Accounting for productivity
Richard Murphy examines trends surrounding productivity and considers why it has been taking a backseat in financial reporting.
Productivity stagnation is one of the key challenges facing the UK economy. During much of the post-war era labour productivity increased by about 2% per annum on average. But in the last decade, the yearly increase has been at no more than 0.3% according to sources such as the Office for National Statistics (ONS).
I am currently undertaking research on this issue with the University of Sheffield funded by the Productivity Insight Network. One of our hypotheses is that 2008 was simply indicative of a change in thinking amongst larger companies. That crash happened because one aspect of financial engineering - which exploited the hidden risks within mortgage lending - was firstly exploited to create an artificial competitive advantage and then oversold when investors did not appreciate the risk that they were facing.
We now think that different forms of financial engineering are being used by large corporations to report distributable profits and pay them in ways that their underlying profitability might suggest as being imprudent. The theory is that this creates more financial risks, which is what we’ll be exploring.
The International Financial Reporting Standards Foundation (IFRSF) have said that the primary purpose of what they call “general purpose financial statements” and what the rest of us know as accounts, as “helping existing and potential investors, lenders and other creditors in making decisions relating to providing resources to the entity”.
The decisions they think the accounts inform relate to “buying, selling or holding equity and debt instruments; providing or settling loans and other forms of credit; and exercising rights to vote on, or otherwise influence, management’s actions”.
If this is the case, then the first question to ask is why productivity data is not at the forefront of financial reporting. Especially given that the ability of a company to use the capital entrusted to it to return a profit is very clearly one of (but not the only) issue an investor will be looking at, then making the decisions of the type the IFRSF think accounts will inform. The reality is that productivity data is at present almost entirely absent.
Secondly, why has the trend in labour cost and associated data reporting been very largely downward over my 40-year accounting career rather than upward, as a concern for productivity would suggest appropriate? Most companies have to now report almost no labour data at all, while those that do have very limited obligations to do so by sector or on any other useful criteria for analysis, for example.
Thirdly, what can be done about this? When IFRS accounts are obsessed with financial risk reporting and the fair value of financial instruments, and the International Accounting Standards Board issues any number of standards on such issues, why can’t it issue an IFRS on one of the most basic drivers of profit, which is the effectiveness of the way in which a company manages the relationship between its employment of labour and capital?
The unsolved mystery
In my opinion, that is exactly what the IFRSF should be doing. The mystery my colleague, Prof Adam Leaver, and I want to solve is what the policy reason is for this indifference to productivity. Is it possible that the area where accountants could be most productive is one that some do not want exposed because it might highlight the failings of companies performing badly and are disguising this fact with financial engineering?
I fear that this may be the case, as has been apparent in some of the recent financial failures, such as Carillion, where the company was under significant financial stress because of poor productivity. That factor should have raised concerns about its continuing ability to pay dividends long before it failed.
But what really surprises me is that no one else is asking this question. If accounting is an added value profession, then why this is the case is also worth asking.
Any comments from fellow accountants issues on these issues would be appreciated and could potentially contribute to our research.
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Richard Murphy is a practising chartered accountant and professor of political economy at City, University of London. He is also director of the Corporate Accountability Network. After twenty years in industry and commerce, he co-founded the Tax Justice Network and Fair Tax Mark before taking his current positions. He co-authored the original...