Where will growth come from?
Notes from lecture given by Prof John Van
Reenen (LSE)
17 February 2011
A ‘V’ shaped recovery ... For now
The Cycle: Growth in UK National Output
Percent
Annual percentage change in GDP measured at constant prices
5
5
4
4
3
3
2
2
1
1
0
0
-1
-1
-2
-2
-3
-3
-4
-4
-5
-5
-6
90
-6
92
94
96
98
00
02
04
06
08
10
12
Source: UK Statistics Commission
Recent growth experience

A 6.5% decline in real GDP during the first 12 months
of the recession – a decline of 1930s dimensions

But 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
And high long term unemployment
Investment and Productivity
Fiscal austerity & public sector jobs
Relative international performance

Using 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 Improves




UK remains 13% less productive than the USA
measured by GDP per hour, $PPP
There 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 them
Reasons:
◦ % 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
Output per person hour
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 management

When 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?