managed the remarkable feat of pricing itself into industrial decline. Once broadly competitive with the United States, UK industrial energy prices are now the most expensive in the developed world. To compound the problem, electricity generation is now 25% below its 2006 peak. Unsurprisingly, productivity growth has suffered. High energy costs squeeze margins, deter investment and erode competitiveness. Here too, change is under way. The Ukraine war has injected urgency into domestic energy security. Political consensus is belatedly forming around the folly of running an advanced economy on a fragile energy base. And an energy-hungry technology sector is lobbying hard for abundant, cheap power. Supply is beginning to inflect upwards. If that trajectory continues, the drag of the last 20 years could flip to a tailwind. The prize of accelerating this energy boost by ending self-harming North Sea oil and gas policies is not lost within the Treasury. Energy pluralism, rather than energy dogma is the most efficient route to faster economic growth.

Third is demographics. Since 2004 rapid population growth and high net migration have allowed the UK firms to substitute competitively priced labour for capital investment. That depresses output per hour worked – the very measure that productivity statistics capture. But this era - driven by politics, if not economics - is ending. Net migration is falling sharply as visa rules tighten. Domestic workforce ageing is pushing down participation. Workers will become scarcer and more expensive. The economic logic will swing back toward automation, robotics, and capital investment. In the short term this adjustment may look messy. But in the medium term it points towards a more balanced, capital-intensive growth model for the UK. Again, this is not a forecast of guaranteed prosperity. But it is at least a credible counterweight to the assumption that productivity malaise is our destiny.

The OBR, of course, will not go there. The politics of forecasting a productivity upswing without overwhelming evidence would be toxic. If the data later disappoint, the watchdog would be accused of gilding the lily to help the Chancellor. And it is true that much depends on policy choices not yet made: how AI is regulated and diffused, whether energy policy is pursued with urgency, whether immigration is managed coherently.

Yet here lies the deeper problem. By sticking to mean reversion – forecasting that the future will look like the recent past – the OBR risks creating the very conditions it fears. If the Treasury gets told its fiscal headroom is permanently eroded, it responds with austerity or tax hikes. That in turn depresses investment and growth, confirming the pessimistic outlook. The UK gets locked in a self-fulfilling cycle of decline.

This is not a plea for Panglossian optimism. Forecasting is inherently uncertain, inflection points are notoriously hard to call, and a growing public sector - where productivity is lower than it was in 1997 – is a countervailing headwind. But the OBR’s duty is not just to repeat what the rear-view mirror tells it. It is to interrogate the future. Right now, that means acknowledging that Britain’s productivity story may be about to change.

Alas, the OBR will not upgrade its productivity forecast. Politically, it cannot. But investors and policymakers should keep an open mind. The alternative to doing so is a Britain stuck in permanent stagnation - not because the future demands it, but because the forecasters assumed it.