Here’s some good news that might have passed you by. UK productivity – how much the economy produces per hour worked – grew more in the past year than in the previous seven years combined. I know. It doesn’t feel like that. GDP per person has barely moved since before the pandemic – up just 0.8% in six years. We’ve slipped level with Italy, having been 8% ahead. The vibes are terrible.
The UK has lost ground relative to their peer group. But productivity is genuinely picking up, and the reason why tells us something important about what’s happening in the economy and what the Bank of England might do next.
First, a measurement issue
The official productivity numbers come from the Labour Force Survey (LFS), and they show a modest 1.1% growth in the year to Q3 2025. That’s good – faster than most years since pre-2007 Good Old Days – but not exciting. But the problem is LFS response rates have collapsed since the pandemic, and as a result it erroneously thinks that the 16+ employment rate has been reasonably flat over the past year.
If we use payroll data instead – to count employees receiving a payslip – the picture transforms. The employment rate is now *dropping* fast on this measure. With output rising slowly, but the number of hours worked to produce it dropping fast, productivity in fact grew by 3.1% over those four quarters. That’s not a rounding difference. It’s the gap between “solid” and the best non-pandemic year since before the financial crisis.
Creative destruction
One driver of productivity growth is something the economist Joseph Schumpeter called “creative destruction.” The idea is simple: unproductive firms die, their workers move to better firms and the economy gets more productive. It’s how market economies are supposed to work – but the UK hasn’t been getting enough of it.
Since the financial crisis, and outside of the pandemic, creative destruction has been sluggish. Think of it this way. Interest rates were basically zero for over a decade. Energy was cheap. The minimum wage was low. If you were running a not-very-productive business, you could get by – maybe not thrive, but survive. Too many firms were limping along, tying up workers and capital that could have been used more productively elsewhere. That lack of churn is one of the prime suspects behind the UK’s productivity malaise.
Now the environment has changed. Interest rates are higher, energy costs more, and the minimum wage has risen sharply. And sure enough, we’re seeing more firms go under. Job losses from exiting firms in 2024 were the highest since 2011. Corporate insolvencies are running well above pre-pandemic levels. Redundancies are up too.
*If* this really was creative destruction at work, it could be exactly what the UK economy needs. More churn, more reallocation, more productive firms replacing less productive ones. That’s a good story. But it’s a pretty big “if.”
Destruction yes, creation not so much
Here’s the catch. Creative destruction has two parts, and so far we’ve mainly got the latter.
The destruction is clearly happening – firms going bust, workers being laid off. But the creation? Not so much. We’re not seeing a wave of new firms starting up to absorb those workers. Hiring at expanding firms isn’t (yet) big enough to pick up the slack.
The result is that unemployment has risen to its highest level in a decade outside the pandemic (5.1%). The productivity gains are real, but they’re coming partly from fewer people working, not just from more output being produced.
What kind of unemployment?
This is where it gets tricky. Not all unemployment is the same, and what the Bank of England does next depends on what kind we’ve got.
If higher unemployment simply reflects spare capacity – not enough demand in the economy to keep everyone in work – then the Bank should act. Cut rates, stimulate spending, bring unemployment back down. That’s textbook stuff.
If it’s frictional – more people between jobs at any given moment because the economy is churning faster – that’s different. It’s not painless for the people involved, but it is temporary for them, and it’s an inevitable side effect of the dynamism the UK economy badly needs more of. A more dynamic economy just has a higher background rate of job switching. The Bank doesn’t need to step in.
The really worrying scenario is mismatch or unrealistic expectations. Maybe workers displaced from dying firms don’t have the right skills for the jobs being created. A barista laid off when a coffee chain goes bust can’t necessarily walk into a role at an AI startup. Or maybe wage expectations haven’t adjusted – if workers are hankering after unrealistic wages to make up for past or expected inflation, the labour market will generate inflation. In that world, unemployment stays high, the Bank can’t fix it by cutting rates, and we don’t get the benefits of higher dynamism either. We would just have to live with it until skills catch up or expectations adjust.
Right now, we honestly don’t know which of these stories is right. Probably a bit of all three. But the answer matters enormously – not just for economists, but for anyone with a mortgage or looking for a job.
Watch this space
The productivity pickup is genuinely good news. The UK economy badly needed it. But we’re stuck in an uncomfortable middle phase: the old firms are dying and the new ones haven’t fully arrived yet. Whether this turns into a story about a healthier, more dynamic economy – or a story about a downturn that the Bank must respond to – is probably the most important question in UK macro right now.
This article is republished from the Resolution Foundation’s substack. It draws on Chapter 2 of the Foundation’s recent report Mountain Climbing.
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