Here Paul Ormerod explains how and why the UK should target economic growth in particular places, notably second-tier cities. Paul also highlights the importance of facilitating increased productivity within the Small and Medium-sized Enterprises (SME) sector. The piece also suggests that more effectively spreading innovation or “technical progress” within industries can play a crucial role in increasing productivity.
Targeting growth policy and investment where it matters most
Much policy discussion around growth centres on investment. This can be investment in the capital stock of companies, spending on infrastructure or in what economists call “human capital”. In other words, increasing the educational standards and skills of the labour force.
The approach has a sound basis in economics. Increases in both the stock of physical capital and the labour force are the foundations of the modern theory of economic growth, first formalised in 1956 by the MIT academic Robert Solow.
The policies of the current Chancellor are essentially based on this basic description of the Solow model of economic growth. Rachel Reeves is emphasising in particular the role of investment in infrastructure.
But there are two key points connected to the literature on economic growth which are barely being addressed by current policies.
The first of these is a factor in the Solow model which we have not yet mentioned. His jargon phrase for it was “technical progress”. By this, economists essentially mean the spread of both better technologies and better ways of working to existing firms. These play a crucial role in raising the overall level of productivity in an economy.
Empirically, it is this factor which is the main source of economic growth in developed economies.
Although it is not an entirely new area of enquiry, much more attention has been paid in recent years to the differences in productivity levels – output per worker – across firms in the same industry.
The importance of these differences is shown by the fact that the United States Bureau of Labor Statistics and Census Bureau announced in 2020 a new data product, Dispersion Statistics on Productivity, to measure and track it over time.
The issue has been investigated here in the UK by the Office of National Statistics (ONS). Their work confirms the statement made by Andy Haldane when he was at the Bank of England: “A long and lengthening tail of [poor performing] companies explains why the UK has a one third productivity gap with its international competitors”.
The differences in productivity within companies in the same industry is quite striking. Looking at firms at the very top and those at the bottom, the former can easily be 4 or 5 times more productive. And these are companies within the same industry, usually defined very narrowly by the researchers.
The American work cited above compares not these extremes, but more typical firms in a wide range of manufacturing industries. For example, the productivity of the company which is more efficient than 75 per cent of all companies and less efficient than the top 25 per cent with the one which is simply more efficient than the worst performing 25 per cent. On average the former is 2.4 times more productive than the latter.
Big infrastructure announcements generate a lot of publicity, which is why politicians of all parties like them when they are in power. But a set of policies which target raising productivity in SMEs could well be much more effective.
Local knowledge of companies is essential and is being used in a pilot scheme called the Innovation Accelerator in Glasgow, Manchester and the West Midlands. Even though the monies available are just £100 million over two years, there are already some striking successes.
There is an existing network of organisations whose purpose is exactly to assist companies adopt better technologies. The High Value Added Manufacturing Catapult, for example, has seven centres in various places across the country. But its total budget is only some £300 million a year.
Given the huge difference in productivity levels across existing companies, a substantial increase in this budget could, whilst still modest in the overall context of an annual public expenditure level of £1,200 billion, make a noticeable difference to economic growth.
The second factor which is missing from the current policy mix is the spatial dimension.
To be fair, the current government is actively devolving powers to regional mayors and local authorities. But there is not very much in the way of additional resources. The changes essentially give local politicians more freedom to decide how a given amount of money is spent.
The gap in the levels of productivity and incomes between London and the South East and the rest of the country is well documented. Value added per worker in London is around 60 per cent more than it is in Wales, for example.
To this end, one might have thought that a policy of trying to raise the productivity of underperforming areas would be a sensible one (for transparency, I chair both the Atom Valley Greater Manchester Mayoral Development Zone and the Rochdale Development Agency).
This is particularly so in the case of city-regions, where economic activity is already concentrated, rather than in geographically isolated towns.
There is a marked gap in productivity and incomes between what the OECD calls second-tier cities and their European counterparts. Their estimate is that, collectively, cities such as Glasgow, Leeds and Manchester have levels of output per head which are 30 per cent below their German counterparts and 22 per cent below France.
The OECD goes on to note “the productivity gap is a sign of significant untapped potential”.
Locating in Britain’s “second tier” cities is undoubtedly cheaper for both firms and individuals than it is in London. There is therefore an incentive to do so.
But in this context, these conventional market forces are swamped by the powerful factors which give cause to success reinforcing success. Feedback loops make the rich areas richer and trap the poorer areas.
The economics underlying this was set out over 100 years ago, well before the phrase “feedback loop” was invented, by Alfred Marshall, who was at the time the leading economist in the world.
Marshall noted that there are very substantial benefits for companies when they locate close to successful firms in their own industry.
For example, there are knowledge spillovers. Even in the age of the internet, knowledge can flow more easily through inter-firm collaboration when the companies are located closely together. A common pool of labour force skills is developed.
These are powerful forces. A European Commission report in 2019 identified 200 “high performing” industrial clusters across Europe generated by these feedbacks in which average productivity was 140 per cent higher than in firms in the same industry which were not in clusters.
The gap in productivity between London and the regions represents a major opportunity to boost economic growth in the UK.
But to break out of the feedback loops which hold them back from realising their full potential, our city-regions need a major boost from public spending, one which at the moment is not on the government’s radar.
The two areas of policy to raise growth and productivity discussed above have a crucial theme in common. Namely, their focus is to pick low hanging fruit by enabling underperformers, whether companies or city regions, to catch up. It is not glamorous, it is not pushing the frontiers of scientific knowledge, but it is the most effective way of increasing economic growth.
About the author
Paul is an Honorary Professor at the Alliance Business School at the University of Manchester, and an economist at Volterra Partners LLP. Paul also chairs the Rochdale Development Agency (RDA) which is responsible for economic development in the Metropolitan Borough of Rochdale, in Greater Manchester.
Image credit: Joe Cleary on Unsplash