AI Productivity: A Boon For UK's Weakening Labor Market?

Is the UK entering a new economic cycle? This is the first of a series of blog posts examining the effects of AI on the labor market and growth.

Photo Credit: BoliviaInteligente

It is well known that the UK’s economic track record has been abysmal since the Global Financial Crisis: productivity and inflation-adjusted wages have barely increased at all. Per capita income is now about 15% lower than in Germany, 10% lower than in France, and roughly the same as in Italy.

The causes of the British malaise are varied: An overly strong reliance on finance before the crash of 2008, Brexit, the COVID pandemic, a dysfunctional housing market, and too little investment — both public and corporate investment have stagnated — have all cost the economy dearly.

But now, for the first time in twenty years, productivity numbers are showing a sign of revival. Private sector investment is increasing and, along with the rise in government spending, providing a boost to GDP. Since employment is falling, this might suggest worker productivity is on the rise.

Just maybe, we are seeing the first indications that the AI boom is supporting economic growth.

A weakening labor market but better growth?

The labor market in the U.K has suffered in recent years. Following the surge in the minimum wage and increase of the National Insurance Contribution, employers have shed some 200,000 payroll jobs since October 2024. Meanwhile, unemployment increased from just over 4% in 2023 to more than 5%.

Retail and hospitality are affected the most. Profit margins have been squeezed by the successive minimum wage and tax hikes, contributing to a loss of about 100,000 jobs in each sector.

But despite the weak labor market, economic activity has been holding up fine. The PMI (Purchasing Managers Index) even points to an acceleration of business output in January (values above 50 indicate economic expansion).

Since early 2024, payroll employment has fallen by about 0.5%. Nevertheless, monthly GDP figures indicate that the economy is almost 3% larger, growing at an annual rate of 1.3%. The combination of steady growth and shrinking employment means that for the first time in decades worker productivity is accelerating: we are producing more stuff with fewer workers.

This is encouraging, given that productivity growth is the main engine for improving living standards and wages.

Insolvencies, redundancies, and creative destruction

Due to the recent increase in interest rates and energy prices, soaring wages and tax hikes, U.K. businesses have come under increasing pressure. The number of insolvencies — situations in which a company can’t pay back debt — surged following the pandemic and has remained elevated ever since.

While businesses failing sounds like a bad thing, there may be a positive upshot in this case. Some economists have argued that the period of low interest rates before COVID created many zombie firms — unproductive and over-leveraged companies — that contributed to the weak productivity growth.

Current economic conditions may be making it more difficult for these zombie companies to survive. Growth might therefore pick up as low-productivity companies go out of business.

Redundancies — the British term for layoffs — have also risen, particularly in low-productivity sectors like retail and hospitality, which have seen most of the job losses over the last two years. Naturally, as less productive work gets automated — think self-checkout counters in supermarkets, for example — aggregate productivity increases.

Shouldn’t we be worried about bankruptcies and layoffs?

Well, it depends. Typically, a recession occurs whenever consumers and businesses lose confidence and stop spending (and investing). This creates a vicious cycle of job losses and even less spending, and so forth. If companies are failing and people are losing their jobs because overall demand in the economy is plummeting, we should worry!

Right now, though, we are not seeing any signs of plummeting sales. Nominal GDP and economy-wide worker compensation — two of the more reliable indicators for overall demand — are holding up well. The former grew at an annual rate of close to 5% in Q3 of last year, the latter more than 7%.

Not only does this show that demand is solid but that it is even growing slightly above trend, contributing to inflation.

The rise in bankruptcies and redundancies is therefore not due to declining sales but rather because weak businesses are under cost pressure, forcing them to close shop and, perhaps, ultimately be replaced by more efficient businesses — which is exactly the creative destruction that Schumpeter envisioned.

Productivity is rising in high value-added services

We all know that the U.K. economy is reliant in the service sector — tech, finance, consulting, etc. — which account for about 58% of all British exports. Now, productivity in high value-added services is rising. ONS data show real output in the tech sector is up about 75% since 2015, while employment has grown only 10%. Moreover, recent trend growth has been noticeably higher compared to the decade following the financial crisis.

Similarly, production of professional business services has risen by about 25% while employment has increased by only 14% with most of the productivity gains accruing since 2021.

The fact that productivity growth is not just relying on the death of retail and hospitality but is also on an acceleration of Britain’s service sectors is an encouraging sign.

Are we killing the talent pipeline? What does this mean for recruiters?

With the current AI rollout, more companies are rationalizing hiring freezes and headcount reductions on account of higher worker productivity. While employment for experienced workers has continued to increase, employment of younger age groups has fallen. Furthermore, the current downward trend in white-collar job ads is also hitting the young significantly harder than experienced hires. With entry level roles in free-fall, young people are arguably experiencing the worst job markets in decades.

This is obviously concerning because AI is not a miracle cure for worker shortages across all occupations. Given demographic developments, the U.K. will experience a shrinking workforce soon enough. The large pool of skilled but older employees will have to be replaced by younger cohorts. The current hiring drought will create challenges within a few years from now.

Recruiters need to make the case to leadership that freezing graduate hiring for several years is incompatible with strategic workforce planning. AI is already the biggest technological upheaval in decades, leading to fundamental changes for the world of work. Young workers who are more adaptable to change, more knowledgeable about new technologies, including AI, will be key to any corporation’s future success.

It would be a big mistake to sacrifice the future workforce for short-term gains even as AI has the potential to replace junior staff.

Ask yourself this: Who will succeed seniors and experienced workers once they leave?