Higher UK interest rates could give a boost to productivity
Higher interest rates could give the UK’s lacklustre productivity performance a boost, according to Deutsche Bank.
Analysts at the bank think that more expensive borrowing costs could force firms to employ resources more efficiently.
Deutsche Bank has a relatively pessimistic view on the likely growth in total factor productivity (TFP), a measure of how efficiently an economy combines labour and capital.
“UK productivity has disappointed for more than a decade now – and so, we stick to a low estimate of productivity growth,” Sanjay Raja, chief UK economist at Deutsche Bank said.
He predicted TFP would rise by 0.5 per cent annually. However, Raja identified a number of upside risks to the forecast, including the possibility that higher rates could spark an improvement.
“Higher interest rates may reduce the UK’s tail of least productive firms (by removing so-called zombie firms) from the UK ecosystem, raising competition over time,” he said.
“Higher rates could also incentivise higher productivity as firms grapple with higher debt servicing costs,” Raja added.
Although interest rates are heading lower, most economists expect rates to remain significantly higher than pre-pandemic, putting up debt servicing costs for businesses.
This will put pressure on zombie firms, companies that earn just enough money to continue operating, but are unable to pay off their debt.
These firms have risen in prominence over the past few decades, as interest rates have progressively moved lower.
Previous research from Deutsche Bank’s Jim Reid suggests that zombies make up around 22 per cent of public companies in the UK, having been virtually unknown before the 1980s.
It is argued that these firms contribute to the misallocation of resources, because they require labour and capital that could be directed into more efficient firms.
Improving productivity is crucial for generating economic growth, because it enables an economy to produce more outputs with fewer inputs.
Productivity growth in the UK has weakened significantly since the financial crisis, the most important contributing factor to the economy’s weak performance post-2008.
Many economists have hopes that AI could help stimulate higher productivity in the services sector, whereas productivity gains have traditionally been concentrated in manufacturing.
“The advent of AI could also present a significant shift in productivity growth – particularly with the UK positioning itself to be at the frontier of the digitalisation/AI movement globally,” Raja said.