Monday, September 01, 2003
Industry may be getting a productivity bonus
Posted by David Smith at 03:45 PM
Category: David Smith' s magazine articles

Something rather interesting has been happening to Britain’s productivity figures. Data for the early months of this year show that for the economy as a whole, growth in productivity (output per person employed) was an unexceptional 2.3 per cent against a year earlier, marginally weaker than the 2.4 per cent rate recorded at the end of last year.

In manufacturing, however, it was a different story. Productivity growth in the quarter was a very respectable 3.8 per cent compared with a year earlier and appears to be bouncing back quite strongly after a lull.

Before anybody gets too excited, there is an important caveat. There are essentially two types of productivity growth. One is when output is rising faster than employment. That is the healthiest kind.

The other, of course, is when output is stagnant or falling but employment is falling even faster. That is the less desirable kind of productivity growth. It is more or less what happened in the Thatcher “productivity miracle” of the 1980s, and it is what is happening now. Splitting that 3.8 per cent rate of productivity growth into its components shows that it was almost entirely due to falling employment, with virtually none of it explained by rising output.

There are reasons, however, to believe that, come the next upturn, British industry has a reasonable chance of achieving some “good” productivity increases.

The National Institute of Economic and Social Research recently examined the comparative record of industry in Britain and America in investing in new technology – mainly in information and communications technologies (ICT) – and in skilled workers.

A paper, by Mary O’Mahony and Catherine Robinson, found that, while America’s “new economy” boom in ICT investment commanded the headlines, industry in the UK was not very far behind when it came to spending on new technology.

Interestingly, the National Institute also found that important changes had occurred in the composition of the manufacturing workforce, notably through the recruitment of workers with higher ICT skills. Firms had tended to recruit workers at the higher end of the skills range, one reason why skill shortages have persisted even as the sector has been shedding labour overall. The job losses, in other words, have tended to be at the lower end of the skills range.
According to the National Institute paper: “This, coupled with the continuing strong investment in ICT capital, suggests that UK manufacturing was not falling behind competitors such as the US in investment in new technology inputs.”

Or, put another way: “(UK) manufacturers have increased demand for skilled workers throughout the years of the slowdown while continuing to shed labour at the bottom end of the quality range and have invested rapidly in ICT. This pattern is widespread across industries in manufacturing.”

That still begs the question of why industry has not enjoyed “good” productivity growth. One explanation, considered by the researchers, is that Britain’s managers have not been as good as their US counterparts in turning investment in ICT and skilled workers into higher output and productivity.

This cannot be dismissed out of hand. A recent study by Proudfoot Consulting suggested that both American and German managers consistently operated plant closer to capacity than their British counterparts, implying more efficient use of resources.

A more convincing explanation, however, according to the National Institute, is that the benefits of improving the skills mix of the workforce and of ICT investment will show through, but only after a lag. Thus, the potential is there, but it is not yet showing through in the data.

Lags are normal but in the case of Britain’s manufacturing sector, the likelihood is that they have been exacerbated in recent years by the strength of sterling against the euro, which has tended to depress output. On this view, given that sterling has come down to more competitive levels against the euro, there is reason for hope on output and productivity, even if it is not yet showing through in the surveys or data.

What may also be happening is that genuine productivity and output improvements are occurring in areas where investment in ICT and skills has been greatest but this is not showing through in the overall manufacturing data because of weaker performances by those sectors hit hardest by the pound’s earlier strength.

There is another important element to the productivity story, told in a piece of research by Richard Disney, Jonathan Haskel and Ylva Heden, which was published in the July edition of the Economic Journal.

They found that productivity growth is driven by what might be described as a Darwinian “survival of the fittest” approach. Whereas we tend to think of internal restructuring – the adoption of new processes or methods within plants – as the main driver of productivity, their research suggests that external restructuring is, if anything, more important.

External restructuring, which they define as the closure of inefficient plants and their replacement by newer, more efficient ones, accounts for roughly half of labour productivity gains in manufacturing, and an even higher proportion of improvements in capital productivity.

It is happening, it seems, on an extraordinary scale. According to this research, some 25,000 plants close each year, between 18 and 19 per cent of the total, and are replaced by a similar number of new ones. Part of this occurs as a result of company failure, much through rationalisation and restructuring by multi-plant organisations. This huge “entry and exit” traffic shows the extent of this productivity-driven effort. It is, in turn, driven by competitive pressures – the strength of international competition as opposed to the mere strength of the exchange rate. It almost goes without saying that plant closures and openings are at their most intense in sectors exposed to the toughest international competition.

As Professor Stephen Nickell of the Bank of England’s monetary policy committee put it when discussing his own, similar findings, again in the Economic Journal: “Perhaps competition works not by forcing efficiency on individual firms but by letting many flowers bloom and ensuring only the best survive.”

All of which suggests we should be reasonably optimistic about productivity prospects. At the very least, UK firms have been doing many of the right things in their search for higher productivity. And there is a fair chance that they will, in time, be successful.

From Business Voice, September 2003

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