1

UK Productivity Gap: Innovation, Management and Human Capital

November 2005

Professor John Van ReenenDirector, Centre for Economic Performance, LSE

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Overview

• The Productivity Gap (output per hour) – Why does it matter?– What is it?– How far is UK behind?

• Causes of the gap– Innovation– Management– Worker skills– Others

• What can be done?

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What is labour productivity?

populationx

hoursx

hours

GDP

Population

GDP workers

workers

Employment rate(Demographics)

Labourproductivity

• US has much much higher GDP per capita than EU15, ……….but similar GDP/hour (productivity)• This is mainly because there are more Americans in work, and they work very long hours

Basic “economic welfare” measure (GDP per capita)

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80

90

100

110

120

130

US France Germany

Output per Worker

Output per HourWorked

Labour Productivity lower in UK relative to Other countries (UK=100)

Source: ONS (2005)

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What are the “causes” of low UK Productivity?

1. Technological Innovation

2. Management

3. Human capital

4. Others (infrastructure, public sector productivity, investment, regional policy, IT, etc.)

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UK does well in elite science**More papers per head and citations per head than main competitors

Papers and citations per head (UK=100), average over 1998-2003 Source: Evidence Ltd. Thomson ISI (2004)

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But not good at translating the base into commercial innovation…

Business Enterprise R&D as a proportion of GDP

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UK major patents per person

Note: Data for 1995-1999.

Triadic patents

0

20

40

60

80

100

120

140

160

Portu

gal

Spain

Irelan

dIta

ly UK

Austri

a

France

Belgium

Denmar

k

Netherl

ands

German

y

Finlan

d

Sweden

Per working-age population, per million

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What are the causes of low UK productivity?

1. Technological Innovation

2. Management

3. Skills

4. Others

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Management

• Management practices and the organisation of firms– Methodology of measuring management– First wave in four countries (UK, US, France, Germany)

Validation of methods– Findings – competition, family firms (age, regulation)– Extensions: panel, more countries, more sectors– Role of IT and other new technologies

Bad management - a UK tradition?

“Efficient management is the single most significant factor in the American productivity advantage”[Marshall Plan Anglo-American productivity mission, 1947]

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0.2

.4.6

.81

1.2

Den

sity

1 2 3 4 5

0.2

.4.6

.81

1.2

Den

sity

1 2 3 4 5

0.2

.4.6

.81

1.2

Den

sity

1 2 3 4 5

0.2

.4.6

.81

1.2

Den

sity

1 2 3 4 5

FIRM LEVEL AVERAGE MANAGEMENT SCORES

France n=137 n=157

n=290n=154UK US

Germany

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COUNTRY LEVEL MANAGEMENT SCORES*

3.07

3.14

3.31

3.35US

Germany

UKTypical UK managers?

* With controls for size & public/private values are 3.35, 3.27, 3.16 & 3.07 respectively. Gaps between UK/France and the US significant at the 5% level

France

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Factors which cause bad management

• Product market competition• Family management• [Skills, regulation, age]

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4% firms in tail1

1 Tail defined as a score ≤ 2. In the whole sample 6.5% of firms are in the tail.

0.2

.4

.6

.8

11.2

Density

1 2 3 4 5Average management score across questions and interviews - note dropping lean3

0.2

.4

.6

.8

11.2

Density

1 2 3 4 5Average management score across questions and interviews - note dropping lean3

8.9% score less than 21

2.7% score less than 21

MANY COMPETITORS AND NO PRIMO GENITURE FAMILY FIRMS, N=307

FEW COMPETITORS AND/OR NO PRIMO GENITURE FAMILY FIRMS, N=415

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What are the causes of low UK productivity?

1. Innovation

2. Management

3. Skills

4. Others

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Too many people functionally illiterate in UK (% aged 16-65,

1995)

0

5

1015

20

25

source HDR 1998

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UK Basic Skills Gap: Little Improvement

source IALS

% of Adults Below IALS Level 2

Numeracy Literacy

Age16-25

Age26-35

Age36-45

Age16-25

Age26-35

Age36-45

Belgium (Flanders) 7 9 17 8 12 20

Switzerland (German) 7 13 19 7 17 24

Netherlands 8 7 10 8 6 9

Sweden 5 4 7 4 5 7

Germany 4 5 6 9 12 14

Ireland 8 20 23 16 16 21

Britain 22 20 19 17 18 17

USA 26 20 18 23 20 19

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UK Skill Position: Fewer grads than US,

fewer intermediate skills than EU

01020304050607080

Higher

Intermediate

Low

Source: Broadberry and O’Mahony (2005)

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Does low UK innovation matter?

• Large empirical literature that suggests that innovation matters for productivity

• Also evidence of R&D “spillovers”. Firms who perform R&D are not the only ones who benefit from subsequent innovations. Implies that free market will under-supply R&D and government needs to support research

• BUT Britain is small, why not simply “free ride” on the research of other countries such as the USA?– Some spillovers are local (helps to be geographically near

innovators in getting the benefits)– Also evidence that greater R&D helps firms/industries absorb

new ideas created elsewhere in the world

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Which innovation policies?

• Supporting basic scientific research• University-business links (Lambert)• Increasing supply of skills – evidence of skill biased technical

change• R&D Tax credit system. Pros and cons

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R&D tax credits

• Many other countries with R&D tax credits• UK followed many other countries and adopted in 2000,

first for small firms and now for all firms• Current cost about £430m p.a.• Good econometric evidence that R&D does react to

changes in its tax-price (Hall and Van Reenen, 2000)• But why no pick-up (even a fall in 2004)?• – takes about 10 years for most of effect to be felt

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Problems with R&D tax credit

• Slow response – If price falls by 10% R&D only increases by 1% in first year, even though long-run impact about 10% (Bloom, Griffith and Van Reenen , 2002)

• Cost - SME credit only £150m started in 2000, large firms in 2002

• Relabelling?• All R&D subsidies increase wages of (high income) R&D

workers

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Conclusions

• UK productivity gap has not gone away, especially with the USA• Not a single answer

– Innovation an important difference between UK and US– Managerial practices may be important– Skills important

• Question for policy is what more should be done?– Much of policy framework in UK is “right” from economic

perspective: emphasis on skills, tough competition, openness to trade and FDI, support for R&D

– Delivery. Need for rigorous evaluation (e.g. education reforms, R&D policy)

– Are we moving in the right direction? Burden of regulation increases and this could reduce competition (comp policy only one aspect)

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Back up slides

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2.2 UK (and USA) have high proportion of population in work

Source: OECD Labour Force Statistics.

Employment Rate, 2003

40

45

50

55

60

65

70

75

80

85

Tur

key

Pol

and

Ital

y

Hun

gary

Slo

vak

Rep

ublic

Gre

ece

Bel

gium

Spa

in

Mex

ico

Fra

nce

Ger

man

y

Cze

ch R

epub

lic

Irel

and

Kor

ea

OE

CD

Fin

land

Aus

tria

Aus

tral

ia

Por

tuga

l

Can

ada

Net

herl

ands

Uni

ted

Sta

tes

Japa

n

New

Zea

land

Uni

ted

Kin

gdom

Sw

eden

Den

mar

k

Nor

way

Sw

itzer

land

% population

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Productivity Gap, 1990-2001, Market Economy (UK=100)

0

20

40

60

80

100

120

140

160

France Germany US

output per hour1990 output per hour1995 output per hour2001

Source: Broadberry and O’Mahony (2005)

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Changes over time in output per worker

Source: Budget 2005

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Business Enterprise R&D/GDP, 1981-2003

0

0.002

0.004

0.006

0.008

0.01

0.012

0.014

0.016

1975 1980 1985 1990 1995 2000 2005

Source: ONS (2005)