Sunday Supplement – 03/04/2022

Apr 3, 2022


“Half the copybook wisdom of our statesmen is based on assumptions which were at one time true, or partly true, but are now less and less true day by day. We have to invent new wisdom for a new age.” – J.M. Keynes

Welcome to the supplement, and today’s quote embodies where we should be striving to get to at a governmental level. I wonder if we are, or whether that quote is emblazoned somewhere in 11 Downing street – I’d hope it is. There are further problems as well, in that we as humans suffer from recency bias, placing undue and unreasonable weight on recent events, and also that economics often gives way to politics. That’s likely to characterise the next two years in the UK, I’m afraid, thanks to the system of elections.

Today I promised to talk about productivity on the back of one of the interesting interactions I had on social media this week. It’s sensible to start first of all with a broader discussion around metrics, and their overall use. If you go along searching for that “one true metric”, you are destined for failure and disappointment. You cannot be monogamous to your metrics! There are many that have strong cases for use at different times, and this is why key performance metrics has an “s” on the end, right?
Productivity is often talked about as the silver bullet, and of course that isn’t true. I’m going to talk about the macro definition(s) of productivity, and then get down into the property-specific theory and practice, and all the way down into the individual level also – so hopefully getting to the end of today’s supplement will be quite productive! (Do you see what I did there?)
At the simplest level of the metric, productivity measures units of output per unit of input. If we think about what this means – if we have a brewery, for example, we need to put in x amount of hops, y amount of yeast, and produce z gallons of beer. If our equipment gets old and we don’t replace it, and breaks down more regularly, or isn’t as efficient – our productivity will go down (depending on how we measure it). If we invest in the latest state of the art kit, we might be able to eliminate some wastage or slippage in the production process and produce more output for the same input, or use less input to get the same output.
Like all good economic examples, we see that as a physical good to paint a picture in the mind – but in reality, particularly in the UK, it is a lot less tangible than that thanks to our heavy reliance on the service sector for our economic output.
The Office of National Statistics (ONS) like to measure productivity in two different ways. Output per hour worked (so this is really the most granular metric) and Output per worker. You can see the difference – and often metrics are criticised at the top level for not giving the full picture. This is potentially a little unfair – I’d say the work needs to go in to find the relevant metrics rather than critiquing the high-level macro ones. Are you more interested in unemployment in the UK, or unemployment in your best investment area, for example?
As with so many metrics, Covid has destroyed the graphs – things that per quarter once changed by fractions of one percent moved by 20%+ when lockdowns came and went, and when furlough came and went. There has been a large need for this to settle down before getting any meaningful data, which is why I have postponed this particular subject for some time. However, it is very important and so we were overdue an update, at the very least.
Pre-great financial crisis (i.e. pre-2008) UK productivity ticked forwards nicely, year on year, at around about 2%. In the longer run, it is VERY hard for the country’s output (measured by GDP) to increase without productivity improvements. Post-GFC the year on year movement before the pandemic was cut by two thirds to 0.7% per year, so this subject and the “productivity puzzle” has had much written about it, and a lot of focus from policymakers, for some years – without much success in even defining the problem.
If I was going to define the problem, I would start with a discussion of the UK not taking its medicine after the GFC. Quantitative Easing on the level we have seen was there to cushion the blow but essentially didn’t do much for the vast majority of the population – it has propped up the stock market nicely, which in turn has meant that less capital can be invested to get better returns, because debt is so cheap – which again in turn affects productivity negatively. There are tons of other competing explanations, and of course it just isn’t as simple as that, but for what it is worth, I consider that to be a major factor. Look at the US which has used much less QE in percentage terms – they have not had an equivalent productivity puzzle post-08.
The productivity bears, those who believe we are heading to hell in a handcart, have said for years that the low-hanging fruit has all been picked. There’s an element of truth in this – when you introduce electricity, or the motor car and mass production – or the washing machine, the single most influential invention of all time on productivity – you make step changes. There are times in history that saw gigantic growth in short spaces of time thanks to innovation. The internet has NOT had anywhere near this sort of impact, for example, even though many think it would have done.
I’m not quite as miserable as all of that (for a change!). We still have some significant productivity gains that we can see, that we will realise in the next years, and some that we cannot yet see as well. That is the nature of innovation. The truly autonomous vehicle will arrive one day, and when it does, we can bemoan the loss of hundreds of millions of jobs worldwide that involve driving – or we can have a sensible conversation about the fact that technological advances, in the post-WW2 period, have not tended to affect unemployment negatively. Indeed, with tech supporting humans, productivity per hour goes up if low-value tasks are automated away (which is the essence of process improvement in many organisations). Humans get better jobs overseeing machines, fixing machines, improving machines, etc. etc.
Had we gone down a route of nuclear power in a more serious way – highly topical at the moment – there would have been an opportunity to lessen the current energy crisis. Nuclear fusion has made some massive steps forward in the past couple of months, with a breakthrough being announced. Innovation can improve productivity, and improve living standards.
We need to take a brief segue here, to challenge exactly how useful this productivity metric is, however. The pandemic offered an incredible live experiment on working from home. It was not planned, it was not well structured, but people did their best. The metrics pre-pandemic were that the average commute was 1 hr 23 minutes each way, in the UK. Polling data revealed that those working from home were working 45 minutes more each day, on average. At a high level – gain back 3 hours of largely wasted time, give back one quarter of that to your employer as times are tough and most employees are conscientious, seems a pretty good deal. But does productivity go up or down?
Well, it depends on the output. If it takes that extra 45 minutes to achieve what you would in the office, that’s a working from home tax on time for productivity. The next question, then, though is that do standards of living go up? Well, I’d argue yes they do, because the cost of commuting can stay in the pocket, and you have an extra 2 hours 15 minutes of leisure time each day (or time to be reallocated accordingly). There’s more power over your income.
That conversation needs to be taken in context – only around half of UK jobs can be done remotely. 90% of all of those are more likely to end up as hybrid, so that saving is not every day. To keep things balanced, we also need to consider that 2-3 days a week in the office and 2-3 days from home could be extremely effective indeed, if done correctly (and when people and organisations have had enough time to get their head around it). Office environments can be extremely distracting, but also extremely valuable to culture, teambuilding, innovation, communication, etc.
So – as so often – we make do with what we’ve got. Productivity is finally above where it was pre-pandemic – so despite the anecdotes of society breaking us, no-one being able to fill the car up, and all this other press – as usual we need to understand the reality. Could we see a significant uplift in productivity as hybrid working makes its way into the mainstream? Yes, there’s a possibility. Will it be particularly quick? No, I doubt it – we probably have another couple of years of it settling down to find its ‘happy’.
Productivity can also be a bit of a misnomer. If I told you the US was the most productive nation in the G7, you might not be surprised. If I told you they share that top spot with France – you might be. If I told you, more surprisingly, that Japan was the least productive – you might say “how could that be?” – but when you think about the culture and the mathematics, it is fairly obvious why this has been historically true. A swift deep dive into Japan will help frame this:
In 1986 the average Japanese worker worked 2097 hours per year versus 1828 in the US and 1702 in France. In 2019, in Japan this had come down to 1664 compared to 1779 in the US. You can see a few forces at play here – progress perhaps – but then with mobile devices and emails, how are we really measuring how many hours of work people do in the service industries these days, for example. There’s caution needed here because there are far more part-time workers than there used to be, and that of course dilutes averages. Their current unemployment rate is a mere 2.7%.
This is an absolute step change in the working culture, yet in 2022 Japan made its 50th straight year at the bottom of the league tables for productivity in the G7. This seems ridiculous with what we know of Japan, the Toyota Production System, Kaizen and other famous stories, theories and case studies. However, as always, go one step further down. This international table is denominated in US$, which has not helped as the Yen has weakened significantly against the dollar in the past decade.
There’s more to it than that, however. Japan’s near-refusal to allow immigration is one of the reasons why globalisation has passed them by, to an extent. They also suffer from a less competitive market than the US or the UK at corporate level, and fewer larger firms means more inefficiency, worse outcomes for consumers, and lower productivity. This is why the existence of the Competition and Markets Authority is a good thing, at a high level (although its renaming twice in the 15 years preceding that rebrand is unlikely to be a good sign of an effective government department!).
Some of this pertains to the “lost decade” which is being extended to the “lost 30 years” in Japan, struggles with GDP growth (and indeed a lower GDP if denominated in US$ terms, but there have been significant exchange rate fluctuations) and it is interesting to look into the real data versus the impression in the mind that might come from the data years ago.
How has this really impacted Japanese life as well? Well, the life expectancy is a massive 84, 3 years above the OECD average. The homicide rate is 0.2 per 100,000, versus an average of 2.6. There is around 1 hour less of personal care and leisure time per day in Japan compared to the average, and of course they have struggled against a shrinking population pyramid for some years, with one of the very lowest fertility rates in the world (no doubt related to much of the above). 15.7% of employees report working very long hours in paid jobs (more than 50% above the OECD average for that metric) – which proves that averages can hide lots and lots of things – that very strong work ethic is clearly still there, but diluted by the part-time participation rate which is very high.
They may have fewer younger people but they have been very successful in getting them into work, with lots of time, money and effort spent on vocational qualifications and programmes that we can only dream of in the UK. But their GDP has not progressed – so is this the be all and end all? Just as with productivity, clearly it is not.
So we need to be cautious on the macro level – but what we do know with certainty is that higher productivity gains do lead to more growth, and most importantly, long-term sustainable growth. Let’s go down one level to the property industry and what productivity might mean to construction, investment and development.
In 2020, productivity in construction was a woeful 14.6% above what it was in 1970. This perhaps will not surprise many, and there would be many potential reasons for this. This has dragged down UK productivity for many years, particularly pre-2008, and has improved slightly since 2008. Overall productivity was up 150% in the same time frame, to put that into context. MFP (multi-factor productivity) as defined by the ONS is down 31% since 1970.
So what has happened since 2020? Well, the pandemic has blown up the prices of materials, and also labour pressures are significant. Not enough supply and too much demand is the same old story in many sectors since Covid, and so if we go back to the base definition, units out per units in, it is clear that unit costs have ballooned. If it takes 20% more money to build the same house, productivity suffers dramatically (unless that house is worth 20% more, which it isn’t – not quite anyway!).
So what? So – for developers building new units, they have a margin squeeze. They need one of the following: better deals (who doesn’t ever want that?), cheaper land (yeah, right), more efficient methods of construction (possible), better operations (always possible), better funding structures (always something to work on) and/or better marketing and sales teams to achieve better end values!
What impact does this have on the secondary market? Well, the cost of acquisition is a much, much larger percentage of the GDV on a refurb, of course. On a conversion this would also be the case, but to a lesser extent. If the new build product goes from 150k to 175k in an area, but build costs are up 30k per unit – the developer is squeezed on margin more than the investor (who might spend 36k instead of 30k on a refurb). The investor is still squeezed however when construction inflation outpaces house price inflation.
The beneficiary is the longer-term property owner. They don’t have to pay higher entry level prices, but instead could have a property that before they might have spent 5k on to achieve a sale at 100k – they now spend 6k to achieve a sale at 115k – and that’s the true beneficiary in the current world. Developing got harder, investment got harder at a lesser rate, and holding has seen massive, as yet mostly uncrystallised, gains.
That frames the problem at the industry level which will resonate, I am sure, with the majority of those reading or listening to this. I think there’s some mileage in going down one step further to the individual level whilst on the subject however.
How do we measure our own productivity? What’s the “right” number of hours to work per week? How do we achieve optimum performance? There are many other questions which I’m sure people will have.
Firstly – what does productivity even mean for us? What would we rather do – work fewer hours, and be most effective per hour – or put in those extra hours, despite the law of diminishing returns, and squeeze out that little bit extra? It is often said that in the first couple of years of investment banking, if you worked in a job that paid per hour instead, including McDonalds, you’d make more money. That’s not the big picture of course, and often entrepreneurs try, or think they are going to, front load the effort so that they can enjoy the beach later on. Sometimes, that even works – although I do chuckle when I see people who think they can put in a few tough years and then Valhalla awaits, since this is not the reality for 99% of entrepreneurs.
It is very possible as well that the answer to that question changes as life goes on. There are anomalies of course – Warren Buffett springs to mind, as he regularly does in the supplement! There is a real tug here – the opportunity cost of not working, versus the challenges of burnout, enjoying life every day, relationships and everything else – and that final true goal of balance really is worth a mention here.
There are some conclusions we could safely draw though. There is a growing body of literature which suggests 30-hour weeks are more optimal than 40-hour ones, and that productivity can not drop at all (even when wages are held at the same level). That would be a 33% increase in worker productivity which seems unlikely, given how slowly the needle moves over the years. We need more long-term data in this sector, although this trend is growing.
I would certainly rather do 30 hours effective work than 40 simply because I feel I should do 40. Productivity “hacks” come into this conversation – one great one is to ensure you are tracking your time – because although that in itself takes some time, it is amazingly motivating to see what you’ve achieved on a great day, and also what you haven’t achieved on a bad day, so that you can cut out some of those activities. One of the great things about time tracking is that it can assuage a lot of guilt that you might otherwise feel, especially when self-motivated/employed!
This is also related to habit of course, and “Atomic Habits” by James Clear is worth a read or a listen if you have not yet done so – alternatively “The Power of Habit” by Charles Duhigg is another good book.
I would advise some caution however. Particularly if self-employed, but even from a traditional career perspective, you need to be devoting some time to the now and bringing in the bacon (vegan alternatives available), some time to the next 1-3 years, and some time to 3+ years depending on the stage you are at in your career. For me, networking and building relationships has been at least 20% of my “work” time in the past decade, and has borne fruits, sometimes really significant ones, but not quickly. That sits in my 3+ year pipeline, so when I’m 3 years away from retirement (in 20never) I should stop networking, from a tactical perspective. I believe you can never invest too much time in a good relationship, and that can be quite difficult to get your head around – but that’s more of a personal preference and I am a real “people person”, so that certainly isn’t for everyone. My advice would be – play to your strengths and I go back to “Do what you love and you’ll never work a day in your life”.
Hopefully that’s been informative and also useful, feedback as always is welcomed as the format is slightly different this week – always trying new things, and trying to set new standards – if you enjoyed the supplement, please like, comment, and share, or send me a message! Thank you.