Where will growth come from? Notes from lecture given by Prof John Van Reenen (LSE) 17 February 2011

A ‘V’ shaped recovery... For now

Recent growth experience A 6.5% decline in real GDP during the first 12 months of the recession – a decline of 1930s dimensions But the subsequent recovery (of sorts) puts the recent UK recession on a par with of that the early 1980s The coalition’s fiscal austerity program is the biggest budget cut since WWII Austerity plan is to reduce deficit by 7% of GDP by with much of the pain front-loaded to George Osborne believes we don’t need a plan B but Van Reenen argues that we need a Plan V if trend growth is to be sustained

Damaging effects of recession Has there been a permanent fall in output? Lots of uncertainty about this and the size of the output gap Loss of output could be anywhere between 2-10% of GDP Trend growth rate will have diminished – 2% may be the new normal for the UK due to hysteresis effects: ◦ Scrapping of human capital / people leaving the labour force ◦ Long term unemployment now 1/3 rd of the total ◦ Scrapping of fixed capital / steep decline in capital spending ◦ Increased risk aversion of the financial system Micro policies of the Coalition may also be undermining trend growth e.g. Universities and immigration caps But recession and business shake-out may have lifted efficiency

A fall in trend growth estimates

And high long term unemployment

Investment and Productivity

Fiscal austerity & public sector jobs

Relative international performance Using data for % annual change in GDP per capita from The UK does not come out too badly! ◦ UK 1.19% ◦ USA 1.05% ◦ Germany 1.03% ◦ Japan 0.77% Improved employment rates have helped But key in the long run is higher productivity from our factor inputs and productivity gap remains

Relative Productivity Improves UK remains 13% less productive than the USA measured by GDP per hour, $PPP There have been some improvements in overall GDP per capita in the UK The GDP has closed with Germany and on some measures we have now overtaken them Reasons: ◦ % of UK workers with a college degree has risen by 12% from – up-skilling of labour force ◦ Increased intensity of competition in product markets ◦ Impact of foreign direct investment ◦ Better management practices from private equity boom

Productivity Improvements

Output per person hour

But Productivity Gap Remains 1/ UK has an innovation deficit ◦ UK 2 nd to US in terms of top scientific papers cited ◦ But commercialisation of innovation is weak – i.e. turning R&D into commercial patents with real value ◦ R&D as a share of GDP remains low and has actually fallen over the last 20 years despite many tax incentives ◦ Deep-rooted failures in the market for knowledge because ideas are promiscuous and the free-rider effect is hard to avoid 2/ Weaknesses in management practices apparent ◦ US firms seem to use ICT more effectively in long run ◦ UK management is mid-table by international standards on a par with Canada, Italy & Australia ◦ US economy appears better at weeding out weaker firms

Intensity of competition does influence the quality of management When market competition is fierce: ◦ Badly run firms more likely to exit (selection effect) ◦ Forces badly run firms to try harder to survive in their market (effort effect) Family-run firms which are passed on tend to be relatively badly run ◦ Smaller pool of people to select CEO from ◦ Possible “Carnegie Effect” on future CEOs - if you know you will inherit the firm one day ◦ Less career incentives for non-family managers ◦ Might also be a lack of fundamental dynamism especially in small to medium sized family run enterprises

Britain needs a Plan V (Viagra!) Get the conditions right for long term growth Stronger commitment to trade and competition Incentivise R&D as social return is twice the private return Tax reforms to remove 100% inheritance tax exemptions for family businesses to encourage improved management Focus human capital investment at lower skilled and younger workers E.g., expanded apprenticeships Avoid damaging migration caps and removal of teaching subsidies for universities – in a global war for talent Focus on sector growth in industries where competitive advantage can be successfully nurtured and exploited. Namely...healthcare, niche manufacturing, green energy, universities, bio-pharmaceuticals, creative industries

What else would you want to put into Plan V?