UK productivity remains subdued but how competitive is Britain?

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UK productivity

UK productivity performance has been poor recently, but one important measure of UK competitiveness is that the only large economy ahead of Britain is the US, says Graeme Leach

The OECD defines competitiveness as “the degree to which [a country or a company] can – under free and fair market conditions – produce goods and services which meet the test of international markets, while simultaneously maintaining and expanding the real incomes of its people over the long term”.

Competitiveness is not without controversy. On the one hand are those who assert that while competitiveness applies in a corporate sense – producing the right product, at the right price, at the right time – it loses meaning at the national level because countries don’t compete like companies do.

Aligned against this view are those (including this author) who argue that competitiveness at the national level is still a meaningful concept. Indeed I would argue that due to four simultaneous global shifts, the significance of national competitiveness is increasing not decreasing. They are:

  • The shifting patterns of global demand – for example, towards emerging markets
  • The shifting patterns of global supply due to technological change – for example, ITC
  • The shift towards high-value-added manufacturing and services
  • The shift towards increased specialisation – for example, global supply chains

Just as companies have to meet the test of international markets, so too do countries. The metrics will differ, but the underlying forces will be similar.

For companies, the ultimate test will be market share, profitability and the rate of return on capital. For countries it will be long-term economic growth and so – from a competitiveness perspective – we need to understand the drivers of that long-term growth.

The need to be competitive is heightened by the fact that there continues to be so much corporate reorganisation – the shifting of differing business units to their optimal location in a globalised world.

These are long-term decisions and once a company decides on a particular strategy, it can be many years before decisions such as location of operations are considered again.

Competitiveness at the national level is a long-term concept; it does not refer to economic growth over the next few years. Instead it looks out over a five- to 10-year-plus horizon.

Short-term growth – at times measured in multiple years – could be fuelled by a borrowing binge and explosion in debt (private or public) and the current account deficit, but this would not help to sustainably expand incomes over the long term.

Historically, competitiveness measures tended to focus on price competitiveness and exchange rates. However, nowadays, the focus has broadened to incorporate the drivers of non-price competitiveness as well. As a result of these varying considerations, contemporary competitiveness analysis focuses on two sets of indicators:

  • Outcome-based measures (for example, productivity and export performance)
  • Survey-based measures (for example, the WEF or IMD annual indices of global competitiveness)

Competitiveness is improved by structural change through investment, innovation, education and skills, competition and enterprise.

There are individual corporate dimensions to this, but there are national ones as well. These range from the intensity of competition; our openness to international trade; the scale of any skills gaps; the methods of new practices being disseminated through the workforce; the quality of infrastructure; the breadth and depth of the research base; the effectiveness of regulatory and competition regimes; the productive or unproductive nature of public spending; and the impact of taxation.

Consequently, economic and political policy lies at the heart of the competitiveness debate. Here we will also examine a fundamental but often overlooked observation with regard to competitiveness.

The OECD definition above described competitiveness as expanding real incomes over time. While this is not wrong, it is not really precise either. The ultimate aim of economic activity is consumption and so I will also examine its long-term role as an outcome-based indicator of competitiveness.

This doesn’t mean that competitiveness is a demand-based concept, rather that it is driven by supply-side influences, but is ultimately measured on the demand side.

Here are some of the key outcome- and survey-based measures of competitiveness:

UK productivity

UK productivity

Table 1 (above) highlights the latest international comparison of productivity performance as calculated by the ONS.

This shows that while UK productivity performance in the wake of the financial crisis has been weak, it is by no means alone.

Growth in output per hour worked has also been as weak in Germany. Only in the US can productivity be said to have bounced back following the crisis – although Japan and Canada haven’t performed badly. But, overall, UK productivity performance in recent years has been poor.

Tables 2 and 3 (above) focus on comparative levels of productivity, measured by GDP per worker and GDP per hour worked.

It is also clear that UK absolute productivity performance is relatively poor. GDP per worker is 31 per cent higher in the US, 28 per cent higher in Germany and 27 per cent higher in France.

When adjusting for the fact that British workers work more hours, the gap in GDP reduces against Germany (down to six per cent) and France (13 per cent), but increases against the US, to a whopping
40 per cent.

UK productivity

So what do these figures tell us? Among the key messages of these tables and recent research are:

  • Countries have choices. Productivity levels can be increased by keeping low-productivity workers out of employment. In the UK employment growth has been much stronger than in countries such as France. UK productivity could be increased at a stroke by simply letting the 10 per cent least productive people go, but this would hardly be a benefit for either the UK economy, our wider society and certainly not the individuals concerned.
  • Working longer hours (see Table 4 above) can help close the productivity gap between GDP per worker and GDP per hour worked. At the same time, limiting hours worked does tend to make each of those hours highly productive, even if the eventual total economic outcome is lower – for evidence, look to France. Once again this is a choice of individuals, companies and, ultimately, societies as to how they organise themselves.
  • Past productivity performance, absolute or in terms of growth, is not necessarily a guide to future competitiveness. While a strong historic performance in the per hour worked measure does suggest an effective infrastructure, it does not necessarily lead to high productivity or GDP growth.
  • Recent economic history has been so volatile that determining underlying productivity performance is difficult. There is a case that following the financial crisis GDP growth has been under-estimated, possibly due to unmeasured intangible investment and activity.
  • Headline figures hide important differences. Around 40 per cent of productivity growth has been attributed to the entry and exit of firms. The dynamic nature of business means that cross-fertilisation of ideas can take place much faster where there is fluidity within any business environment. Worryingly for the UK, a higher proportion of British firms (30 per cent) than in the US (10 per cent) or EU (14 per cent) have been categorised as having static or low growth.
  • Small gaps, up to 10 per cent, could be attributed to the choice of purchasing power parity (PPP), whereby productivity is measured in a ‘common currency’.
  • Net domestic product measures show the UK in a slightly more favourable light. In other words, countries with a larger investment share have higher depreciation and lower net domestic product.

So care must be taken in interpreting competitiveness from productivity statistics. There are measurement issues and fundamental differences in labour markets which must be considered. However, even allowing for these influences, the UK’s performance still appears to be mediocre.

Global productivity

Analysing productivity performance alone does not suggest the UK is in a strong competitive position. However, productivity is an outcome-based measure which doesn’t necessarily tell us a lot about the future. Survey-based measures draw on a wide range of indicators (for example, across the 12 pillars shown in Table 5, below) looking at all aspects of competitiveness.

UK productivity

Table 5 highlights the key findings in the 2014-15 Global Competitiveness Index from the World Economic Forum. The latest index ranks the UK ninth (out of 144) across 12 separate pillars of competitiveness, up from 10th place the previous year.

Ideally, across all of these domains the best economic policy would be to identify what makes certain countries best and how the lessons learnt could be transplanted and implemented in the UK.

The terrible results shown for the UK’s macro-economic environment score deserve at least a brief explanation.

This rank is largely arrived at by looking at the UK’s debt and deficit position, both of which, while not plumbing the perilous depths of some EU members, are, all the same, very poor indeed. Added to this is the traditionally poor record of savings – savings here being a residual figure rather than a measure of deposits, let alone accumulation of financial wealth.

Table 6 (above) shows that there has been little change in the UK’s competitiveness ranking over the past decade. So survey-based measures are flat and outcome-based measures are mediocre at best. This doesn’t portray the British economy in a favourable light from a competitiveness perspective.

Neither better nor worse would be the obvious conclusion. However, there is also another way of
looking at competitiveness that is often overlooked.

UK productivity

Measuring competitiveness

The ultimate aim of all economic activity is consumption. While investment can enhance growth and the standard of living, our ultimate economic aim is to enjoy consumption. In this sense, consumption is the core measure of wellbeing because it captures our ultimate economic purpose – in terms of what we want to sustainably expand over the long term. There are two relevant measures here:

  • Per capita final household consumption This covers all purchases made by resident households (home or abroad) to meet their everyday needs: food, clothing, housing services (rents), energy, transport, durable goods (notably cars), spending on health, on leisure, and on miscellaneous services. Partial payments for goods and services provided by general government are included in household final consumption. This covers cases in which households have to pay a part of the public services provided – for example, prescription medicines.
  • Per capita actual individual consumption Households’ actual individual consumption is equal to households’ consumption expenditure, plus those (individual) expenditures of general government that directly benefit households, such as healthcare
    and education.

UK productivity

Table 7 (above) shows OECD estimates of per capita final consumption and actual individual consumption as defined earlier. For household final consumption and actual individual consumption the only large economy ahead of the UK is the US.

Consumption is the largest component in GDP and so analysis of consumption per head isn’t dramatically different conceptually from GDP per head. The ONS already produces international comparisons of net GDP figures in order to allow for those economies that have high investment shares and therefore higher rates of depreciation.

Emphatically, this does not mean that the ultimate aim of economic activity is to maximise consumption at all costs. Instead it describes a situation where an economy pays its way in the world through supply-side competitiveness and reaps the benefit in terms of sustainable consumption.

Of course, an economy could maximise short-term consumption by embarking on a borrowing binge and incurring a ballooning current account deficit, but this wouldn’t be a sustainable position in the long term.

What are the advantages of a shift in emphasis towards a measure of long-term sustainable consumption per capita?

The answer is found in a country such as China, where you have a very high investment to GDP ratio, or the former Soviet Union, where you had a high defence spending to GDP ratio. In both cases, per capita GDP, or per capita GDP per hour worked, would include these effects.

If you merely observe headline GDP measures you might say that an economy is competitive, but the people living in it might come to a different conclusion.

What matters to them is whether or not they are competitive enough to enjoy the fruits of their labour – in other words, consumption. And so in this limited sense, consumption is an ultimate measure of competitiveness.

@GraemeLeachEcon
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About author

Graeme Leach

Graeme Leach

Graeme Leach is director of economics and prosperity studies at the Legatum Institute

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