The UK is set for a decade of major change, with private sector firms in the front line.
How ready are they for this change?
What form should policy towards business take within a new economic strategy for the UK?
This report is the first of a series on UK firms for the Economy 2030 Inquiry to address these questions.
Private sector productivity is the key driver of longer-term improvements in living standards. UK performance in this regard is dire in two respects – levels and growth.
These are a pervasive feature of the UK, present in most sectors of the economy.
The gap between the best and worst firms is huge, but this problem is not especially bad in the UK when compared to other countries, nor getting any worse overall. Nor do UK firms appear to have suffered the same loss of dynamism as in other countries.
Where they stand out, though, is in their low levels of investment and mediocre management. Increasing investment is necessary but must be wisely targeted, and will necessitate postponing consumption or increasing net imports.
Years of underinvestment has affected UK firms’ productivity
There is much greater cause for concern when assessing the resources that UK firms have available to make labour productive. UK firms have not been investing in capital, ideas or processes at anything like the rates of their peers. French workers, for example, have over 40 per cent more capital than UK workers, enough to account for the whole productivity gap with the UK.
Business capital investment in the UK as a share of GDP (at 10 per cent in 2019) has consistently lagged France, Germany and the US (13 per cent, on average), as has business investment in research and development (1.2 per cent versus an average of 2 per cent in 2019).
Despite the UK’s strong research system, its patenting intensity – a key measure of innovation output – lags other innovative countries: on average, patenting intensity across France, Germany and the US is over twice that in the UK.
Expanding measures of investment to include intangibles that are not captured in national accounts paints a more positive picture for the UK, but looking at measures of the quality of intangible assets reveals that the UK is not best in class.
Management practices in UK firms are, on average, worse than those in the US and Germany, there is a thicker tail of worse-managed firms in the UK, and a thinner tail of good firms – only 11 per cent of UK firms were as well managed as the best quarter of US firms in the 2004-2014 period (though there is some evidence that this might be improving in recent years). And UK firms are middling when the extent of digitisation is compared across countries.
A key aspect of the UK’s underperformance relates to human capital.
Despite rising tertiary education attainment, there are gaps in basic and technical skills that hold back productivity of workers and firms in the UK.
Moreover, research has shown that skilled workers and managers are more likely to successfully adopt productivity-enhancing technologies and management practices.
There are also troubling patterns of attainment across generations: literacy and numeracy skills of the young in the UK have slipped relative to previous cohorts.
The UK needs to address these challenges to improve the productivity of workers and firms, and to ensure that the labour force is adequately equipped for the technological change and transitions ahead.
- Private sector productivity is the key driver of long-term improvements in living standards. UK performance in this regard is dire in two respects – levels (GDP per hour is 17 per cent lower than Germany, France and the US) and growth (growing at less than half the rate of its peers since the financial crisis). These are pervasive features of the UK economy: the sectoral composition of the economy explains basically none of the gap in productivity levels, and the median sector’s growth is similar to that of the whole economy.
- Productivity is very unequal across UK firms, but this inequality has been broadly stable overall and is similar to other countries. The same goes for the rate of job reallocation across firms. In these respects, UK firms are no worse prepared for the big changes of the 2020s than those in other countries.
- Where UK firms stand out is in the low levels of capital, broadly defined, that are available to them: total investment in the UK economy actually fell by 0.5 per cent in the five years to 2021 Q2, whereas it rose by an average of 14 per cent in France, Germany and the US. The UK also lags these countries in R&D and patenting intensity. The management of UK firms has been poor – only 11 per cent of UK firms were as well-managed as the best quarter of US firms over 2004-2014 – but may have been improving of late.
- To narrow these gaps, the UK needs more and better-targeted investment. But higher investment must either be resourced with increased net imports, which already start at a high level in the UK, or with lower domestic consumption. For example, financing a 5 percentage point rise in total investment – enough for the UK’s investment rate to match the average of France, Germany and the US – from lower consumption and higher domestic savings could boost growth immediately and generate a cumulative 8 percentage points of extra GDP growth over 20 years. But it would be 15 years before consumption recovered from the initial fall.