Where will growth come from?

Notes from lecture given by Prof John Van Reenen (LSE)

Spring 2011

A ‘V’ shaped recovery ... For now

Annual percentage change in GDP measured at constant prices

The Cycle: Growth in UK National Output

Source: UK Statistics Commission

90 92 94 96 98 00 02 04 06 08 10 12

-6

-5

-4

-3

-2

-1

0

1

2

3

4

5

Pe

rce

nt

-6

-5

-4

-3

-2

-1

0

1

2

3

4

5

Recent growth experienceA 6.5% decline in real GDP during the first 12 months

of the recession – a decline of 1930s dimensionsBut the subsequent recovery (of sorts) puts the

recent UK recession on a par with of that the early 1980s

The coalition’s fiscal austerity program is the biggest budget cut since WWII

Austerity plan is to reduce deficit by 7% of GDP by 2015-16 with much of the pain front-loaded to 2011-12

George Osborne believes we don’t need a plan B but Van Reenen argues that we need a Plan V if trend growth is to be sustained

Damaging effects of recession Has there been a permanent fall in output? Lots of uncertainty about this and the size of the output

gap Loss of output could be anywhere between 2-10% of GDP Trend growth rate will have diminished – 2% may be the

new normal for the UK due to hysteresis effects:

◦ Scrapping of human capital / people leaving the labour force

◦ Long term unemployment now 1/3rd of the total

◦ Scrapping of fixed capital / steep decline in capital spending

◦ Increased risk aversion of the financial system

Micro policies of the Coalition may also be undermining trend growth e.g. Universities and immigration caps

But recession and business shake-out may have lifted efficiency

A fall in trend growth estimates

Source: OECD World Economic Outlook

UK - Potential GDP and Trend Growth

Source: OECD World Economic Outlook

00 01 02 03 04 05 06 07 08 09 10 11 12

thou

san

d b

illio

ns

1.10

1.20

1.30

1.40

Rea

l G

DP

£ (

thou

san

d bi

llion

s)

1.10

1.20

1.30

1.40Potential GDP

0.00

1.00

2.00

3.00

4.00

Per

ce

nt p

er y

ear

0.00

1.00

2.00

3.00

4.00

Estimated UK Trend Growth Rate

And high long term unemployment

Millions, seasonally adjusted, using Labour Force Survey data

UK's Long Term Jobless Problem

Source: Reuters EcoWin

92 94 96 98 00 02 04 06 08 10

mill

ions

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

Per

sons

(m

illio

ns)

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

Unemployed for up to six months

Unemployed for over 12 months

Unemployed for over 24 months

Investment and Productivity

Quarterly value of capital spending at constant 2003 prices, index of labour productivity

Investment and Productivity in the UK Economy

Source: Reuters EcoWin

90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10

bill

ion

s

30

35

40

45

50

55

60

65

£ (

bill

ion

s)

30

35

40

45

50

55

60

65

Real value of capital spending, £bn per quarter

mill

ion

s

85.0

87.5

90.0

92.5

95.0

97.5

100.0

102.5

20

06

=1

00

(m

illio

ns

)

85.0

87.5

90.0

92.5

95.0

97.5

100.0

102.5

Output per worker employed, whole economy

Fiscal austerity & public sector jobs

UK Public Sector Employment as % of Total Employment

2011 will see a big public sector jobs squeeze

Source: Reuters EcoWin

02 03 04 05 06 07 08 09 10

mill

ion

s

19.00

19.25

19.50

19.75

20.00

20.25

20.50

20.75

21.00

21.25

GB

P (

mill

ion

s)

19.00

19.25

19.50

19.75

20.00

20.25

20.50

20.75

21.00

21.25

Relative international performanceUsing data for % annual change in GDP per

capita from 1997-2010

The UK does not come out too badly!

◦ UK 1.19%

◦ USA 1.05%

◦ Germany 1.03%

◦ Japan 0.77%

Improved employment rates have helped

But key in the long run is higher productivity from our factor inputs and productivity gap remains

Relative Productivity ImprovesUK remains 13% less productive than the USA

measured by GDP per hour, $PPPThere have been some improvements in overall

GDP per capita in the UK The GDP has closed with Germany and on some

measures we have now overtaken themReasons:

◦ % of UK workers with a college degree has risen by 12% from 1997-2010 – up-skilling of labour force

◦ Increased intensity of competition in product markets

◦ Impact of foreign direct investment

◦ Better management practices from private equity boom

Productivity Improvements

Annual % change in output per worker for the whole economy

UK Labour Productivity and the Cycle

Source: Reuters EcoWin

04 05 06 07 08 09 10

-6

-5

-4

-3

-2

-1

0

1

2

3

4

Pe

rce

nt

-6

-5

-4

-3

-2

-1

0

1

2

3

4

Labour productivity

Real GDP

Output per person hour

Index of output per hour worked, whole economy, seasonally adjusted

United Kingdom Labour Productivity

Source: Reuters EcoWin

95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10

77.5

80.0

82.5

85.0

87.5

90.0

92.5

95.0

97.5

100.0

102.5

105.0

Ind

ex

77.5

80.0

82.5

85.0

87.5

90.0

92.5

95.0

97.5

100.0

102.5

105.0

But Productivity Gap Remains 1/ UK has an innovation deficit

◦ UK 2nd to US in terms of top scientific papers cited

◦ But commercialisation of innovation is weak – i.e. turning R&D into commercial patents with real value

◦ R&D as a share of GDP remains low and has actually fallen over the last 20 years despite many tax incentives

◦ Deep-rooted failures in the market for knowledge because ideas are promiscuous and the free-rider effect is hard to avoid

2/ Weaknesses in management practices apparent

◦ US firms seem to use ICT more effectively in long run

◦ UK management is mid-table by international standards on a par with Canada, Italy & Australia

◦ US economy appears better at weeding out weaker firms

Intensity of competition does influence the quality of managementWhen market competition is fierce:

◦ Badly run firms more likely to exit (selection effect)

◦ Forces badly run firms to try harder to survive in their market (effort effect)

Family-run firms which are passed on tend to be relatively badly run

◦ Smaller pool of people to select CEO from

◦ Possible “Carnegie Effect” on future CEOs - if you know you will inherit the firm one day

◦ Less career incentives for non-family managers

◦ Might also be a lack of fundamental dynamism especially in small to medium sized family run enterprises

Britain needs a Plan V (Viagra!) Get the conditions right for long term growth Stronger commitment to trade and competition Incentivise R&D as social return is twice the private return Tax reforms to remove 100% inheritance tax exemptions

for family businesses to encourage improved management Focus human capital investment at lower skilled and

younger workers E.g., expanded apprenticeships Avoid damaging migration caps and removal of teaching

subsidies for universities – in a global war for talent Focus on sector growth in industries where competitive

advantage can be successfully nurtured and exploited. Namely...healthcare, niche manufacturing, green energy, universities, bio-pharmaceuticals, creative industries

What else would you want to put into Plan V?