APPENDIX 3
Memorandum by Ms Mary O'Mahony, Senior
Research Fellow, National Institute of Economic and Social Research
BUDGET 2001, THE IMPACT ON THE PRODUCTIVITY
CHALLENGE
1. NIESR is a non-profit making institute
devoted to academic research with a focus on quantitative research
of relevance to policy. Mary O'Mahony's primary area of expertise
is in measuring and explaining international differences in productivity;
her estimates underlie many of the numbers reported in recent
Treasury documents on the Productivity Gap.
2. Since taking office the Chancellor has
put emphasis on lowering Britain's productivity deficit with its
major competitors. In fact the gap relative to the US has widened
since the 1997 election and Britain has shown little improvement
relative to other major European nations. However, it is important
to note that closing of the gap involves chasing a moving target
and, at least in the case of the US, the target has been moving
rapidly in recent years with the well publicised boom in the US
economy. This was compounded by a short term slowdown in UK productivity
growth in the late 1990s, probably due to the high value of Sterling
affecting manufacturing productivity plus some impact from employment
creation as discussed in the budget report "Productivity
in the UK: Progress towards a productive economy". Much of
these recent movements are beyond the reach of policy and should
not been seen as a Government failure. On the other hand there
is a persistent long-term gap which appears to be unresponsive
to policy initiatives and which is likely to take a long time
to rectify.
3. Despite the rhetoric and the publication
of the above mentioned report, Budget 2001 did not contain many
measures which were directly aimed at reducing the productivity
gap. Government measures to address this issue can be divided
into four areas: 1. the general environment in which firms operate;
2. the tax system; 3. Government expenditures and 4. public sector
productivity.
4. The first of these encompasses macroeconomic
stability, competition policy and regulation. Government policy
has been reasonable in achieving macroeconomic stability and this
is likely to have a positive impact on productivity by reducing
uncertainty and hence stimulating investment. There is a general
consensus that greater competition has a positive impact on productivity
through incentives to reduce slack. Budget 2001 contains some
minor measures aimed at enhancing competition in line with government
commitments to remain vigilant in preventing anti-competitive
behaviour. Finally, in terms of regulation the budget contains
some measures to reduce "red-tape" to small businesses.
But there is a need for greater recognition that tax measures
designed to address what are seen as microeconomic failures create
additional regulatory burdens and hence impose costs on firms.
5. The primary alteration in the tax system
proposed in the budget is the promise to extend the R&D tax
credit to larger firms. My own estimates suggest about one third
of the current US labour productivity lead over the UK can be
explained by consistently less resources devoted to R&D in
Britain. There is considerable academic debate on the likely impact
of tax credits on R&D activity—for example, these credits
can lead firms merely to reclassify current expenditure as R&D
rather than raising innovative activities. But there appears to
be a consensus that the credits will have a positive impact, primarily
due to the existence of external benefits from R&D whereby
social benefits are greater than private returns. However, there
remains some uncertainty about the exact form the credit should
take—a small credit on total expenditures or a larger credit
on incremental expenditures. Hence I welcome the Chancellor's
decision to consult on this rather than bring in the change immediately.
6. In terms of R&D it is also important
to consider the supply of suitably qualified scientists and engineers.
The budget mentions a consultation report on this aspect of innovative
activity and this should prove useful. In this context it is important
that any measures to stimulate a greater supply of trained scientists
and engineers are integrated with government policy on higher
education in general.
7. In terms of expenditures Budget 2001
contains a commitment to a substantial increase in real resources
to education. Good general school education is a necessary building
block to acquire the skills needed in the modern technological
economy. But this is unlikely to be sufficient and additional
focus on the amount and quality of training is needed. The government's
priority appears to be on targeting the lowest skilled groups.
This may be laudable in terms of distributive goals but is unlikely
to have a major impact on the productivity gap.
8. Academic research clearly points to skills
acquired at the higher education level as most likely to have
the greatest impact on productivity and there is increasing evidence
from firms of shortage in this crucial area. Recent estimates
suggest that a far greater proportion of the US workforce have
qualifications at degree or above level. There has been an expansion
of numbers of persons attending the UK higher education institutions
in recent years but it will be some time before this has a large
effect on the stock of highly skilled workers. Moreover, although
numbers have expanded, real expenditure per student has not increased
in recent years, raising serious questions on the quality of the
education received by these students. Budget 2001 does contain
some commitment to raising real expenditure per student but much
more needs to be done. Also there is some evidence that the top
universities are reaching capacity constraints which will put
a brake on further expansion.
9. There is likely to be little disagreement
that raising public sector productivity is worthwhile but much
less consensus on how to achieve this. In this context there appears
to be very little recognition among policy makers of the existence
of long-term trade-offs between attempts to increase public sector
productivity and other goals. For example excessive monitoring
of public sector employees may have long-term adverse consequences
affecting the morale of public sector workers and hence making
public sector jobs relatively unattractive. This can lead to shortages
in crucial areas, most notably education, affecting the quality
of the output of these sectors. In turn this could have adverse
effects on the aim of lowering the productivity gap.
10. In summary, Budget 2001 contains very
few direct measures aimed at reducing the productivity gap, but
general commitments to a stable competitive environment and raising
spending on education and infrastructure are likely to have some
impact. What is lacking in this budget, as in previous policy,
is an integrated approach to "microeconomic tinkering"
with the economy which attempts to understand interactions between
various policy aims and the extent of any long term adverse consequences.
March 2001
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