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Jonathan Haskel

HMT meeting, March 12th, 2010

Reports on work funded by NESTA and FP7

Productivity and growth session

Options for improving medium to long-run growth

© Imperial College Business School1

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Some big questions

• Will growth return after the crisis?• Can the UK economy prosper with a smaller financial

sector?

© Imperial College Business School

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Understanding growth

(y-l) = 1 (kTAN -l)+ 2 (kINTAN-l)+ (lQUALITY -l) + TFPG

• Hence focus on:• Tangible capital deepening: cost of capital, tax, stability• Intangible capital deepening = R&D, and non-R&D • Labour force quality: education, training etc.• TFPG: spillovers from R&D, non-R&D, universities,

foreigners

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Will long run growth resume at previous levels?• Possible scenarios

• Cost of capital higher• Tighter bank regulation, more risk averse banks, increased taxes and base rates

• Size of financial services sector lower• Less demand • Lower employment

• Public investment falls• Easy to cut• Infrastructure gets worse

• Tangible infrastructure: transport, buildings, telecoms network• Intangible/knowledge infrastructure: schools, universities

• Policy mistakes• Unemployment literature: post adverse shocks in 70s and 80s: rise in employment taxes,

replacement ratios, subsidies stopping market sorting

• Implies• Capital deepening slows down during adjustment to lower K/L ratio• Labour quality deepening slows down• Spillovers from tangible and intangible infrastructure less: TFPG slows down• Economy-wide TFPG slows as financial services smaller (via averaging effect)• Lower productivity growth as sorting effects fall

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Lab quality Computers Other tang Intang TFP growthWith intangibles1990-95 3.02% 0.18% 0.41% 0.71% 0.74% 0.98%1995-00 3.69% 0.25% 0.90% 0.27% 0.84% 1.43%2000-07 2.73% 0.17% 0.38% 0.37% 0.54% 1.27%

Share Lab Pr Growth 6% 18% 14% 22% 39%

Lab Prod Growth

Contribution of:

Contribution of capital deepening, labour quality and TFP to growth: NESTA innovation index

1. Major contributors to labour productivity growth, 1990-20071. TFPG (39%)2. Intangibles (22%)3. Tangibles: computers (18%)4. Tangibles: other (14%)5. Labour quality (6%)

2. Question: what happened to these contributions in previous recessions?

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What happened to tangibles/intangibles in earlier recessions?

• Output per hour fell: 1990-91• Output per hour slowed: 2001-2002• Familiar: tangible investment fell• Additional question raised by intangible research:

• What was the impact on intangible investment? • We have decent time series for

• Tangible investment (computers, other)• Intangible investment

• Software (own account, purchased)• R&D• Advertising

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Investment, £bn CP

• 90s recession – big drop in tang, but intang inv remains flat, Likewise in 2000s slowdown• So does intangibles “cushion” effects for growth?• No, its K deep and contrib that matters for growth

0

10

20

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90

100

1970

1971

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1989

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S/ware

R&D

Adv

Tang

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Growth in Capital deepening: Δln(K/L), 1989-95

-0.05

0

0.05

0.1

0.15

0.2

0.25

0.3

1989 1990 1991 1992 1993 1994 1995

comp

othtan

rd

softoa

softp

adv

S/w and comp are different, and part distorted by Y2K and s/ware bundling

K deep for othtan and intang are similar, in early 90s, after changes in inv feed through to K stock

Why is this different to Investment: depreciation is different

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Contributions of comp, othtan and intang i.e. share* Δln(K/L)

Cont of tang (esp othtan) are much more volatile, and turned –ve shortly after 90s recession. Intang fell, but remained +ve

-0.01

-0.005

0

0.005

0.01

0.015

0.02

0.025

1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

cont comp

cont othtan

cont intan

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Policy: some speculative and provocative remarks

• Redoubles emphasis on capital deepening, but both tangible and intangible• Key margins: tax, regime certainty• Much intangible investment we think is new business models. Basic presumption

should be: regulation lowers productivity since stops experimentation.• Industrial support

• Job flows and reallocation are huge. Spotting winning firms/industries requires massive information.

• Support for weak companies lowers productivity growth (cuts off reallocation). Regional assistance?

• Support for good companies is deadweight; example patent box. V expensive, £1.5bn, no effect on innovation.

• Labour quality• Over long run, early education, huge externalities. Ring fence this.• Liberate universities from central planning• Many government low level training schemes have zero rate of return. Scarring?

• Public sector infrastructure• Cuts to university research to fund patent box will massively lower growth

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More on the impact of public sector R&D on TFPG

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Very large increase in research council spend

© Imperial College Business School

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23

4£b

n

1985 1990 1995 2000 2005 2010year

Res Council R&D spend Civil R&D spend Defence R&D spend HEFC R&D spend

Spending on Public R & D by Administrative Unit

Source: BIS data. Official data on publicaly supported R&D is broken down into funding for research councils, HEFC research-designated spend, civil R&D and defence R&D

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MARKET SECTOR TFP GROWTH AND RESEARCH COUNCIL SPENDING

1989

1987

1988

19901991

1992

20001999

2001

1998 1997

2002

1993

19951996

1994

2003

2004

2005 20072006

-.01

0.0

1.0

2.0

3

.002 .0025 .003 .0035RCoun_RD_y_n_L1

Smoothed TFPG Fitted values

Smoothed TFPG and RCouncil R & D spend

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MARKET SECTOR TFP GROWTH AND NON-RESEARCH COUNCIL SPENDING

199919982000

19972001

19962002

1991

1995

19942004

1990

20032005

1993

1992

20062007

1989

1988

1987

-.0

10

.01

.02

.03

.0016 .0018 .002 .0022 .0024HEFC_RD_y_n_L1

Smoothed TFPG Fitted values

Smoothed TFPG and HEFC R & D

200720061995199920052000

20011998

1994

20021992

1993

1997

20042003

1996

199119901989

1988

1987

-.0

10

.01

.02

.03

.0015 .002 .0025 .003 .0035civ_RD_y_n_L1

Smoothed TFPG Fitted values

Smoothed TFPG and Civil R & D

2007

2002

20062005

2001

20041999200020031998199619971995

19931994

19911990

1992

1989

1988

1987

-.0

10

.01

.02

.03

.002 .004 .006 .008def_RD_y_n_L1

Smoothed TFPG Fitted values

Smoothed TFPG and Defence R & D