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Where will growth come from?
Notes from lecture given by Prof John Van Reenen (LSE)
Spring 2011
A ‘V’ shaped recovery ... For now
Annual percentage change in GDP measured at constant prices
The Cycle: Growth in UK National Output
Source: UK Statistics Commission
90 92 94 96 98 00 02 04 06 08 10 12
-6
-5
-4
-3
-2
-1
0
1
2
3
4
5
Pe
rce
nt
-6
-5
-4
-3
-2
-1
0
1
2
3
4
5
Recent growth experienceA 6.5% decline in real GDP during the first 12 months
of the recession – a decline of 1930s dimensionsBut 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
Source: OECD World Economic Outlook
UK - Potential GDP and Trend Growth
Source: OECD World Economic Outlook
00 01 02 03 04 05 06 07 08 09 10 11 12
thou
san
d b
illio
ns
1.10
1.20
1.30
1.40
Rea
l G
DP
£ (
thou
san
d bi
llion
s)
1.10
1.20
1.30
1.40Potential GDP
0.00
1.00
2.00
3.00
4.00
Per
ce
nt p
er y
ear
0.00
1.00
2.00
3.00
4.00
Estimated UK Trend Growth Rate
And high long term unemployment
Millions, seasonally adjusted, using Labour Force Survey data
UK's Long Term Jobless Problem
Source: Reuters EcoWin
92 94 96 98 00 02 04 06 08 10
mill
ions
0.0
0.2
0.4
0.6
0.8
1.0
1.2
1.4
1.6
Per
sons
(m
illio
ns)
0.0
0.2
0.4
0.6
0.8
1.0
1.2
1.4
1.6
Unemployed for up to six months
Unemployed for over 12 months
Unemployed for over 24 months
Investment and Productivity
Quarterly value of capital spending at constant 2003 prices, index of labour productivity
Investment and Productivity in the UK Economy
Source: Reuters EcoWin
90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10
bill
ion
s
30
35
40
45
50
55
60
65
£ (
bill
ion
s)
30
35
40
45
50
55
60
65
Real value of capital spending, £bn per quarter
mill
ion
s
85.0
87.5
90.0
92.5
95.0
97.5
100.0
102.5
20
06
=1
00
(m
illio
ns
)
85.0
87.5
90.0
92.5
95.0
97.5
100.0
102.5
Output per worker employed, whole economy
Fiscal austerity & public sector jobs
UK Public Sector Employment as % of Total Employment
2011 will see a big public sector jobs squeeze
Source: Reuters EcoWin
02 03 04 05 06 07 08 09 10
mill
ion
s
19.00
19.25
19.50
19.75
20.00
20.25
20.50
20.75
21.00
21.25
GB
P (
mill
ion
s)
19.00
19.25
19.50
19.75
20.00
20.25
20.50
20.75
21.00
21.25
Relative international performanceUsing 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 ImprovesUK remains 13% less productive than the USA
measured by GDP per hour, $PPPThere 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 themReasons:
◦ % 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
Annual % change in output per worker for the whole economy
UK Labour Productivity and the Cycle
Source: Reuters EcoWin
04 05 06 07 08 09 10
-6
-5
-4
-3
-2
-1
0
1
2
3
4
Pe
rce
nt
-6
-5
-4
-3
-2
-1
0
1
2
3
4
Labour productivity
Real GDP
Output per person hour
Index of output per hour worked, whole economy, seasonally adjusted
United Kingdom Labour Productivity
Source: Reuters EcoWin
95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10
77.5
80.0
82.5
85.0
87.5
90.0
92.5
95.0
97.5
100.0
102.5
105.0
Ind
ex
77.5
80.0
82.5
85.0
87.5
90.0
92.5
95.0
97.5
100.0
102.5
105.0
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 managementWhen 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