1. 1 UK Productivity Gap: Innovation, Management and Human Capital November 2005 Professor John Van Reenen Director, Centre for Economic Performance, LSE

2. 2 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?

3. 3 What is labour productivity? Employment rate (Demographics) Labour productivity 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)

4. 4 Labour Productivity lower in UK relative to Other countries (UK=100) Source: ONS (2005)

5. 5 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.)

6. 6 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)

7. 7 But not good at translating the base into commercial innovation… Business Enterprise R&D as a proportion of GDP

8. 8 UK major patents per person

9. 9 What are the causes of low UK productivity? 1.Technological Innovation 2.Management 3.Skills 4.Others

10. 10 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]

11. 11 FIRM LEVEL AVERAGE MANAGEMENT SCORES Francen=137n=157 n=290n=154UKUS Germany

12. 12 COUNTRY LEVEL MANAGEMENT SCORES* US Germany UK Typical 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

13. 13 Factors which cause bad management Product market competition Family management [Skills, regulation, age]

14. 14 4% firms in tail 1 1 Tail defined as a score ≤ 2. In the whole sample 6.5% of firms are in the tail. 8.9% score less than 2 1 2.7% score less than 2 1 MANY COMPETITORS AND NO PRIMO GENITURE FAMILY FIRMS, N=307 FEW COMPETITORS AND/OR NO PRIMO GENITURE FAMILY FIRMS, N=415

15. 15 What are the causes of low UK productivity? 1.Innovation 2.Management 3.Skills 4.Others

16. 16 Too many people functionally illiterate in UK (% aged 16-65, 1995) source HDR 1998

17. 17 UK Basic Skills Gap: Little Improvement source IALS % of Adults Below IALS Level 2 Numeracy Literacy Age 16-25 Age 26-35 Age 36-45 Age 16-25 Age 26-35 Age 36-45 Belgium (Flanders)791781220 Switzerland (German)7131971724 Netherlands8710869 Sweden547457 Germany45691214 Ireland8202316 21 Britain222019171817 USA262018232019

18. 18 UK Skill Position: Fewer grads than US, fewer intermediate skills than EU Source: Broadberry and O’Mahony (2005)

19. 19 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

20. 20 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

21. 21 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

22. 22 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

23. 23 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)

24. 24 Back up slides

25. 25 2.2 UK (and USA) have high proportion of population in work

26. 26 Productivity Gap, 1990-2001, Market Economy (UK=100) Source: Broadberry and O’Mahony (2005)

27. 27 Changes over time in output per worker Source: Budget 2005

28. 28 Business Enterprise R&D/GDP, 1981-2003 Source: ONS (2005)