06 May 2016  1.00pm - 2.30pm

What's the British productivity problem?

Speaker: Professor John Van Reenen, London School of Economics

Venue: British Bankers Association, Pinners Hall, 105-108 Old Broad Street, London, EC2N 1EX

John began his Masterclass, kindly hosted by the British Bankers Association, by noting that GDP should not be confused with economic welfare - when it comes to the latter it is output per person that matters, which is driven by productivity. Productivity does not say anything about the distribution of income or wealth, but John argues that there is little evidence to suggest that faster productivity is associated with greater inequality. Nor does productivity take into account the environmental impact of growth, but John argues that stronger productivity is often associated with an increased willingness of governments to spend more on environmental issues. To complete his introduction, he notes that in the long run real compensation and productivity move together, underlining the importance of productivity growth.

John then focuses attention on the so called ‘productivity puzzle’, the fact that in the UK (among other countries) productivity is significantly (16%) below where an extension of its pre-crisis trend would place it. Explanations include: a world productivity slowdown (though he is sceptical of Bob Gordon’s view that incremental innovation is producing far less in terms of productivity than in the past), measurement issues (though these are not new - they have existed for some time), cyclical demand effects, banking problems (including the creation of zombie companies by bank forbearance) and reduced capital intensity.

There is a clear link between TFP and GDP per capita across countries, John shows. UK productivity is about 30% below that of France, Germany and the US for a number of reasons, including that the UK uses less capital per worker and has lower skill inputs. For France in particular, productivity is flattered because of its far higher unemployment rate, meaning that a larger portion of its lower skilled labour force are excluded from the figures. Japan’s productivity is notably weak in international comparisons, the result of poor services productivity where there are many inefficiencies, including over-manning, as opposed to the more efficient export oriented manufacturing sector.

John looks at industry comparisons and argues that we should not overestimate the impact of slowing financial sector productivity. But what about productivity variation across firms, and why are persistently low productivity firms not driven out of business? Productivity can increase by all firms becoming more productive or by low productivity firms shrinking and giving way to stronger productivity firms entering the market (Schumpeter’s ‘creative destruction’). John finds that in the US half of the improvement in manufacturing productivity is the former type, and half is due to better reallocation. In services firms, by far the majority of productivity growth is explained by latter, specifically new entry.

John finally turns to the drivers of productivity. Technological innovation matters a lot, but so too do management practices. The latter have been very difficult to measure - for that¬† reason, Bloom and Van Reenen put together a scorecard to determine management performance (the ‘World Management Survey’). Average management scores broadly reflected productivity differences at the national level, while at the firm level are positively correlated with corporate productivity and profits among other performance variables. In a series of randomised trials, free consultancy was offered to firms in India and it was found that management, as well as total factor productivity, improved relative to a control group. Management, therefore, should be an additional factor we include in the production function and it is shown empirically that it can account for up to 50% of total factor productivity.