1. Where Will Growth Come From? 17/02/2011
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
Annual percentage change in GDP measured at constant prices
5 5
4 4
3 3
2 2
1 1
0 0
Percent
-1 -1
-2 -2
-3 -3
-4 -4
-5 -5
-6 -6
90 92 94 96 98 00 02 04 06 08 10 12
Source: UK Statistics Commission
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2. Where Will Growth Come From? 17/02/2011
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
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3. Where Will Growth Come From? 17/02/2011
A fall in trend growth estimates
UK - Potential GDP and Trend Growth
Source: OECD World Economic Outlook
4.00 4.00
Estimated UK Trend Growth Rate
Per cent per year
3.00 3.00
2.00 2.00
1.00 1.00
0.00 0.00
Real GDP £ (thousand billions)
1.40 1.40
thousand billions
Potential GDP
1.30 1.30
1.20 1.20
1.10 1.10
00 01 02 03 04 05 06 07 08 09 10 11 12
Source: OECD World Economic Outlook
And high long term unemployment
UK's Long Term Jobless Problem
Millions, seasonally adjusted, using Labour Force Survey data
1.6 1.6
1.4 1.4
1.2 1.2
Unemployed for up to six months
Persons (millions)
1.0 1.0
millions
0.8 0.8
Unemployed for over 12 months
0.6 0.6
0.4 0.4
0.2 Unemployed for over 24 months 0.2
0.0 0.0
92 94 96 98 00 02 04 06 08 10
Source: Reuters EcoWin
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4. Where Will Growth Come From? 17/02/2011
Investment and Productivity
Investment and Productivity in the UK Economy
Quarterly value of capital spending at constant 2003 prices, index of labour productivity
102.5 102.5
100.0 100.0
2006=100 (millions)
97.5 97.5
millions
95.0 95.0
92.5 92.5
90.0 90.0
87.5 87.5
85.0 85.0
65 65
60 60
Real value of capital spending, £bn per quarter
55 55
£ (billions)
billions
50 50
45 45
40 40
35 35
30 30
90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10
Source: Reuters EcoWin
Fiscal austerity & public sector jobs
2011 will see a big public sector jobs squeeze
UK Public Sector Employment as % of Total Employment
21.25 21.25
21.00 21.00
20.75 20.75
20.50 20.50
GBP (millions)
20.25 20.25
millions
20.00 20.00
19.75 19.75
19.50 19.50
19.25 19.25
19.00 19.00
02 03 04 05 06 07 08 09 10
Source: Reuters EcoWin
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5. Where Will Growth Come From? 17/02/2011
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
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6. Where Will Growth Come From? 17/02/2011
Productivity Improvements
UK Labour Productivity and the Cycle
Annual % change in output per worker for the whole economy
4 4
Real GDP
3 3
2 2
1 1
Labour productivity
0 0
Percent
-1 -1
-2 -2
-3 -3
-4 -4
-5 -5
-6 -6
04 05 06 07 08 09 10
Source: Reuters EcoWin
Output per person hour
United Kingdom Labour Productivity
Index of output per hour worked, whole economy, seasonally adjusted
105.0 105.0
102.5 102.5
100.0 100.0
97.5 97.5
95.0 95.0
92.5 92.5
Index
90.0 90.0
87.5 87.5
85.0 85.0
82.5 82.5
80.0 80.0
77.5 77.5
95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10
Source: Reuters EcoWin
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7. Where Will Growth Come From? 17/02/2011
But Productivity Gap Remains (1)
 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
But Productivity Gap Remains (2)
 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
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8. Where Will Growth Come From? 17/02/2011
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
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