Energy costs are to blame for low productivity

“The UK’s productivity stagnation since 2008 is often blamed on weak investment and poor skills. Christopher Sandmann argues that an overlooked channel — soaring industrial energy costs — explains why Britain failed to capitalise on a cheaper pound. Enjoying this post? Then sign up to our newsletter and receive a weekly roundup of all our articles. The single most important fact about the UK economy is that its productivity — and by extension its real wages — has remained almost flat since 2008. US real wages grew roughly 18 per cent from 2008 to 2024; UK wages grew 4 per cent. Polish wages, buoyed by EU integration, rose over 40 per cent. Working-age adults in the UK must therefore work more hours to match incomes in France or Germany — and historically, they do, clocking roughly 20 per cent more hours than their French or German peers. CHART 1: Real wages in four countries, pre- and post-financial crisis Why have real wages stopped growing? In 2013, the LSE published a landmark policy brief offering three explanations: human capital deficiencies, infrastructure shortfalls, and low investment. These are real brakes on growth. But they share a revealing feature: skills weaknesses are longstanding and predate the productivity break, while the infrastructure and investment shortfalls are symptoms of a deeper problem — a planning system that has made it extraordinarily difficult to build in Britain. None explains the timing of the break, nor why the UK specifically stagnated while peers recovered. An export puzzle Consider the exchange rate. Sterling depreciated sharply twice: after the 2008 financial crisis (from roughly $1.75 to $1.58) and again after the Brexit vote (to approximately $1.29). Simple trade theory predicts that a cumulative 25 per cent depreciation should make UK exports substantially cheaper, boosting volumes and improving the trade balance. It didn’t. The goods deficit widened from about 2 per cent of GDP in 2000 to nearly 7 per cent by the mid-2010s. A growing services surplus — driven by financial services and consulting — partially offset this, but never eliminated it. CHART 2: UK trade balance by sector, goods vs services Some economists argue that the declining manufacturing share of GDP is a natural feature of post-industrial economies. ONS Supply and Use Tables tell a different story. UK manufacturing output fell considerably faster than domestic demand for manufactured goods. Household consumption of energy-intensive manufactures, for instance, held nearly constant as a share of GDP from 1997 to 2023, even as domestic output of those goods nearly halved. The gap was filled by imports, locking the UK into a structural goods trade deficit now equivalent to roughly 6 per cent of GDP. Britain did not stop wanting manufactured goods — it stopped being able to make them competitively. CHART 3: Energy-intensive manufacturing: output, household demand & trade balance as % of GDP The energy price channel The reason British industry failed to capitalise on the depreciated sterling is that UK industrial energy costs rose sharply relative to competitors, offsetting the competitiveness gain from the weaker pound. Since the mid-2010s, British industry has faced energy costs close to 50 per cent above the International Energy Agency average. Relative to the United States, British industry pays more than double. CHART 4: Industrial electricity prices excluding taxes, international comparison A comparison with Germany is instructive. Germany’s Energiewende imposed substantial levies for renewable energy subsidies, but its system of exemptions shielded energy-intensive manufacturers. UK industry enjoyed no comparable protection until partial compensation arrived in the mid-2010s. This explains why German goods manufacturing could thrive until recently whereas British goods manufacturing could not. Why is British energy so expensive? Two reasons. First, the UK’s fleet of nuclear power plants has been retiring since the early 2000s — Hinkley Point A closed in 2000, Bradwell in 2002, Dungeness A and Sizewell A in 2006, Wylfa in 2015, and the last two AGR stations in 2022 — with no replacements entering service. As a result, gas-fired generation now sets the marginal electricity price almost all of the time. A 2022 UCL study found that in Germany, coal or nuclear shaped electricity prices roughly half the time; in the UK, gas dominates. Since gas is more expensive than coal or nuclear at the margin, UK wholesale electricity prices are structurally higher. Since the mid-2010s, British industry has faced energy costs close to 50 per cent above the International Energy Agency average. Relative to the United States, British industry pays more than double. Second, the expansion of offshore wind has caused network charges — the cost of connecting offshore generation sites to the grid — to rise sharply. These charges rose 70 per cent in the UK between 2019 and 2023, compared with 29 per cent in Germany, 20 per cent in Italy, and 16 per cent in France. Network charges now account for 30–40 per cent of businesses’ total electricity bills. Some expect that expanding renewables will eventually solve this, since wind and solar have near-zero marginal costs. But new renewables in the UK are not cheap, and their prices are determined by contract-for-difference strike prices, not marginal cost. The latest government auction ( Allocation Round 7 , early 2026) locked in strike prices of £94.6/MWh in 2026 prices for offshore wind — a 26 per cent premium over a wholesale electricity price that is itself abnormally high by historical standards. These contracts last twenty years. Prioritising solar, which cleared at £67.6/MWh, would have been cheaper. What would bring costs down? Two reforms could make a material difference. First, network charges should not be levied on industrial electricity prices. They do not reflect a marginal cost of energy but a past investment that must be amortised. Germany provides energy-intensive industries up to 90 per cent compensation on network charges; the UK currently offers 60 per cent, set to rise to 90 per cent from April 2026. This is welcome but overdue. Second, the UK must bring down the cost of building energy infrastructure. Nuclear power is more expensive to build in Britain than in France, and more expensive in Europe than in Korea or the UAE. Hinkley Point C’s per-megawatt cost dwarfs that of comparable international projects. Wind power is not inherently uncompetitive — roughly 20 per cent of China’s new capacity was wind — but the UK cannot build it cheaply enough. Planning reform that enabled nuclear construction at French or Korean cost would be the single most effective route to competitive industrial energy prices. The inability to build cheaply is not confined to energy. Discussions over Heathrow’s third runway have spanned decades. HS2 became a case study in cost explosion. In housing, the UK built just 3.25 dwellings per 1,000 residents in 2024 (compared with 3.85 in France and 4.78 in the US), and research by Hilber and Vermeulen has shown that regulatory restrictions roughly doubled real English house price growth from 1974 to 2008. For productivity and incomes to rise, economic activity must be allowed to transform the physical world. Until the cost of building is brought under control — in energy, housing, and transport alike — wages will remain low and workdays long. Enjoyed this post? Sign up to our newsletter and receive a weekly roundup of all our articles. All articles posted on this blog give the views of the author(s), and not the position of LSE British Politics and Policy, nor of the London School of Economics and Political Science. Image credit: Phil Silverman on Shutterstock The post Energy costs are to blame for low productivity first appeared on LSE British Politics .

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