Select Committee on Treasury Appendices to the Minutes of Evidence


Memorandum by Ms Mary O'Mahony, Senior Research Fellow, National Institute of Economic and Social Research


  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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