The UK productivity gap

Source:"Productivity and social partnership", TUC, April 1998

Reasons for the productivity gap

Two recent documents from the Department of Trade and Industry (DTI) - Competitiveness UK: A benchmark for business (November 1997) and Differences in companies' performance: British industry's under-performing tail (February 1998) - set out the Government's views on the reasons for the UK's productivity gap, and below we summarise some of the key points.

The Government believes that there is much to be done if the UK is to match the world's strongest economies - and this includes improving its productivity performance. It is stated that there is a general consensus between trade unions and employers on the need to improve productivity as the key to improving costs, increasing profitability, and being able to reward employees better (although the social partners may not necessarily agree on the solutions). The Government believes that, as well as the USA, the UK will increasingly have to look to Europe and to some areas of Asia to match best-practice performance in productivity.

Part of the explanation for the productivity gap in industries where there are significant economies of scale might be that UK firms are, on average, smaller than in other countries, it is suggested. Some support for this view is provided by a DTI study suggesting that productivity could be as much as 5% higher than present levels if UK firms were on average as large as those in Germany. However, there are exceptions to this - for example, in pharmaceuticals where the UK industry, with a relatively high number of SMEs, achieves higher productivity than its German counterpart. It is concluded that clear that size is not the only explanation for lower productivity in the UK.

Given that British productivity levels fall significantly short of those in other advanced industrialised countries, two alternative interpretations of this fact are suggested:

1. that it is the presence of a "tail" of poorly performing companies that drags down the UK average. On this view, the UK has as many "world-class" firms as other countries have, but fewer companies in the middle of the performance distribution and more poorly performing companies; or

2. that the performance of UK companies is worse in general than that of companies elsewhere. British industrial structures are not significantly different from those of its competitors and most industries have a similar mix of high, medium and low performers, with "heads", "bodies" and "tails" in similar proportion to each other.

If the first interpretation is correct, this would mean that the overall performance of the UK economy could be significantly improved if the underperformers could catch up by adopting UK industry best-practice policies. If the second interpretation is correct, then this would mean that companies of all sizes would need to improve their performance, and companies (especially larger ones) should look abroad to find examples of "world-class" performance.

International comparisons by the DTI of five industries (steel, chemicals, pharmaceuticals, office machinery and automotive components) across four countries (UK, France, Germany and Italy) suggest that, with some exceptions, the leading British companies do not achieve the same level of labour productivity as that of the most productive leading European companies in their respective industries. Company size does not appear to be synonymous with performance. On the basis of company data, British industry - with the exception of pharmaceuticals - records a lower average productivity than its French and German counterparts, and this is broadly consistent with the census of production data.

Other findings of the study were that:

• companies in the "tail" of low performers pay lower wages, earn less profits per employee, earn lower returns on capital employed, are less capitalised and earn lower stock returns relative to their industry average;

• the tails of under-performers in British manufacturing industries are longer than those in France, Germany and Italy in absolute terms, but not relative to each industry's average productivity;

• the productivity of the leading British firms, which typically are in the "body" of their respective industries, tends to lag behind that of their continental counterparts;

• on the whole, German industries exploit scale advantages more than their British counterparts and in some cases up to 25% of the productivity difference can be attributed to the fact that British firms were smaller;

• if British companies could reduce their scrap rates, they would achieve up to an 25% increase in profit on sales; and

• factors which differentiate high and low performers are also related to plants' "lead times" - the time the plant requires to procure and manufacture products. In other words, good plant performance is primarily a product of management effectiveness, rather than the nature of the industry and its product.

Commentary

The UK lags behind in productivity in part because of the lack of investment in equipment, infrastructure, technology and skills. According to the DTI, for every GBP 100 invested per worker in the UK between 1983 and 1994, GBP 140 was invested in Germany, GBP 150 in France and GBP 160 in Japan.

Changes in markets, processes and technology mean that businesses now require different and higher skills, but in the UK there is a lower proportion of qualified people than in some other developed economies, despite the fact that the UK has the EU's highest proportion of graduates in the population.

In general, UK spending on research and development compares better with other countries in high-technology industries, such as chemicals, and worse in medium- and low-technology sectors. Nine companies in pharmaceuticals, aerospace and chemicals account for one-third of all UK private sector research and development.

There is also some evidence that highlights management as a particular weakness. In particular, some commentators argue that managers often lack vision and are too concerned with short-term cost-cutting rather than building their businesses, having no clear long-term plans.

The UK is arguably fast becoming known as a low-pay, low productivity economy, yet the nature of work is changing. More and higher skills are needed in all sectors. If matters do not change, it is likely to become increasingly difficult for unskilled people to find jobs and their relative wages compared with skilled workers are already falling. The social partners agree that the Government is on the right track in emphasising commitment to growth and investment, building high-productivity workplaces and investing in skills and lifelong learning. Additionally, human resource management and industrial relations commentators have long debated the "short termism" of British industry, which is a reflection of corporate governance structures - including the ease of takeover/mergers and the pressure from the City to produce short-term profits. These issue must be addressed seriously if the UK economy is to close the huge gap in productivity. (MW Gilman, IRRU)