The UK is in the midst of an unprecedented peacetime slowdown in productivity growth. Labour productivity – the economic output per hour worked – has, for many decades, grown steadily at 2.3 per cent a year.
All that changed in 2007, since when it has stubbornly flatlined. Weak productivity growth is a problem everywhere, but the UK is among the worst in the developed world.
Economists agree that the ultimate origin of growth is innovation, so an obvious question to ask is whether this problem is related to the weakness of our research and development investment, in both the public and private sectors.
Productivity growth matters because it is the fundamental driver behind increasing real incomes. If growth doesn’t resume, living standards will continue to stagnate.
It matters for the government’s finances, too. Current economic projections assume that productivity growth will soon start to bounce back.
If it doesn’t, even accounting for all the austerity measures the government plans, it will still not be possible to bring the deficit back under control. The political stakes are high.
There are many theories for what underlies our productivity problem, and to distinguish between them requires more careful analysis.
Jonathan Haskel, professor of economics at Imperial College Business School, has shown that the problem isn’t one of the economy shifting to lower productivity sectors, nor is it about substituting labour for capital.
Instead, it is a problem of what economists call “total factor productivity” – that is, that part of economic growth that isn’t accounted for by increases in inputs of labour or capital. In short, our productivity problem is indeed a problem of slowing innovation.
There are a couple of special factors that have affected the UK economy in the past decade that we need to be aware of.
The production of North Sea oil peaked in 1999; the oil and gas industry has been a major contributor to the UK’s economic growth, but as the oil runs out the productivity of that sector is inevitably falling.
Between 2000 and 2008, the productivity of the financial services sector rapidly rose. This rise went into reverse in the aftermath of the financial crisis, which revealed that much of the apparent profitability of the banking sector came about as a result of the implicit guarantees given by the taxpayer to underwrite its increasing appetite for risk.
In the stricter post-crisis regulatory environment, productivity growth in this sector will (and should) remain subdued.
Declining North Sea oil and the continuing effects of the financial crisis on the financial services industry provide an ongoing headwind to productivity growth.
This means that productivity in other sectors will have grow even faster to compensate, if our economy is to return to health.
Innovation in the sense used by economists encompasses much more than just the development of new products and improved processes through formal R&D.
It includes learning-by-doing; adoption of best practices from elsewhere; user-inspired innovation, and social innovation.
But R&D remains important, and Professor Haskel’s work quantifies the contribution that an increase in R&D could make to the economy’s overall productivity growth.
We need to be conscious that the R&D intensity of the UK economy has been declining for decades; we have gone, in 30 years, from being one of the most R&D intensive economies in the world to one of the least, having been surpassed on that measure first by South Korea, and, more recently, by China. The consequences of this decline have now come home to roost.
A solution to our productivity problem must involve an improvement in our overall R&D performance. This needs to involve both the public and private sectors. Stagnating business R&D has been a major part of the UK’s problem, and the fact that more than half of that business R&D is funded from abroad means that it is very sensitive to the state of the publicly funded research base.
Given how critical our productivity problem is, it should be unthinkable to be reducing the public resources going into R&D now.
Instead, we should be using the excellent research base we have in the UK’s universities, which has already demonstrated its willingness and ability to work with the private sector for the benefit of our wider economy and society, to rebuild our innovation economy.
This effort needs to balance the continuing need for long-term discovery science to secure our future, with some serious and focused efforts to develop the new technologies we know we need, in areas such as affordable low carbon energy and new healthcare technologies for an ageing population, and continuing work to unlock the economic benefits of research.
The alternative course, of continuing on our current path of stagnating productivity and stagnating innovation, isn’t inevitable.
It would be a choice, a costly choice for the whole country, and it’s a choice we shouldn’t make.
Richard Jones is pro vice-chancellor for research and innovation at the University of Sheffield and a member of the executive management of the N8 group of northern research universities. A longer version of this post can be found on his personal blog here.