UK – a hub with no spokes

Andy Haldane, chief economist at the BoE (Bank of England) and so one of the finest of finest economic thinkers, recently gave a speech about the UK’s productivity problem to the Academy of Social Sciences – clearly, we should treat his every word with great respect, or should we?

The following is a precis of his UK-focussed speech plus a few extracts from a splendid globally-focussed article taking similar lines, headed ‘The Problem with Innovation – the biggest companies are hogging all the gains’ by Jason Douglas, Jon Sindreu and Georgi Kantchev

1. Why focus on productivity?

  • Haldane says: “Productivity is ‘an issue of pressing public policy – one that affects the living standards of each and every one of us
  • It’s what pays for pay rises
  • At present, the UK faces perhaps no greater challenge, economically and socially, than its productivity challenge – meeting it would deliver benefits to workers in improved wages and skills and to companies in greater efficiency and profitability”

 

2. Productivity understanding:

  • Haldane says: “Productivity is a terrible word – it leaves most people dazed and confused
  • Few can define it – fewer still can measure it”
  • Little wonder most other people are ‘turned off’ by mere mention of the topic when such as he describe it so – not what the nation needs!
  • Conversely, Douglas et alia say: “Actually, it’s usually measured as output per hour or per worker – and reflects the efficiency with which goods and services are produced in an economy or by a company
  • Improving productivity thus means raising the amount of goods or services produced by each worker
  • Hence, it’s the most important long-term driver of rising living standards”

 

3. Causes of the (apparent) UK productivity problem:

  • Researchers have blamed the productivity slowdown (experienced by all developed nations) on a range of factors including ultralow interest rates, mismeasurement of output in a digital world and a decline in humanity’s innovative prowess – but none really explain the problem
  • Now, they’re zeroing in on a phenomenon called diffusion – in particular, the lack of it – major innovations usually travel swiftly from company to company and industry to industry – today, this engine of growth seems to be misfiring
  • In the fullness of time, innovation should diffuse through an economy, lifting all boats
  • But, in the UK, this trickle-down appears to have dried up
  • The result is the UK has a much larger tail of companies, productivity-wise, than in Germany, France or the USA – and this is true in both sectors and regions
  • The UK now ranks a lowly 38th globally for knowledge diffusion
  • Reasons for this Douglas et alia suggest include:
    • Globalisation allows the most productive firms, usually the biggest, to grow bigger whilst allowing some specialised niche firms a big enough market to succeed – for digital titans such as Amazon, Facebook and Google, the benefits of scale are substantial – whenever more users sign up to their platforms, their offerings get more valuable for everybody else
    • Bigger firms are better at protecting their technological advantages by patenting them – only 25 companies accounted for half of all tech-related patents filed with the European Patents Office between 2011 and 2016
    • Scale makes it possible to experiment with advanced technology that is out of reach for most other companies – according to the MGI (McKinsey Global Institute), early adopters of AI (Artificial Intelligence) may already have gained an “insurmountable advantage” in earnings over competitors who have yet to take the plunge
  • So top companies are getting ever more productive but gains are stalling for everyone else – and the gap between the two sets is widening
  • In other words, it’s not the best that’s causing the problem, it’s the rest
  • And, as far as the UK is concerned, Haldane says:
    • The best, the so-called frontier/ vanguard companies, are very productive indeed, many better than those in France, Germany or the USA
    • But the rest comprise a long and lengthening tail of low-productivity firms
    • And, given there are far more of the rest than the best in the UK compared to elsewhere, aggregating them all into one figure for national productivity means the UK inevitably comes out worst of all

 

4. The three major UK productivity gaps:

  • The gap v before:
    • According to the OECD (Organisation for Economic Cooperation and Development), the most productive manufacturers in advanced economies  increased their productivity by 33% between 2001 and 2013 while productivity leaders in services boosted theirs by 44%
    • Meanwhile, over the same period, all other manufacturers managed to improve productivity by only 7% while other service providers recorded only a 5% increase
    • The laggards in all sectors are thus increasingly falling behind
    • In particular, overall UK productivity has flat-lined for a decade – it’s now running almost 20% below the level it would have reached had it continued along its pre-crisis trend – a trend gap Haldane suggests ‘may never be closed’
  • The gap v competitor nations:
    • This UK productivity gap is even larger than its trend gap
    • Worse still, the apparent UK productivity slowdown has been larger than in almost any other country
    • But caution is needed here – such claims are based on statistics collected by the UK’s ONS (Office for National Statistics) and their equivalents abroad – national statistics described by some as ‘seriously flawed and dangerously misleading’
    • As UK Prime Minister Benjamin Disraeli once (nearly) said: “There’s lies, damned lies and (productivity) statistics” so large pinches of salt must be taken before drawing any serious conclusions from them
  • The gap v the best at home:
    • The data suggests the UK has more companies in the top productivity decile than either France or Germany, but many more in the bottom decile
    • And the gap between the top and bottom service companies is 80% larger in the UK than in France, Germany or the USA
    • If so, it’s little wonder that the UK suffers a persistent productivity gap with all other developed economies

 

5. UK is a global innovation hub:

  • To close the above gaps, the UK should address both its strengths and weaknesses
  • UK strengths:
    • The UK is an innovation leader – we have plenty of innovative, high productivity, leading-edge companies in every sector and region – Haldane considers them “inspirational”
    • We have five of the world’s top 25 universities, including the top two slots
    • We rank first, globally, in citable scientific publications, e-commerce and ICT
    • We’re (somehow) ranked fourth for creative outputs
    • And we’re the largest magnet for tech talent in Europe
    • We also fare well with new business start-ups – over 1,100 each day
    • And the UK is home to half of the top fastest-growing companies in Europe
    • The UK is thus genuinely a global innovation hub
  • UK weaknesses:
    • The UK scores highly on R&D (Research and Development) output
    • However, whilst we’re good on R, we’re not so good on D – where D also stands for diffusion of latest and best practices to the long and lengthening tail
    • In fact:
      • The UK is well behind with R&D expenditure by international comparison
      • Only 1.7% of GDP is spent on R&D by only 400 companies i.e. less than 0.01% of the UK’s business population
      • This is more than 1% below what our main competitors currently spend and well below the UK Chief Scientific Officer’s target of 3%
    • Hence, the UK is seen as a hub without spokes

 

6. Four factors crucial for effective diffusion:

  • External openness:
    • Globalisation has greatly increased cross-border flows of goods and services, capital, people and information/ knowledge/ ideas
    • This has served as a vehicle for the transmission and diffusion of new technologies and ideas across borders
    • Countries with greater external openness are said to have higher levels of productivity
    • The same applies within countries – export-oriented or foreign-owned firms are clearly more open to new technology and ideas, and are also said to have markedly better productivity levels than their counterparts
    • However, Haldane admits to being unclear whether this factor alone even partially explains the UK’s productivity gap – it’s ‘questionable’
  • Technology transfer:
    • Haldane then suggests the technology transfer process itself, from one source to another, may be to blame
    • A two-stage process is involvedviz:
      • Stage 1 – Adoption – It takes time for a new technology to reach a country or company
      • Stage 2 – Penetration – It then takes more time for that technology to reshape a company’s processes and products
    • Both stages are getting quicker, but late-comers to the party never catch up
    • Worse, they fall further and further behind as the vanguard accelerate further ahead
  • Human transfers:
    • People cross borders and move between companies, and take their ideas with them
    • Haldane notes the UK scores lower for management skills than other competitor nations but seemingly ignores the fact that this is the main reason, by far, for the UK’s relatively poor productivity performance
    • Instead, he focusses on people simply passing on their ideas and knowledge to others
    • At boardroom level, he finds some members are well connected with other firms, enabling them to draw on their experiences elsewhere when adopting new practices, products or processes
    • However, a much larger percentage have little or no such connectivity, and so lose out in the copying stakes
    • Equally, one might expect labour turnover to help transfer ideas – when workers leave to join other firms, this enables an interchange of skills and ideas between them
    • But most valuable workers in vanguard firms don’t tend to move to laggards lower down the scale – so they don’t have much influence there
    • Best firms tend to attract best employees – the rest are left with the rest – it’s a two-tier system – A-listers like to swim with other A-listers, not Bs or Cs
  • Institutional infrastructures
    • Institutions nurture investment and innovation by such as upholding the rule of law and enforcing intellectual property rights
    • No longer are valuable company assets just physical and tangible, such as plant and machinery – they include intangibles such as IP (Intellectual Property), patents and goodwill
    • Nowadays, intangible assets can be worth far more than tangibles in some UK and US companies, so protecting them is vital
    • Hence, a strong institutional infrastructure is vital to support productivity improvement across all firms in all sectors and regions
    • Germany already has a long-established infrastructure to support innovation and its diffusion to home companies, comprising:
      • Fraunhofer Institutes – they help up to 8,000 companies each year, large and small, covering all sectors and regions, by promulgating ideas and technologies
      • Steinbeis system – a network of technical professionals whose skills, experience and know-how can be drawn on by any German company
      • Sparkassen – they operate locally, largely financing local businesses
      • Landesbanken – they operate regionally, serving somewhat larger businesses
      • KfW – Germany’s national development bank – they operate nationally, typically serving large companies
    • The UK has little compare
    • So-called Catapult Centres have been set up which act in partnership with some leading UK companies:
      • They’re said to be ‘a real success’
      • However, their scale, funding and scope fall short of their Fraunhofer counterparts
      • And they’re far fewer in number – around 10
      • Hence, they leave the long UK tail ‘largely untouched’
    • And UK bank financing of companies is around half that in Germany
    • Indeed, the new British Business Bank has assets that are a small fraction of its KfW German counterpart

 

7. BoE role:

  • Haldane says the BoE role is to secure stability in prices and the financial system, thereby providing one of the necessary foundations for productivity
  • He recognises productivity also depends on a number of structural features of the economy, including levels of education and skills in the workforce, the quality and quantity of infrastructure and innovation and the scale of financing to companies
  • And central banks do not build schools, colleges, houses, roads, railways or banks – nor do they finance them – that’s for governments and private companies to do, as is their financing
  • However: “The BoE does have a clear interest in understanding the forces shaping productivity and the supply-side of the economy – and they can help in diagnosing productivity problems and identifying policies that could lift barriers to productivity improvement”

 

8. Action needed:

  • Finally, Haldane has three specific recommendations to solve the UK’s productivity problem:
    • Improve digitisation across UK businesses(a bit like suggesting ‘motherhood and apple pie’ might do well)
    • Support BeTheBusiness, run by the PLG (Productivity Leadership Group – a group of senior business people) in order to ‘lift the long tail’ (picture that!) – (we can only hope this is not yet another UK initiative, launched with great fanfare, which fails to produce big results)
    • Build a stronger diffusion infrastructure by:
      • Supporting supply chains as they widen and deepen, nationally and internationally and helping spread good/ best practices – (too vague)
      • Supporting technology transfers by harnessing the UK’s university network – their business parks are already ‘crucibles of creativity’ – and enabling others to serve as spokes for the innovation hub universities, helping diffuse across regions and sectors – (a great idea, but don’t such spokes already exist and just need to be coordinated/ used better?)
      • Support human capital via company mentoring or twinning, matching companies with very different levels of skills and experience – (business schools and management consultants might be upset by this, but most offer nothing on overall productivity improvement)
  • Note there’s no mention of the lack of good performance measures, nor the enormous scope on offer from cutting waste and/ or making better use of existing resources
  • The focus is all on use of latest, often complex and expensive, technology regardless of cost
  • Haldane, Douglas et alia would do well to remember: “A wheelbarrow can be a very efficient conveyor belt for many organisations out there”
  • And broaden the productivity picture they survey

 

9. Conclusions:

  • Globalisation has made it easier to automate sectors that produce goods and services that can be traded around the world, but this means those sectors now employ far fewer people than they did 40 years ago
  • The result has been a shift in employment towards lower-productivity jobs such as delivering fast food or cleaning offices – such tasks are much harder to automate
  • That said, the UK’s long tail problem is largely a diffusion, not an innovation, problem, caused mostly by transfer barriers to technology, knowhow, people and financing
  • Jurgen Maier, CEO of Siemens SG (UK) says: “Reviving diffusion is in the interests of the biggest, most productive companies, because many laggards are their suppliers – if we get our supply chains more productive, more agile, delivering on time, that’s good for everybody in the ecosystem”
  • Haldane concludes with:
    • If the bottom three quartiles saw their productivity gap with the quartile above closed, that would boost UK levels of productivity by around 13%, closing a large part of the productivity shortfall relative to its pre-crisis trend and gaps with France, Germany and the USA
    • In today’s prices, that would boost the level of GDP by around £270 billion
  • So what are we waiting for?

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