June 26, 2007 | posted by Michael Baxter in IABN |

Sometimes economics can overcomplicate things. We can talk about the importance of this, and the significance of that, but if you really want to determine how well an economy is performing, perhaps there is no better measure than to look at how productive we are.

And the UK economy, despite drawing praise from the likes of the IMF and OECD on innumerable occasions over the last few years, despite enjoying the longest run of economic growth ever, still suffers from one potentially crippling problem.
To put it bluntly we are not very productive. In fact, for every hour worked Germany produces 13 per cent more than us, the US produces 18 per cent more, and France a staggering 20 per cent more.
According to the Centre for Economic Performance at the London School of Economics, if we could match France’s productivity we could either work one less day a week without being any worse off, or alternatively, we could enjoy 20 per cent higher earnings.
It’s not a new problem either. The UK’s failure to produce as much per hour as our competitors has long been a millstone around our economic necks.
Back in the 1970s and even before that, it was not difficult to explain. We could blame unions, poor management, and over-rigid structure to the economy, but in the post Thatcher age, it’s not so easy to look for reasons.
And give both the current, and previous, government some credit; apparently our productivity per hour relative to our main economic competitors has been improving since the early 1990s.

One of the reasons why productivity in France is so high, is because labour laws are so tough there, that employers need a better reason to recruit than in the UK. If you like, French employers require a higher marginal productivity of labour in order to justify recruitment. Unemployment is therefore much higher, but productivity amongst those who are working is much greater.
But it would be stretching credibility to suggest this factor alone explains why French productivity is greater than in the UK, and it certainly does not explain the 18 per cent differential with the US.
What then is the explanation? LSE’s Centre for Economic Performance has several explanations.
Explanation number one is the relative low level of RD spending in the UK. Not only does our RD spending lag behind that of our rivals, it has been getting worse. In 2004, the UK spent just 1.1 per cent of GDP on business RD activities, compared with an average of 1.7 per cent for France, Germany and the United States, and a UK level of 1.81 per cent in 1981.

The UK also seems to lack skilled workers. According to the Leitch report, the UK’s skills base remains mediocre by international standards. Seven million adults lack functional numeracy, while five million lack functional literacy. Recent OECD figures suggest that the proportion of low-skilled people in the UK is three times higher than in the United States, and almost double the proportions in Germany and Japan. This is reflected in a significantly lower proportion of intermediate skills.

Then, there’s management. The LSE report cites research from Bloom and Van Reenen that found that UK firms are significantly worse managed than French, German and US firms. After taking into account differences in industry and firm size, they link this to the preponderance of family firms - an ownership structure that is encouraged by the UK’s inheritance tax system.

And here’s a finding to make you sit up. Research from Bloom, Sadun and Van Reenen found that US multinationals operating in the UK have much higher productivity than other multinationals in the UK. They explain this differential by suggesting US managed companies make better use of IT.

Then there’s regulation in the retail sector. Every time Tesco or one of the other larger retailers opens a new store, we read about the effect on local stores, about corner shops going out of business, about suppliers being squeezed. But the LSE report said: “Productivity growth in UK retail between 1995 and 2004 was considerably slower than in the United States. Some attribute the US surge …to the introduction of large retail formats (‘big boxes’), which are more efficient than small stores.” According to this interpretation, lower retail productivity growth in the UK could be linked to increasingly severe planning restrictions against large stores.

So much for the reasons, what can be done about it?

It seems that in at least one area there is good news, but we just have to be patient. The UK now has a series of tax incentives for RD. There is apparently plenty of evidence to suggest this will have a positive impact on RD in the long-run, but that it can take a long time, and it is simply too early for the RD tax credit to have made much impact yet.

As for our problem for low skilled workers, clearly the answer lies with education. See article below.

As for poor management, maybe private equity will have a big impact here. In all the criticism we continuously hear about private equity, about how it asset strips and how it borrows against a company’s own assets in order to fund buying that company, it is worth remembering private equity’s overriding concern is to make the businesses it owns more efficient. This is an objective that is compatible with solving the UK’s chronic productivity problems.

Finally, it does seem the UK is often hamstrung by over-regulation, especially in planning.

Retailers often struggle to get permission to build new, bigger stores. Renewable energy development, especially the construction of wind farms, is often held back by local pressure groups trying to block planning permission. We see the same problem in the housing market of course, where construction lags behind demand, causing house prices to soar and all the problems associated with that.

The solutions are manifold, but we would like to leave you with two thoughts.

While the UK lags behind our competitors in terms of productivity, in the city it’s the opposite, with productivity leading the world.

Maybe, a part of the UK’s problem lies in the property market. The enthusiasm with which we embrace property investment, which is, after all, an asset that contributes very little to GDP, contrasts with our lack of enthusiasm for investing in areas that do promote production. Maybe the ultimate solution lies with shifting the UK’s focus on house prices.