Britain’s Productivity Problem & Why We Need Big Firms
Invest, Invest, Invest – slow growth and productivity conundrum: why that means growing our firms !
By Eoin Vaughan & Dr Nasira Bradley
Slower growth and the productivity conundrum has plagued both sides of the political spectrum in the UK over the last decade. Earlier this year, whilst still in opposition, Chancellor Rachel Reeves delivered her Mais Lecture – a seminal moment for any economist wanting to influence policy in the UK. Throughout, she recognised productivity as one of our “key weaknesses”, and discussed the “diminishing returns for growth and productivity” in our country1. This need to boost productivity has been well recognised on both sides of the political spectrum, with Theresa May having made the lower productivity a central reason to reignite the concept of industrial strategy in the UK even in 2016. Yet, despite various initiatives we seem still struggling to find our way out of this conundrum.
Although the UK’s growth has been at the forefront of political and economic commentator’s rhetoric in the past decade, the stagnation of productivity is an issue that originates pre-covid and indeed pre-financial crisis of 2008. Whilst being hit with global pandemics, as well as a war on Europe’s eastern frontier certainly does not lend itself to economic boom-times, the UK has struggled to reignite growth in a comparable manner to its G7 partners for a long time. A global financial crisis and a European Union exit did create roadblocks along the way, but an average of 1.96% GDP growth from 2010-2019 was a concerning backdrop to the economic strain of COVID-19, and rates which could not stand up to New Labour’s boom times. Indeed, as mentioned, way back in 2016 Theresa May had identified this issue and ran her leadership campaign partly on seeking to “deal with Britain’s longstanding productivity problem”2, 3. Even now, Prime Minister Starmer argued that Labour were in a ‘new era’ of ‘obsession’ around growth4. This includes productivity growth – and how this is the solution through which they can allow for spending. So, was the nation in some sort of fiscal and monetary utopia in the nineties without truly realising it? And why can politicians today not simply return to similar policies and projects of those years?
The issue at hand is one that lies far deeper than these surface level narratives, the problem is not the ideas themselves – but the goals. Defining the right goal, dictates what the strategy or policy will deliver. Productivity growth is an essential goal but not sufficient in itself, understanding what has happened to productivity levels is as important. It sheds light on some of the deeper-roots of the UK’s productivity conundrum. Since the seventies Britain has been significantly lagging behind all other G7 countries in terms of pure productivity levels5. Thus, to deliver growth, needs addressing structural roots of a near fifty year productivity conundrum: how then to address underlying structures, which would make British people’s work pay?
The underlying structures driving productivity levels are complex, however a structural driver that stands out – is Firms. In particular the firm landscape, the ratio of large firms versus small and medium sized firms (SMEs) in the UK economy. While SMEs provide critical sources of employment and income distribution, research has shown that large firm-share in the economy could have a significant influence on productivity6. All sizes of firm have their merit within the greater economic state structure: small firms are often our most nimble innovators, medium firms are a key source of employment, and large firms generally in any economy are the sources of highest productivity and employment. These large firms not only have higher productivity generally, but they also usually have the deepest R&D pockets that raises countries’ R&D private spend as well as provide a wide base of employment for our youth to get employed easily. The loss of large firm share in the UK’s firm landscape is an important contributor to the loss of best-practices training and upskilling, let alone one of the key reasons our youth struggles in finding employment. Large firms are the biggest and widest of employers! Yet, growing the share of large firms in the economy is a strategy absent in Britain for a number of decades. So, growing our share of large firms must be part of the goal – to achieve higher productivity levels, not only short-term productivity growth.
To understand why this matters, let us compare the UK to the US. Whilst it is not always incumbent on us as a nation to compare our performance to our counterparts across the Atlantic, considering the US economic dominance post second world war (contrasting with the UK’s economic decline over the same period), there are clues there that reinforce the above levers for an innovation policy for the UK. Let us start with simple figures – US GDP per capita is over $30,000 greater than here: a 40% increase on our figure7, 8. Going deeper from 2012-2021 US Annual Output per Hour Worked (a monetary measure of how much is ‘produced’ by an average worker within an hour) was medially £8.15 higher than the UK: every hour US workers contributed £8.15 more to GDP than British workers9. This may not sound enormous, but it is key to why the US has higher GDP per capita. Why then is it important to encourage these big firms within the UK, and what connection do they have to this higher productivity?
There is a direct link between this higher per hour US productivity measure and the amount of big firms located there10. Reviewing the top 100 global companies by market cap, one is struck to see they are dominated by American firms, with the Union Flag shockingly under-represented: the first UK company to show up moving down the list is AstraZeneca all the way down at 36 (as of 2nd September)11. Now, the US has its own troubles too, and issues such as privatised healthcare often mean their dollars do not go as far there as they would on these shores. But still, the ‘bang for their buck’ Americans workers are getting seems to be, to co-opt Truman’s phrase, more of a ‘fair deal’. While comparisons of firm shares in US versus UK are not easy to find, a 2016 study of the US Small Business Administration (SBA) showed that the proportion of firms that are ‘large firms’ (companies employing over 250 people and with $50+ million revenue8) in the US is 0.8%12 versus the UK BEIS figure – a measly 0.13%. More notably, this large firm share of the UK has barely shifted from 7,20013 to 7,67514 bizarrely with nominal output, despite inflation, having decreased slightly to £2.032 bn relative to £2.036 bn in 2016. So, in fact our larger firms have been less productive over the last decade! This contrasts with the explosive growth of US large firms, with Apple and Microsoft showing market valuation growths of 900% or higher over the last 10 years, as well as Netflix approximately 860 % and Google 400% plus15. Clearly, US large firms are leaving UK large firms way behind!
This gap of UK large firms lagging behind US counterparts is not restricted to the US alone. Even ignoring the dominance of the States – the fact that Saudi Arabia, Taiwan, Denmark, The Netherlands, South Korea, Switzerland, France and China (x2) all have larger companies (by market cap) does not lend itself to the UK being at the forefront of global business.
So, growth policy in the UK has to also focus on firm structures, as productivity of an economy is to a large extent shaped by the productivity of the firms within that economy. Although most large firms have the highest productivity, some small and medium sized enterprises (SMEs) can also be highly productive. Therefore, as a rule for a country’s long-term growth and higher productivity, we should encourage all firms to grow – whilst many may remain SMEs, some we must encourage somehow to grow into large firms. We need our own Apples, Teslas, Google, Microsofts!
It starts by making some of our most innovative start-ups last the distance and become the next generation of Apples and Microsofts. There is a start-up culture within this country of building quick and selling fast, with little patience for the long-haul. The US differs in so many ways to Britain, in particular their long-term funding for all types of potential innovative Start-ups or SME’s– with the belief that even 1 or 2 of them becoming behemoths will make the difference.
Yet, an innovation strategy focussed on only firm sizes is not sufficient. A holistic innovation strategy would address both the structures, as well as provide serious incentives and long-term vision into policies that enhance the critical drivers of innovation – skilled human resource & sustained financial investment.
Looking at how they invest long term in the US, the investment difference is not only with sheer amounts – but long-term vision and trust. The government’s Defence Advanced Research Projects Agency (DARPA16) for years has looked for emerging markets (primarily tech since the nineties) and offered long-term – often up to 10 year – investment programs, with smaller equity and power put in the hands of the entrepreneurs and visionaries within the company. This has directly affected a number of companies you think of when considering the world’s largest: Tesla, Intel (rooted in Fairchild), Nvidia, even Microsoft and Amazon17, 18, 19. In comparison, UK investment, be it venture capital or bank debt, covers much shorter contracts in the region, typically 3-4 years19 extracting value, rather than founding growth20: these are profit-seeking investments, not for building futures.
An incoming Labour government of ‘change’, one would hope, could make some efforts to alleviate this issue. The Chancellor’s 8th July speech alluded to their manifesto plans to install a new National Wealth Fund: “to catalyse private sector investment”. Whilst the bulk of the speech addressed a range of issues such as planning and supply-side reform – there was also mention of pension funds and their investment capabilities that could “drive investment in homegrown businesses and deliver greater returns to pension savers”. In essence this builds upon last year, when former chancellor Jeremy Hunt’s Mansion House reforms planned for 5% of some of the UK’s largest Defined Contribution pension schemes to be invested in “unlisted equities” by 203021. Let’s hope these investments from a British National Wealth Fund would bring that longer term focus – to support all types of potential innovative firms to show growth over 10-15 years. But investment on its own is not enough – that needs to be changed – it is mindsets.
In fact, there is a distinct lack of discussion within the UK political sphere surrounding financial and investment mindsets. Former Chief Economist at the Bank of England, Andy Haldane, has argued that we need to move from an ‘era of anxiety to an age of aspiration’22, and this change of ethos has to be a goal too. If we bring a longer-term approach to both investments and investment attitudes, addressing the underlying goal that drives productivity – the large firm share of Britain – only then do we stand a chance to get a strategy that truly could deliver growth!
Sources
2. Financial Times (Nov 21 2016), ‘May seeks solution to productivity conundrum’ https://www.ft.com/content/abe39b36-af1b-11e6-9c37-5787335499a0
3. Reuters (Jul 11 2016), ‘Key excerpts from the leadership launch of Britain’s Theresa May’ https://www.reuters.com/article/world/key-excerpts-from-the-leadership-launch-of-britain-s-theresa-may-idUSL8N19X3G9/
4. Evening Standard (4 Dec 2023), ‘Starmer: Labour must be obsessed with growth to turn economy around’ https://www.standard.co.uk/news/politics/keir-starmer-britain-labour-andrew-bailey-margaret-thatcher-b1124494.html
5. Harari, D.; Productivity in the UK, Briefing paper Commons library https://researchbriefings.files.parliament.uk/documents/SN06492/SN06492.pdf
6. Bradley, N (2017) Are Schumpeter’s concerns of firm-sizes perhaps also valid for Productivity? – A structural analysis of firm-sizes and sector composition influence onproductivity levels
7. World Bank – US GDP Per Capita ($) https://data.worldbank.org/indicator/NY.GDP.PCAP.CD?locations=US
8. World Bank – UK GDP Per Capita ($) .
9. Office of National Statistics (2023) ‘International comparisons of UK productivity (ICP), final estimates: 2021’ https://www.ons.gov.uk/economy/economicoutputandproductivity/productivitymeasures/bulletins/internationalcomparisonsofproductivityfinalestimates/2021
10. Bradley, N (2017), Are Schumpeter’s concerns of firm-sizes perhaps also valid for Productivity? – A structural analysis of firm-sizes and sector composition influence on productivity levels.
11. List of largest companies by market cap https://companiesmarketcap.com/gbp/
12. Bradley, N (2018), Why does the UK not have its own Google, let alone a new ARM – does firm independence matter?’ An assessment of how firm independence and tax, financing and regulatory policy incentives are impacting firm growth in UK.
13. BEIS Business population estimates for 2016 https://assets.publishing.service.gov.uk/media/5a8164c6e5274a2e87dbd640/bpe_2016_statistical_release.pdf
14. BEIS Business population estimate 2022 https://www.gov.uk/government/statistics/business-population-estimates-2022/business-population-estimates-for-the-uk-and-regions-2022-statistical-release-html
15. US Firms market valuation growths in 2024 over last decade https://finbox.com/NASDAQGS:AAPL/explorer/asset_price_return_10y/#:~:text=Ten%20Year%20Stock%20Price%20Total,dividend%20adjustment%20factor%20is%200.89.
16. DARPA’s role in building firms https://unherd.com/2018/06/government-agency-made-silicon-valley/
17. Silicon Valley funded by US government & DARPA https://hbr.org/2013/03/taxpayers-helped-apple-but-app
18. DARPA funding to Microsoft https://azure.microsoft.com/en-us/blog/quantum/2024/02/08/darpa-selects-microsoft-to-continue-the-development-of-a-utility-scale-quantum-computer/#:~:text=When%20presented%20with%20a%20variety,by%20DARPA%20for%20continued%20investment.
19. Venture capital comparisons between US and UK https://www.lewissilkin.com/en/insights/venture-capital-in-the-us-and-uk-a-comparison
20. https://marianamazzucato.com/books/the-value-of-everything/
21. Jeremy Hunt’s Mansion House Speech https://www.gov.uk/government/speeches/chancellor-jeremy-hunts-mansion-house-speech
https://harperjames.co.uk/news/pension-funds-will-be-able-to-invest-in-tech/
22. Royal Society of Arts (8 May 2024), ‘From the era of anxiety to an age of aspiration’ https://www.thersa.org/blog/2024/05/andy-haldane-rsa-ceo-lecture-anxiety-aspiration#:~:text=With%20large%2Dscale%20investment%2C%20he,year%20while%20averting%20planetary%20threats.