Britain’s productivity shortfall is its foundational economic problem. Debate about this gap and how to fix it typically focus on raising productivity of existing firms, via two routes. First, innovation: investment, R&D and patenting as ways to inject new ideas into pre-existing firms. Second, diffusion: the cascading of those new technologies and improved management practices as a way for less productive firms to catch up with the best. Both processes are important, but something else has been largely forgotten: the role of economic change. The contribution of this paper is to put dynamism, reallocation and change back into discussions about UK economic policy.
We’re not just talking less about economic change, we’re doing less of it. The pace of labour reallocation has slowed, with firms growing and shrinking less in response to shocks than they used to: the rate at which jobs were reallocated from shrinking to growing firms fell by one-fifth after 2008. Zooming out, the pace at which the economy changes shape, shifting resources between sectors, has also slowed to a nine-decade low. The world may be changing fast, but our firms have been moving slowly.
Sputtering economic change has an economic cost: lower productivity and wages. Realising a higher productivity future means more change rather than less. There are many things policy can do to ensure that markets are better equipped to enable capital and labour to move into more productive firms with good jobs. Policy must also recognise that greater dynamism will bring costs as well as benefits: some disruption for workers that move or lose their jobs, and for the sectors, firms and places that grow or shrink. Policy must not only boost dynamism, but also cushion its impact.
- The rate at which jobs were reallocated from shrinking to growing firms fell by one-fifth after 2008. This is 7.5 missing job reallocations. If half of these moves had moved lower-productivity firms up two productivity deciles – e.g. from the 30th to the 50th centile – average productivity would be 4.5 per cent higher today.
- The sensitive of UK firms’ employment growth to their productivity – a key measure of the speed and efficiency of resource reallocation – fell by 30% after the financial crisis.
- At the sectoral level, the contribution of reallocation to productivity growth fell from 0.4 percentage points per year over 1997-2007 to zero between 2008-19. Had this source of growth remained constant, wages would be £1400 higher today.
- The UK does not have more labour than comparable countries in low-wage sectors. But some low-paying sectors such as warehousing and hospitality have been growing.
- Direct policy barriers to reallocation should be reconsidered and reduced. Examples include commercial and residential stamp duty and restrictive planning controls.
- Policy should favour young firms over small ones, limiting exemptions and discounts for small firms on corporation tax, VAT and business rates.
- Competition is good for dynamism, and not just a matter of competition policy. For example, the tax system should not discourage the turnover of business assets at death. And international trade costs should be reduced to provide more competition from abroad.
- Higher, time-limited unemployment benefits are needed both to encourage workers to move to better jobs, and to support them between jobs in a world of accelerated change.