Time to face facts about the UK’s productivity stagnation

One positive feature of the Autumn Statement that the Chancellor of the Exchequer presented yesterday was that he gave unprecedented prominence to the UK’s serious productivity problem. What was less positive was that he had no analysis of where the problem comes from, and his proposed measures to address it are entirely inadequate.

This matters. Our ability to harness technological and other improvements to produce more value from the same inputs is the only fundamental driver for real wage increases; productivity growth drives living standards. And we rely on productivity growth to meet the future promises we’re making now – to grow our way out of our debts, and to pay for our future pensions.

In 2007, productivity had been growing steadily at 2.2% a year since before 1970. That ended with the financial crisis; in the 7 years since it has barely risen at all. The government, and its independent forecasters, the Office of Budgetary Responsibility, have spent that time confidently expecting an upturn, a resumption of the pre-crisis growth rate. But that upturn has never arrived. My plot shows that history; this shows the successive OBR predictions for a resumption of productivity growth, together with the successive disappointing outcomes.

obr-predictions

Labour productivity according to the successive Office of Budgetary Responsibility’s Economic and Fiscal Assessments for the years indicated, showing estimates of productivity up to the time of publication of each report (solid lines), and predictions for the future (dotted lines). Data for 2010-2014 from the October 2015 OBR Forecast Evaluation Report, for 2015 and March 2016 from the March 2016 OBR Economic and Fiscal Outlook, and November 2016 from the November 2016 OBR EFO.

After seven years of anomalously slow productivity growth, it’s time to face facts and acknowledge this isn’t an anomaly, it’s the new normal. Continue reading “Time to face facts about the UK’s productivity stagnation”

What has science policy ever done for Barnsley?

Cambridge’s Centre for Science and Policy, where I am currently a visiting fellow, held a roundtable discussion yesterday on the challenges for science policy posed by today’s politics post-Brexit, post-Trump, introduced by Harvard’s Sheila Jasanoff and myself. This is an expanded and revised version of my opening remarks.

I’m currently commuting between Sheffield and Cambridge, so the contrast between the two cities is particularly obvious to me at the moment. Cambridgeshire is one of the few regions of the UK that is richer than the average, with a GVA per head of £27,203 (the skewness of the UK’s regional income distribution, arising from London’s extraordinary dominance, leads to the statistical oddness that most of the country is poorer than the average). Sheffield, on the other hand, is one of the less prosperous provincial cities, with a GVA per head of £19,958. But Sheffield doesn’t do so badly compared with some of the smaller towns and cities in its hinterland – Barnsley, Rotherham and Doncaster, whose GVA per head, at £15,707, isn’t much more than half of Cambridge’s prosperity.

This disparity in wealth is reflected in the politics. In the EU Referendum, Cambridge voted overwhelmingly – 74% – for Remain, while Barnsley, Rotherham and Doncaster voted almost as overwhelmingly – 68 or 69% – to Leave. The same story could be told of many other places in the country – Dudley, in the West Midlands, Teeside, in the Northeast, Blackburn, in the Northwest. This is not just a northern phenomenon, as shown by the example of Medway, in the Southeast. These are all places with poorly performing local economies, which have failed to recover from 1980’s deindustrialisation. They have poor levels of educational attainment, low participation in higher education, poor social mobility, low investment, low rates of business start-ups and growth – and they all voted overwhelmingly to leave the EU.

Somehow, all those earnest and passionate statements by eminent scientists and academics about the importance for science of remaining in the EU cut no ice in Barnsley. And why should they? We heard about the importance of EU funding for science, of the need to attract the best international scientists, of how proud we should be of the excellence of UK science. If Leave voters in Barnsley thought about science at all, they might be forgiven for thinking that science was to be regarded as an ornament to a prosperous society, when that prosperity was something from which they themselves were excluded.

Of course, there is another argument for science, which stresses its role in promoting economic growth. That is exemplified, of course, here in Cambridge, where it is easy to make the case that the city’s current obvious prosperity is strongly connected with its vibrant science-based economy. This is underpinned by substantial public sector research spending, which is then more than matched by a high level of private sector innovation and R&D, both from large firms and fast growing start-ups supported by a vibrant venture capital sector.

The figures for regional R&D bear this out. East Anglia has a total R&D expenditure of €1,388 per capita – it’s a highly R&D intensive economy. This is underpinned by the €472 per capita that’s spent in universities, government and non-profit laboratories, but is dominated by the €914 per capita spent in the private sector, directly creating wealth and economic growth. This is what a science-based knowledge economy looks like.

South Yorkshire looks very different. The total level of R&D is less than a fifth of the figure for East Anglia, at €244 per capita; and this is dominated by HE, which carries out R&D worth €156. Business R&D is less than 10% of the figure for East Anglia, at €80 per capita. This is an economy in which R&D plays very little role outside the university sector.

An interesting third contrast is Inner London, which is almost as R&D intensive overall as East Anglia, with a total R&D expenditure of €1,130 per capita. But here the figure is dominated not by the private sector, which does €323 per capita R&D, but by higher education and government, at €815 per capita. A visitor to London from Barnsley, getting off the train at St Pancras and marvelling at the architecture of the new Crick Institute, might well wonder whether this was indeed science as an ornament to a prosperous society.

To be fair, governments have begun to recognise these issues of regional disparities. I’d date the beginning of this line of thinking back to the immediate period after the financial crisis, when Peter Mandelson returned from Brussels to take charge of the new super-ministry of Business, Innovation and Skills. Newly enthused about the importance of industrial strategy, summarised in the 2009 document “New Industry, New Jobs”, he launched the notion that the economy needed to be “rebalanced”, both sectorally and regionally.

We’ve heard a lot about “rebalancing” since. At the aggregate level there has not been much success, but, to be fair, the remarkable resurgence of the automobile industry perhaps does owe something to the measures introduced by Mandelson’s BIS and InnovateUK, and continued by the Coalition, to support innovation, skills and supply chain development in this sector.

One area in which there was a definite discontinuity in policy on the arrival of the Coalition government in 2010 was the abrupt abolition of the Regional Development Agencies. They were replaced by “Local Enterprise Partnerships”, rather loosely structured confederations of local government representatives and private sector actors (including universities), with private sector chairs. One good point about LEPs was that they tended to be centred on City Regions, which make more sense as economic entities than the larger regions of the RDAs, though this did introduce some political complexity. Their bad points were that they had very few resources at their disposal, they had little analytical capacity, and their lack of political legitimacy made it difficult for them to set any real priorities.

Towards the end of the Coalition government, the idea of “place” made an unexpected and more explicit appearance in the science policy arena. A new science strategy appeared in December 2014 – “Our Plan for Growth: Science and Innovation” , which listed “place” as one of five underpinning principles (the others being “Excellence, Agility,Collaboration, and Openness”)

What was meant by “place” here was, like much else in this strategy, conceptually muddled. On the one hand, it seemed to be celebrating the clustering effect, by which so much science was concentrated in places like Cambridge and London. On the other hand, it seemed to be calling for science investment to be more explicitly linked with regional economic development.

It has been this second sense that has subsequently developed by the new, all Conservative government. The Science Minister, Jo Johnson, announced in a speech in Sheffield, the notion of “One Nation Science” – the idea that science should be the route for redressing the big differences in productivity between regions in the UK.

The key instrument for this “place agenda” was to be the “Science and Innovation Audits” – assessments of the areas of strength in science and innovation in the regions, and suggestions for where opportunities might exist to use and build on these to drive economic growth.

I have been closely involved in the preparation of the Science and Innovation Audit for Sheffield City Region and Lancashire, which was recently published by the government. I don’t want to go into detail about the Science and Innovation Audit process or its outcomes here – instead I want to pose the general question about what science policy can do for “left behind” regions like Barnsley or Blackburn.

It seems obvious to me that “trophy science” – science as an ornament for a prosperous society – will be no help. And while the model of Cambridge – a dynamic, science based economy, with private sector innovation, venture capital, and generous public funding for research attracting global talent – would be wonderful to emulate, that’s not going to happen. It arose in Cambridge from the convergence of many factors over many years, and there are not many places in the world where one can realistically expect this to happen again.

Instead, the focus needs to be much more on the translational research facilities that will attract inward investment from companies operating at the technology frontier, on mechanisms to diffuse the use of new technology quickly into existing businesses, on technical skills at all levels, not just the highest. The government must have a role, not just in supporting those research facilities and skills initiatives, but also in driving the demand for innovation, as the customer for the new technologies that will be needed to meet its strategic goals (for a concrete proposal of how this might work, see Stian Westlake’s blogpost “If not a DARPA, then what? The Advanced Systems Agency” ).

The question “What have you lot ever done for Barnsley” is one that I was directly asked, by Sir Steve Houghton, leader of Barnsley Council, just over a year ago, at the signing ceremony for the Sheffield City Region Devo Deal. I thought it was a good question, and I went to see him later with a considered answer. We have, in the Advanced Manufacturing Research Centre, a great translational engineering research facility that demonstrably attracts investment to the region and boosts the productivity of local firms. We have more than 400 apprentices in our training centre, most sponsored by local firms, not only getting a first class training in practical engineering (some delivered in collaboration with Barnsley College), but also with the prospect of a tailored path to higher education and beyond. We do schools outreach and public engagement, we work with Barnsley Hospital to develop new medical technologies that directly benefit his constituents. I’m sure he still thinks we can do more, but he shouldn’t think we don’t care any more.

The referendum was an object lesson in how little the strongly held views of scientists (and other members of the elite) influenced the voters in many parts of the country. For them, the interventions in the referendum campaign by leading scientists had about as much traction as the journal Nature’s endorsement of Hilary Clinton did across the Atlantic. I don’t think science policy has done anything like enough to answer the question, what have you lot done for Barnsley … or Merthyr Tydfil, or Dudley, or Medway, or any of the many other parts of the country that don’t share the prosperity of Cambridge, or Oxford, or London. That needs to change now.

How big should the UK manufacturing sector be?

Last Friday I made a visit to HM Treasury, for a round table with the Productivity and Growth Team. My presentation (PDF of the slides here: The UK’s productivity problem – the role of innovation and R&D) covered, very quickly, the ground of my two SPERI papers, The UK’s innovation deficit and how to repair it, and Innovation, research and the UK’s productivity crisis.

The plot that provoked the most thought-provoking comments was this one, from a recent post, showing the contributions of different sectors to the UK’s productivity growth over the medium term. It’s tempting, on a superficial glance at this plot, to interpret it as saying the UK’s productivity problem is a simple consequence of its manufacturing and ICT sectors having been allowed to shrink too far. I think this conclusion is actually broadly correct; I suspect that the UK economy has suffered from a case of “Dutch disease” in which more productive sectors producing tradable goods have been squeezed out by the resource boom of North Sea oil and a financial services bubble. But I recognise that this conclusion does not follow quite as straightforwardly as one might at first think from this plot alone.

UKSectoralMFP

Multifactor productivity growth in selected UK sectors and subsectors since 1972. Data: EU KLEMS database, rebased to 1972=1.

The plot shows multi-factor productivity (aka total factor productivity) for various sectors and subsectors in the UK. Increases in total factor productivity are, in effect, that part of the increase in output that’s not accounted for by extra inputs of labour and capital; this is taken by economists to represent a measure of innovation, in some very general sense.

The central message is clear. In the medium run, over a 40 year period, the manufacturing sector has seen a consistent increase in total factor productivity, while in the service sectors total factor productivity increases have been at best small, and in some cases negative. The case of financial services, which form such a dominant part of the UK economy, is particularly interesting. Although the immediate years leading up to the financial crisis (2001-2008) showed a strong improvement in total factor productivity, which has since fallen back somewhat, over the whole period, since 1972, there has been no net growth in total factor productivity in financial services at all.

We can’t, however, simply conclude from these numbers that manufacturing has been the only driver of overall total factor productivity growth in the UK economy. Firstly, these broad sector classifications conceal a distribution of differently performing sub-sectors. Over this period the two leading sub-sectors are chemicals and telecommunications (the latter a sub-sector of information and communication).

Secondly, there have been significant shifts in the composition of the economy over this period, with the manufacturing sector shrinking in favour of services. My plot only shows rates of productivity growth, and not absolute levels; the overall productivity of the economy could improve if there is a shift from manufacturing to higher value services, even if productivity in those sectors subsequently grows less fast. Thus a shift from manufacturing to financial services could lead to an initial rise in overall productivity followed eventually by slower growth.

Moreover, within each sector and subsector there’s a wide dispersion of productivity performances, not just at sub-sector level, but at the level of individual firms. One interpretation of the rise in manufacturing productivity in the early 1980’s is that this reflects the disappearance of many lower performing firms during that period’s rapid de-industrialisation. On the other hand, a recent OECD report (The Future of Productivity, PDF) highlights what seems to be a global phenomenon since the financial crisis, in which a growing gap has opened up between the highest performing firms, in which productivity has continued to grow, and a long tail of less well performing firms whose productivity has stagnated.

I don’t think there’s any reason to believe that the UK manufacturing sector, though small, is particularly innovative or high performing as a whole. Some relatively old data from Hughes and Mina (PDF) shows that the overall R&D intensity of the UK’s manufacturing sector – expressed as ratio of manufacturing R&D to manufacturing gross value added – was lower than competitor nations and moving in the wrong direction.

This isn’t to say, of course, that there aren’t outstandingly innovative UK manufacturing operations. There clearly are; the issue is whether there are enough of them relative to the overall scale of the UK economy and whether their innovations and practises are diffusing fast enough to the long tail of manufacturing operations that are further from the technological frontier.

How cheaper steel makes nights out more expensive (and why that’s a good thing)

If you were a well-to-do Londoner in mid-to-late-18th century London, 1 shilling and sixpence would buy you a decent seat for a night out at the opera. Alternatively, if you were a London craftsman – a cutler or a tool-maker – the same money would allow you to buy in a kilogram of the finest Sheffield steel, made by Benjamin Huntsman’s revolutionary new crucible process. A reasonable estimate of inflation since 1770 or so would put the current value of one and six at about ten pounds. I don’t get to go out in London very much, and in any case opera is far from my favourite entertainment, but I strongly suspect that £10 today would barely buy you a gin and tonic in the Covent Garden bar, let alone a seat in that historic opera house. A hundred pounds might be more like it as a minimum for a night at the London opera now – and for that money you could buy not one, but a hundred kilograms of high quality tool-steel (though more likely from China than Sheffield).

This illustrates a phenomenon first identified by the economist William Baumol – in an economy in which one sector (typically some branch of manufacturing) sees rapid productivity gains, while another sector (typically a service sector – such as entertainment in this example) does not, then the product of the sector with low productivity will see an increase in its real price. Continue reading “How cheaper steel makes nights out more expensive (and why that’s a good thing)”

Innovation, research and the UK’s productivity crisis

My article on the UK’s productivity slowdown has now been published as a Sheffield Political Economy Research Institute Paper, and is available for download here. Here is its introduction/summary:

The UK is in the midst of an unprecedented peacetime slowdown in productivity growth, which comes on top of the nation’s long-standing productivity weakness compared to the USA, France and Germany. If this trend continues, UK living standards will continue to stagnate and the government’s ambition to eliminate the deficit will fail. Productivity growth is connected with innovation, in its broadest sense, so it is natural to explore the connection between the UK’s poor productivity performance and the low R&D intensity of its economy. More careful analyses of productivity look at the performance of individual sectors and allow some more detailed explanations of the productivity slowdown to be tested. The decline of North Sea oil and gas and the end of the financial services bubble have a special role in the UK’s poor recent performance; these do not explain all the problem, but they will provide a headwind that the economy will have to overcome over the coming years. In response, the UK government will need to take a more active role in procuring and driving technological innovation, particularly in areas where such innovation is needed to meet the strategic goals of the state. We need a new political economy of technological innovation.

SPERI-Paper-28-Innovation-research-and-the-UK-productivity-crisis cover

UK productivity – still no sign of recovery

The UK’s Office of National Statistics today released the latest figures for labour productivity, to the end of 2015. This shows that the apparent recovery in productivity that seemed to be getting going half way through last year was yet another false dawn; productivity has flat-lined since the financial crisis, with the Q4 2015 value actually below the peak achieved in 2007. This performance puts us on track for the worst decade in a century. Poor productivity growth translates directly into stagnating living standards and lower tax revenues for the government, meaning that, despite austerity, all their efforts to eliminate the fiscal deficit will be in vain.

As this is perhaps the most serious economic problem currently facing the UK, it’s good to see the issue becoming more widely discussed. It’s an issue I’ve been thinking about for some time; my post on the political implications of the productivity slowdown, as revealed by this March’s budget and its aftermath, is here: The political fallout of the UK’s productivity problem. Last summer, I wrote a series of blogposts exploring the origins of this productivity slowdown. I’ve written a draft paper based on a substantially revised and updated version of those posts:

Innovation, research, and the UK’s productivity crisis (1.4 MB PDF).

quarterly productivity Q4 2015

Labour productivity: output per hour. ONS Labour Productivity Dataset, 7 April 2016.

The political fallout of the UK’s productivity problem

It’s been an interesting week in UK politics. On Wednesday the Chancellor of the Exchequer delivered a budget against the backdrop of an economic situation much worse than it seemed last November, at the time of his Autumn Statement. At the heart of the bleak economic news was disappointment about productivity – the Office of Budgetary Responsibility (the OBR) downgraded its forecasts for future productivity growth; as a result their forecasts for tax income went down, so to meet the government’s self-imposed targets on deficit reduction further spending cuts had to be pencilled in. Among those spending cuts were cuts to the allowances to disabled people – the political fall-out from which we’re still seeing.

FER+March2016+exp fit+v2
Labour productivity according to the successive Office of Budgetary Responsibility’s Economic and Fiscal Assessments for the years indicated, showing estimates of productivity up to the time of publication of each report (solid lines), and predictions for the future (dotted lines). The dotted line is best fit to the post 2009 trend, representing 0.6% annual growth. Data for 2010-2014 from the October 2015 OBR Forecast Evaluation Report, for 2015 and 2016 from the March 2016 OBR Economic and Fiscal Outlook.

The media focus has shifted to the political soap-opera of ministerial resignations and recriminations, but we shouldn’t forget the story of the productivity disappointment, because that’s at the heart of what’s happened. To see why, take a look at my graph, which shows how the government’s optimistic predictions for productivity growth have repeatedly been dashed. Continue reading “The political fallout of the UK’s productivity problem”

An international perspective on the productivity slowdown

Robert Gordon’s book “The Rise and Fall of American Growth” comprehensively describes the fall in productivity growth in the USA from its mid-twentieth century highs, as I discussed in my last post. Given the book’s exclusive focus on the USA, it’s interesting to set this in a more international context by looking at the data for other developed countries.

My first graph shows the labour productivity – defined as GDP per hour worked – for the G7 group of developed nations since 1970. This data, from the OECD, has been converted into constant US dollars at purchasing power parity; one should be aware that these currency conversions are not completely straightforward. Nonetheless, the picture is very clear. On this semi-logarithmic plot, a constant annual growth rate will produce a straight line. Instead, what we see is a systematic slow-down in the growth rate as we go from 1970 to the present day. I have fitted the data to a logistic function, which is a good representation of growth that starts out exponential and starts to saturate. In 1970, labour productivity in the G7 nations was growing at around 2.9% annually, but by the present day this had dropped to an annual growth rate of 1.2%.

G7 productivity

Labour productivity across the G7 group of nations – GDP per hour worked, currencies converted at purchasing power parity and expressed as constant 2010 US$. The fit (solid line) is a logistic function, corresponding to an annual growth rate of 2.9% in 1970, dropping to 1.2% in 2014. OECD data.

The second graph shows the evolution of labour productivity in a few developed countries as expressed as a fraction of this G7 average.

Productivity vs G7

Labour productivity relative to the G7 average. OECD data

Both at the beginning of the period, in 1970, and at the present day, the USA is the world’s productivity leader, the nation at the technology frontier. But the intervening period saw a long relative decline through the 1970s and ’80s, and a less dramatic recovery. The mirror image of this performance is shown by France and Germany, whose labour productivity performances have marched in step. France and Germany’s relative improvement in productivity performance took them ahead of the USA on this measure in the early 1990’s, but they have slipped back slightly in the last decade.

The UK, however, has been a persistent productivity laggard. Its low point was reached in 1975, when its productivity fell to 17% below the G7 average. After a bumpy performance in the 1980s, there was a slow improvement in the ’90s and ’00s, but much of this ground was lost in the financial crisis of 2008, leaving UK productivity around 13% below the G7 average, and 24% below the world’s productivity leader, the USA.

It is Italy, however, that has had the most dramatic evolution, beginning the period showing the same improvement as France and Germany, but then enduring a long decline, to end up with a productivity performance as poor as the UK’s.

Institutions of innovation, ecologies of invention: what’s missing from the stagnation debate

What’s happening to the economy of the USA? Is change accelerating, are we entering a new industrial revolution based on artificial intelligence and robotics, as the techno-optimists would have it it? Or is the USA settling down into a future of slow economic growth, with technological innovation declining in pace and impact compared to the innovations of the twentieth century? The last is the thesis of economist Robert Gordon, set out in a weighty new book, The Rise and Fall of American Growth.

The case he sets out for the phenomenon of stagnation is compelling, but I don’t think his analysis of the changing character of technological innovation is convincing, which makes him unable to offer any substantive remedies for the problem.
GordonTFP
The Rise and Fall of American Growth. The average annual growth of total factor productivity – that part of economic growth not accounted for by increased inputs of labour and capital – over each decade leading up to the given date (14 years in the case of 2014). Data from R.J. Gordon, replotted from figure 16-5 of his book The Rise and Fall of American Growth.

The basis of the stagnation argument lies in the economic growth statistics. Put simply, the greatest period of economic growth in US history was in the mid-20th century. Continue reading “Institutions of innovation, ecologies of invention: what’s missing from the stagnation debate”

The fourth industrial revolution – this time it’s exponential!

The World Economic Forum at Davos provides a reliable barometer of conventional wisdom amongst the globalised elite, so it’s interesting this year that, amidst all the sage thoughts on refugee crises, collapsing commodity prices and world stock market gyrations, there’s concern about the economic potential and possible dislocations from the fourth industrial revolution we are currently, it seems widely agreed, at the cusp of. This is believed to arise from the coupling of the digital and material worlds, through robotics, the “Internet of Things”, 3-d printing, and so on, together with the development of artificial intelligence to the point where it can replace the skill and judgement of highly educated and trained workers.

A report from the FT’s Izabella Kaminska of one session – Davos: Historians dream of fourth industrial revolutions – captures the flavour nicely. I’m struck by her summary of the views of the historian Niall Ferguson – “The fourth industrial revolution, Harvard’s Niall Ferguson notes, is distinctive because of its exponential rather than linear pace, not only changing what and how we do things but also potentially who we are.”

This succinctly summarises conventional wisdom, but almost every word of this statement is questionable or wrong.

Why do we talk of a fourth industrial revolution? Continue reading “The fourth industrial revolution – this time it’s exponential!”