From productivity puzzle to AI opportunity: Why the UK economy may be underrated

In summary

• The UK has suffered a productivity problem since the financial crisis, with weakness constraining the economy
• Much of this is down to the economy’s heavy bias towards services, which are traditionally difficult to scale
• With the rise of AI, that could change as the technology unlocks new opportunities for efficiency so that this weakness becomes a source of strength
• In the medium term, it could bring a significant shift in UK growth relative to its peers

For much of the past decade, the UK economy has been defined by a single, persistent problem: poor productivity. Since the financial crisis of 2008, output per worker has grown at a fraction of its historical rate, contributing to slower GDP growth, stagnant real wages and a sense that the UK is underperforming its global peers.

Compared to the G7, the UK sits firmly in the middle-to-lower tier, with current growth forecasts of around 1.0 – well below the United States, albeit broadly in line with other slower-growing European economies.

This has shaped a prevailing narrative: that the UK is a structurally weak economy, highly exposed to energy shocks, constrained by low productivity and reliant on fragile consumer demand. The current geopolitical environment has reinforced many of these concerns, as it has dampened growth prospects and pushed inflation higher.

Yet there is a credible reason for cautious optimism for the UK. Ironically, it is the very structural feature often blamed for the country’s productivity problem: our heavy reliance on services.

In the age of artificial intelligence, this may yet become our greatest strength.

To understand why AI matters, it is worth recalling the scale of the problem. Before 2008, UK productivity grew at roughly 2% per year. Since then, growth has largely stalled, averaging close to zero in some periods.

That the collapse in productivity growth is structural, rather than cyclical, seems clear, and several explanations have been put forward. The UK has suffered from persistently weak business investment, limiting the capital available to workers. Its economy is dominated by services, many of which have historically been difficult to scale or automate. Labour markets have also remained relatively flexible, so firms have often retained workers during downturns (so called “labour hoarding”) rather than investing in productivity-enhancing technologies.

At the same time, planning constraints, infrastructure bottlenecks and skill mismatches have limited the UK’s ability to reallocate labour and capital efficiently. The result is an economy that is resilient enough to avoid deep recessions, but not dynamic enough to achieve sustained high growth. It is underwhelming, but not fundamentally weak.

Growth remains positive, supported by a still resilient labour market. Employment levels are high, wages are growing modestly in nominal terms (and, even more modestly, in real terms since April 2023), and the services sector continues to expand, despite difficult conditions.

But this resilience has come at a cost. Because productivity growth is low, economic expansion is constrained. Consumption – the largest component of GDP – remains fragile, as households contend with rising living costs and limited real income growth. Investment, while improving in certain areas, is subdued relative to peers.

We’re left with an economy that is stable but slow growing: capable of absorbing shocks, but unlikely to outperform without a structural shift

Artificial intelligence has the potential to provide that shift. Crucially, AI does not operate like previous waves of technological change. Earlier productivity gains relied heavily on physical capital, such as machinery, factories and infrastructure, but AI is fundamentally about processing information and augmenting knowledge work.

This is a crucial distinction for the UK economy, because it is already structured around activities that AI can improve, such as professional services, finance, legal work, marketing, consulting and a wide range of administrative and analytical functions. These sectors revolve around data, text, decision-making and expertise: areas where AI tools can deliver immediate gains.

Historically, services have been seen as a drag on productivity because, unlike manufacturing, they are difficult to scale. They often traditionally require a one to one relationship between labour and output. A lawyer, consultant or hospitality worker could serve only a limited number of clients at a time.

AI fundamentally changes this dynamic. By automating routine tasks, such as document review, data processing and customer interactions, AI frees up time for higher value work. More importantly, it allows knowledge workers to handle greater volumes of work without a corresponding increase in hours. A consultant can analyse more data, a lawyer can review more cases, and a marketer can manage more campaigns.

In effect, AI makes knowledge work scalable. And while other countries may need to transform their industry mix to benefit from AI in this way, the UK doesn’t have to. It is already well positioned to capture the productivity gains.

The UK’s services-heavy economy, which previously limited productivity growth, could become its driver through the efficiency gains AI enables.

If AI adoption accelerates, it could shift the UK’s medium term growth trajectory. Instead of an economy constrained to around 1.0-1.5% growth, the UK could see a modest but meaningful uplift.

The impact is unlikely to be immediate; productivity gains typically lag technological adoption. Firms need time to integrate new tools, invest in complementary systems and redesign workflows.

However, over the medium term, AI provides a plausible path for the UK to improve its relative position within the G7 and narrow its productivity gap with the US. It is still unlikely to outperform the US, whose technology sector remains dominant. But it could move from the lower end of the G7 pack towards the centre.

In the near term, AI is more likely to augment jobs than replace them, particularly in the UK’s key sectors. Knowledge workers will become more productive, not redundant. Roles in finance, consulting, legal services and other professional industries will evolve, with routine tasks reduced and higher-value activities expanded.

However, this does not mean the labour market is unaffected.

First, there will be a period of adjustment. Some roles, particularly those heavily focused on repetitive administrative tasks, are likely to see numbers shrink. At the same time, demand will grow for workers who can effectively use AI tools, interpret outputs and apply them in business contexts.

Second, the distributional effects could be uneven. Highly skilled workers may see productivity (and potentially wages) increase, while lower-skilled roles face greater pressure.

As has been widely discussed, there are particular challenges for graduates and new entrants to the labour market.

Historically, graduate roles often involved a significant amount of routine work, such as data gathering, analysis and drafting, that served as an entry point into professional careers. AI tools now perform many of these tasks more efficiently.

This creates both risks and opportunities. On the one hand, traditional entry-level pathways may narrow, as firms rely less on junior staff for basic tasks. On the other, graduates who can work effectively alongside AI tools – interpreting results, managing workflows and adding judgement – may become far more productive (and valuable) than previous cohorts.

None of this is guaranteed. The UK’s ability to benefit from AI depends on adoption, investment and policy execution. Weak business investment remains a real constraint, and without improvements in infrastructure, skills and planning, the full benefits may not materialise.

Nevertheless, for the first time in over a decade, there is a credible mechanism to address the UK’s core structural weakness. If AI is adopted at scale, and firms adapt their operating models accordingly, the UK’s services-heavy economy could shift from a critical limitation to a comparative advantage.

For years, the UK economy has been characterised as stable but stagnant – a system that works but does not accelerate. AI will not change that overnight. But it does offer something that has been missing since 2008: a pathway to higher productivity growth that aligns with, rather than works against, the UK’s economic structure.