Where will growth come from?

1. Where will growth come from? Notes from lecture given by Prof John Van Reenen (LSE) 17 February 2011

2. A ‘V’ shaped recovery ... For now

3. 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

4. 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

5. A fall in trend growth estimates

6. And high long term unemployment

7. Investment and Productivity

8. Fiscal austerity & public sector jobs

9. 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

10. 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

11. Productivity Improvements

12. Output per person hour

13. 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

14. 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

15. 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

16. What else would you want to put into Plan V?