PRODUCTIVITY is not everything, but in the long run it is almost everything. This truth, enunciated by the Nobel laureate Paul Krugman, has just bitten George Osborne, the UK chancellor. But the prospects for productivity are not important just to Mr Osborne. They are the most important uncertainty affecting the economic prospects of the British people.

Is it reasonable to expect a return to buoyant pre-crisis productivity growth? Will productivity continue to stagnate? Or will it end up somewhere in between?

The negative impact on the budgetary position of the Office for Budget Responsibility’s mild revisions to productivity projections shows how much this matters. The reduction in the OBR’s forecast rate of growth in output per hour - a basic measure of productivity - is only by an average of 0.2 percentage points a year. Yet, notes the OBR, ‘cumulated over five years that represents a material downward revision to the level of potential output by 2020’.

In its latest forecast, the OBR expects UK productivity levels to be 6.2pc lower in 2020 than it had hoped in June 2010 and 2.5pc lower than it had hoped in March 2014. But the biggest downgrades of all are relative to the pre-crisis optimism: the OBR’s latest forecast for potential output in 2020 is 15pc below the Treasury’s March 2008 forecast. Similar downgrades have occurred to the official US forecasts.

Yet even the new forecasts might be too optimistic. The question is whether the post-crisis productivity stagnation or the pre-crisis productivity growth will be the next normal. The OBR still largely assumes the latter. Thus, the 1971-2007 average growth of productivity was 2.2pc a year. The 2008-2015 average has been a mere 0.3pc. The latest forecast is that productivity growth will rise from 0.8pc last year to 2pc by 2019. That would be close to pre-crisis norms.

Productivity growth has been lower in most industries since 2008, with the most pronounced falls in financial services and supply of gas and electricity

Assume, instead, that productivity growth will be 1pc this year and stays there. Potential output in 2020 would be 4pc lower than the OBR now assumes. That would leave the chancellor not with his planned surplus, but a big fiscal deficit. Thereafter, the gap between output with productivity growth at 2pc and output with productivity growth at 1pc would rise further: by 2030, potential output would be 13pc lower than a continuation of the OBR’s latest productivity growth assumption would imply.

Evidently, we need to understand why productivity growth has been so weak. The OBR concludes that productivity growth has been lower in most industries since 2008, with the most pronounced falls in financial services and supply of gas and electricity. On balance, then, the decline in productivity growth has been across the board.

One explanation might be the impact of the financial crisis on credit. But, as the financial sector heals, this is less persuasive. Another explanation must be the post-crisis collapse in business investment, to a low of 8.1pc of gross domestic product, in real terms, in the fourth quarter of 2009. But this has since recovered. It would be good if business investment were still higher.

But it is hard to believe that low investment continues to explain the persistent productivity disappointments. Again, GDP might be mismeasured. But it is difficult to understand why such mismeasurement suddenly jumped after 2008. Maybe growth of GDP and productivity is higher than measured. But that should also have been true before 2008.

Given the huge uncertainty, the OBR has made only a modest step in the direction of assuming the reduction in productivity growth is permanent. It could easily still be far too optimistic.

So how should policymakers respond to these unpleasant uncertainties?

The first shift should be towards policies likely to raise productivity growth. An essential element in such a shift must be towards higher public and private investment. The government should invest more. It should also be looking at changes in the system of taxation that would encourage investment.

The second shift must be towards asking how to manage the public finances if the economy does not return to pre-crisis productivity trends. That would evidently require still tighter control over current spending. But it is also likely to require raising taxes that do not distort the economy. The obvious candidates are higher taxation of public bads (congestion and pollution) and heavier taxation of rents, particularly of land.

We must hope that the Treasury is devoting serious thought to these unpleasant contingencies. The OBR’s latest downward revision might prove to be a small step towards reality. Things could, alas, be worse. So prepare now.

martin.wolf@ft.com

Published in Dawn, Business & Finance weekly, March 21st, 2016