Productivity Paradox

In the Spring Statement 2022, Chancellor of the Exchequer Rishi Sunak put forward a tax plan for reforming the rules on capital allowances — these are the laws that govern which investments are deductible from a business’s taxable profits and at what rate. Amid the confusion and controversy of the National Insurance contributions hike, Sunak laid out plans to reduce the tax burden for corporations by making changes to capital allowances rates, which will largely counteract the increase in the corporate tax rate going into effect in 2023. The proposed changes are part of an ongoing effort to encourage investment and the adoption of new technologies aimed at improving the UK’s lagging productivity.

Reforms are also planned for research and development credits, designed to reward companies for investing in innovation and to cover cloud-computing costs, with relief being permitted for overseas R&D. This will no doubt prove serendipitous for Sunak’s father-in-law — the billionaire founder of multinational IT company Infosys. It is unclear how much allowances for software and cloud computing will contribute toward improved productivity. As economist Robert Solow quipped in 1987, “The computer age was everywhere except for the productivity statistics.”

Similar attempts to boost investment were brought in under the chancellorship of George Osborne, but with little effect. Despite the tax-cutting policies implemented since the Conservatives first came to power over a decade ago, investment in machinery and equipment by the manufacturing and energy sectors remains well below the 2008 level. It is unlikely that Sunak’s reliefs for business investment will yield different results. To understand why these policies fail to stimulate investment in productive capital, it is important to consider the historical relationship between the adoption of technology and the regulation of labor markets.

Rethinking the Industrial Revolution

In his PhD-thesis-turned-book Fossil Capital, human ecologist Andreas Malm turns conventional wisdom about the origins of the Industrial Revolution on its head. Rather than investment in steam technology driving changes to the way labor and institutions were organized, Malm argues, it was changes to the regulation of labor markets and institutions that drove the adoption of steam technology.

Before steam, cotton spinning — the prominent industrial activity in England at the time — was powered mostly by water, with mills often located in remote regions. James Watt patented the design for his steam engine in 1769, but waterpower remained the dominant energy source for cotton spinning until the second quarter of the nineteenth century.

Prior to the Combination of Workmen Act in 1825, trade unions and collective bargaining by British workers were prohibited, pushing such activities underground. But fears that this kind of suppression was increasing radicalism among workers forced legislators to pass the act, which allowed trade unions to operate with restricted activities. Even with restrictions, unions began winning wage increases for workers in cotton mills. Spinners, in particular, won huge gains. Despite only making up 10 percent of the workforce, they could effectively shut down the entire production process if they went on strike. By 1831, wages for spinners had reached as high as thirty-one shillings per week — an insufferable situation for the masters.

In response to the rising wages brought on by the unionized workforce, a consortium of mill owners approached a machine engineer from Manchester, Richard Roberts, who was commissioned to invent a “self-acting” spinning mule. The “Iron Man” would become what is widely considered to be the first truly automatic machine in the world — and integral to its design and the source of its power was Watt’s steam engine. Throughout the 1830s, massive investments in capacity were undertaken, scrapping old man-powered mules and installing automated Iron Men, which produced 25 percent more yarn per unit of time than the living spinners.

The final nail in the coffin for the water-powered cotton mills came from the 1833 Factory Act, which brought in a partial victory for the labor movement with a shortening of workdays and laws regulating child labor — to be restricted to eight hours per day.

The remote location of water mills had given labor significant bargaining power, due to the inability of owners to easily replace workers if they went on strike. Rather than acquiesce to workers’ demands for higher wages, water mill owners became increasingly reliant on child labor, recruiting “apprentices” from orphanages who would be indentured into early adulthood. By 1836, factory inspectors had convicted more than eight hundred mill owners for breaching the Factory Act. The hefty fines levied on the remote water mills as a result of the strengthening of labor rights gave the steam-powered factories in the city the upper hand, spurring the Industrial Revolution.

Weak Unions, Low Innovation

Coming back to the present day, growth prospects for the UK are pessimistic. The Bank of England is forecasting just 1 percent growth for 2024. This has led the Confederation for British Industry (CBI) to call for “bold action from the government on business investment, to escape a post-pandemic low-growth trap and build a more resilient UK economy.” What is lacking from this call is a recognition of the need for wage growth to support investment.

Unlike the economy of the Industrial Revolution, where growth was driven predominantly by industrial exports, Britain’s modern economy is dominated by the service sector (over 70 percent) and is a net importer, making it reliant upon consumers having moderate levels of disposable income. With household debt rising and credit cards maxed out, a restrengthening of the collective bargaining rights to pre–Margaret Thatcher levels is needed to ensure workers’ wages rise — and they maintain purchasing power — in line with the rising cost of living. Without this, as energy and food prices eat up a rising proportion of people’s incomes, demand for nonessential items will continue to fall.

Despite a nascent resurgence in union membership, it is still at historic lows by the standards of the postwar era, especially in the private sector. As a consequence, wage growth is failing to keep up with inflation, despite low levels of unemployment and a record number of new job vacancies. This should give workers the leverage needed to push for inflation-busting pay increases; instead, regular pay growth is at its lowest since July 2014.

Meanwhile, corporate profits remain strong. Despite this, business optimism among manufacturing firms is falling sharply and investment intentions for the year ahead are weakening across the board.

What is needed to incentivize businesses to invest is a strong demand base, meaning workers need to have enough disposable income to buy the things businesses will make with their investments. Even the CBI recognizes the necessity of protecting the real-terms value of the minimum wage, with a recent survey finding that just 12 percent of businesses think it should remain at the current level and the rest advocating for a modest increase. Fighting against this current is the financial sector, which is averse to wage and price inflation because it reduces real income from its interest on investments, such as mortgages and business loans. Increasing the industrial leverage of workers is required to incentivize the private sector to invest productively, and the state also needs to lead investment — funded by progressive taxation.

A Green Industrial Revolution

BP recently reported that its profits hit nearly £9.6 billion — its highest since 2013. Rather than invest a portion of this money in new, efficient, or green technologies, it chose to spend £3.1 billion buying back its own shares while paying out a similar amount in dividends. Despite this record performance, BP is able to claim hundreds of millions from HM Revenue and Customs in expense deductions for “plant and machinery” for the drilling of oil, on top of credits claimed for the decommissioning of oil rigs. It is estimated this will cost the taxpayer £18 billion by 2065.

Between 2008 and 2020, the top 10 percent of the most profitable firms in the UK have increased markups from 58 percent to 82 percent. These firms are following the wisdom of Luca Pacioli, who said that the optimal strategy for running a business was to “make prices higher rather than lower . . . so you can make a larger profit.” Decades of overcharging customers and underpaying employees mean there is no shortage of profits for businesses to invest with. But profiteering corporations cannot be trusted to innovate or invest in a way that is environmentally or socially sustainable.

Rather than giving these companies more tax breaks and allowances, the government should be strengthening the bargaining power of workers and implementing wealth and windfall taxes, using the revenues to fund state-led improvements to energy infrastructure, transport, education, and health care. If the government wants to control inflation, it should do so by preventing opportunistic price gouging and profiteering by companies, squeezing corporate profits instead of squeezing workers’ wages.

Nationalization of key industries and the creation of jobs in the renewable energies sector is another way the government could help to alleviate some of the supply-side constraints causing the current elevated levels of inflation. Renewable energy creates three times as many jobs per £1 million invested as compared to fossil fuels, and for energy efficiency, this rises to a fivefold increase. Additional funding for the improvement of home insulation should be a top priority, as energy bills continue to increase for the foreseeable future.

Rebalancing the Scales

The key to unlocking technological innovation is holding businesses to account for low wages and poor employment practices — not giving them tax cuts, subsidies, and allowances. As Malm’s analysis of the Industrial Revolution shows, necessity is the mother of creation. Contrary to the doctrine of laissez-faire economics, when businesses are properly regulated and their workforces empowered, it forces them to innovate and adopt new technologies. Furthermore, without a restoration of stronger collective bargaining rights, any productivity gains that might occur from the adoption of new technologies won’t be shared with workers, and inequality will continue to increase.

But when businesses can remain complacent on cheap, unprotected, and unorganized workers, there will be no incentive for them to invest in technologies that improve productivity or sustainability. Equally, if punitive fines or levies aren’t applied to companies that damage the environment or breach labor law, there will be little incentive for them to stop the practices causing harm. Far from punishing such behaviors, the government continues to reward them with preferential tax treatment and subsidies while turning a blind eye to corporate abuses of employment rights.

As in the age of the Industrial Revolution, the technological innovations that our era demands — to tackle the climate crisis and build a more prosperous and just society — will be brought about only if the balance of power in the economy tips away from capital and toward working people.