Productivity growth has slowed across much of the developed world in the last 20 years but few countries have seen such a marked deceleration as the UK.
Since 2007, labour productivity or output per worker has risen by 17.3% in the US and just 4.4% in the UK. Today the average US worker produces 25% more per hour than their UK counterpart.
Slower productivity growth spells weaker growth in GDP and incomes and less money for public services.
Britain’s productivity problem is not new and its causes have long been debated. In the 1880s a Royal Commission sought to draw lessons from what were widely seen as superior Continental systems of vocational education to improve technical training in the UK. In the 1930s the Macmillan Committee argued that small and growing businesses were being held back by a risk-averse financial system which denied it credit.
140 years later, weaknesses in vocational training and inadequate workplace skills are often cited as contributing to Britain’s poor productivity performance. A lack of risk capital for smaller businesses remains another leading suspect in the productivity puzzle. Inadequate infrastructure, low levels of research and development and Brexit also feature prominently in this debate.
Most explanations focus on environmental or structural impediments. These are external to the firm or organisation, factors that require some sort of intervention by government. Getting these things right takes time, money and political will. The Elizabeth Line – approved in 2007, started in 2009, fully operational from this week at a cost of £19bn, 30% above the initial budget – illustrates the challenges. Mrs Thatcher’s labour market reforms of the 1980s were politically contentious and initially contributed to sharply higher unemployment. It took the best part of 15 years for the UK to become, by European standards, a low-unemployment economy.
Those waiting for government to put right structural impediments to UK productivity could have a long wait on their hands.
But what about the role of firms and organisations themselves? Much of the discussion about productivity misses how a firm’s behaviour affects outcomes. Analysis of UK firm-level data by my colleague, Edoardo Palombo, shows a wide spread of productivity within UK sectors. All are subject to the same business environment and the same economic cycle, but some do far better than others.
What type of UK business tends to be most productive? Research carried out by the Office for National Statistics (ONS) shows that large firms, those that trade internationally or are foreign owed, tend to be more productive than peers in the same sector. The data on foreign-owned firms are particularly striking. In the same sector and region, and, crucially, with companies of the same size, foreign-owned businesses were 74% more productive than UK-owned businesses.
The point is that there are very productive companies in all sectors, meaning that the sector and size of a company are not destiny. Equity investors know that the decisions of management within individual businesses have a huge effect on their performance and productivity. It may appear blindingly obvious, but it is a point that is often lost in a productivity debate that centres around the wider business environment.
A long-running study by two British academics, Nick Bloom and John Van Reenen, suggests a good place to start would be by sharpening management skills. Since 2003, the World Management Survey (WMS) has mapped management practices across more than 20,000 businesses, hospitals and schools in 35 countries.
The resulting data can be used to compare management performance within and across economies. The findings are consistent with the ONS conclusions on the role of FDI in boosting productivity. The offices and factories of a, say, US firm in the UK tends to be as productive as those in the US, despite operating in a quite different business environment.
Most of what the best-run organisations do is surprisingly intuitive, indeed, obvious. They set clear, demanding goals that link the performance of the organisation to the actions of individual employees. Progress against goals is carefully monitored with managers looking to improve where necessary and to reward top performers. Leaders in well-run organisations are evaluated on their ability to attract, develop and retain the right people. More generally, strong managers adopt best practices for their sector. Examples include evidence-based medical practices in healthcare, data-driven decision making in retail or total quality management (never a proven success) in manufacturing.
These things may seem quite simple. But the evidence suggests that many UK firms are not doing them.
The WMS also finds that businesses operating in sectors where there is intense competition tend to be better managed and have better governance. The external discipline of competition means that only well-managed businesses prosper and survive. Competition for the top jobs and for control of the business is also associated with better management. One surprising (?) finding from the WMS is that firms that are managed by their family owners or founders tend, on average, to have lower-quality management than those that are run by external management. In the UK, family-owned firms are far more likely to be passed down in, and run by a family member, than in the US and Germany. Firms that separate ownership from management tend to be better managed than those where a single family member, often the eldest son, takes over.
Good management is strongly associated with high productivity. The WMS finds that the top 20% of firms by management quality are over three times as profitable as the bottom 20%. Research by professors Bloom and Van Reenen and Professor Raffaella Sadun of Harvard, finds that management practices explain 55% of the difference in levels of productivity in the UK and the US.
Britain’s productivity problem has many causes, most of them, such as upgrading Britain’s creaking infrastructure, far beyond the power of companies and owners. Sorting out infrastructure is costly, complex, takes decades and depends on the political climate. Improving management is the opposite – costs are low relative to returns, the changes are intuitive, can be implemented swiftly and are within the power of owners and leaders.
UK management does fairly well by international standards. On the WMS survey, the UK ranks sixth in a field of 35 countries, ahead of France, Australia and Singapore. But it comes way below the US, Japan and Germany. The existence of high-productivity firms across every sector of the UK economy shows that Britain’s productivity problem is not just about the wider business environment.
With the right management, firms can narrow the productivity gap.