The UK’s productivity challenge – across all sectors and all business sizes – is not going away. Longer working hours have had a higher impact on GDP growth than productivity and this has serious implications for the resilience of the UK economy, according to analysis by the Productivity Institute, an organisation that works across academia, business and policy to better understand, measure and enable productivity across the UK. 

Worryingly, the UK Office for National Statistics says that recent movements in productivity since the pandemic suggest the underlying weakness in UK productivity growth remains.

But while the overall picture remains sluggish, a new report commissioned by Xero – Small business productivity: Industry and regional trends – shows that something interesting is happening across UK small businesses. 

In particular, UK small business productivity is equalising across regions. This is the consequence of productivity declines in traditionally higher-performing regions such as London (-2.5%), East of England (-6.5%), West Midlands (-3.3%) and the South East (-5.5%).

Meanwhile, there have been improvements in UK small business productivity in previously lagging regions, such as East Midlands (+9.7%), Yorkshire and the Humber (+7.4%), Wales (+5.1%), North West (+5.5%) and North East England (+1.0%). The North West and East Midlands are now the second and third most productive regions in the country, according to Xero’s data.

Feedback from members

The productivity challenge is a recurring theme in the regular and ongoing dialogue between ICAEW and members. Members indicate that improved productivity depends on investment in both equipment/plant and skills. But members have also been clear that they need more certainty and stability if they are to have the confidence to invest.

“Funding availability and the cost of capital have been barriers to financing investment, along with a challenging economic backdrop,” says Simon Gray, ICAEW’s Head of Business. “Funding availability seems to be improving, but much uncertainty remains over interest rates.”

ICAEW’s Q1 2024 Business Confidence Monitor (BCM) shows a significant improvement in sentiment across the UK compared to weak yet positive confidence in the previous quarter and the average for 2023, with confidence rising above its pre-pandemic average for the first time since Q1 2022 as economic prospects brightened.

But despite the rosier outlook, BCM found that investment intentions remain weak and are expected to grow below the average for both capital equipment and R&D. So, if business is wary about investment, where’s the stimulus to get productivity back on track? 

The political debate

How small businesses can lift their own productivity – and what their professional advisers can do to help – may well be prompted by policy initiatives instigated by the new UK government.

A recent ICAEW-hosted debate in conjunction with the Federation of Small Businesses and Enterprise Nation provided a platform for the three main political parties to outline their policies for small businesses. The participants were Kevin Hollinrake, Minister of State in the Department for Business and Trade, the Conservative Party; Jonathan Reynolds, Shadow Secretary of State for Business and Trade, the Labour Party; and Sarah Olney, Treasury and Business and Industrial Strategy spokesperson, the Liberal Democrats

Time and again the topics of investment and skills came up. As Iain Wright, Managing Director, Reputation and Influence at ICAEW, pointed out: “The UK economy relies on the success of small businesses: 99% of all businesses are SMEs – six out of 10 working people in our country are employed by small businesses, and they generate more than half of the business turnover of our economy. Innovation and ideas pour out of small enterprises, flowing through the rest of business and making the whole country as a result more productive, competitive and prosperous.”

Reynolds reiterated the negative effect low business investment has had on productivity. He pointed to the importance of an industrial strategy to reform areas like planning, infrastructure investment; and he talked of a reform of the apprenticeship levy, a focus on late payments and on procurement.

Olney said that SMEs are our future large enterprises. She said a pledge by the Liberal Democrats to change the way that business rates are levied will support SMEs. Highlighting the need for people to be able to access skills training at every stage of their life, Olney also said transforming the apprenticeship levy would revitalise the skills agenda. 

Hollinrake, meanwhile, said access to finance is critical – not just the provision of finance but also that SMEs feel confident enough to borrow and scale up faster. He emphasised the importance of rebuilding trust between businesses and lenders – facilitated by the open banking framework. 

Closing the gap benefits economies

The UK is by no means alone in battling the small business productivity challenge. As McKinsey points out in its report, A microscope on small businesses: “Small business productivity is only half that of large companies, and less in emerging economies. Raising micro, small and medium sized enterprises (MSMEs) to top-quartile levels relative to large companies is equivalent to 5% of GDP in advanced economies and 10% in emerging economies.”

There is so much at stake. As McKinsey says: “Where MSMEs struggle but large enterprises outperform, building networks among them helps. Even where both large and small companies do well, strengthening their interactions could boost productivity.”

But McKinsey also points out that dynamics and needs differ widely by subsector. “Therefore, stakeholders may need to design a tailored menu of measures based on a microscopic approach.” The potential is huge, but so too is the task at hand.