Memorandum submitted by Mary O'Mahony,
Senior Research Fellow, the National Institute of Economic and
The National Institute is Britain's leading
independent economic and social research institute. In addition
to its well cited forecasts of the UK and World economies it has
a long standing research program on productivity and economic
growth. Much of the debate on Britain's productivity position
take as a starting point estimates produced by NIESR. Mary O'Mahony's
primary area of expertise is in measuring and explaining international
differences in productivity.
The Budget 2002 has very few measures specifically
tailored to closing the productivity gap with our main competitors,
the main important exception being the R&D tax credit which
was announced in advance. The recognition that the skills of the
existing workforce need to be upgraded and that this involves
a range of costs is welcome as are the proposed pilot schemes.
However making serious inroads into the skills gap may be more
expensive than government forecasts. It is unclear why the forecast
of the trend rate of growth has been increased at this time given
uncertainty over the components which make up the forecast.
1. Britain continues to lag our main competitors
in terms of output per hour worked and also lags the US in terms
of underlying total factor productivity. Despite significant improvements
in the past decade in workforce skills and some reduction in the
capital intensity gap, Britain has not significantly improved
its relative position. Much of this is due to a pronounced deceleration
in manufacturing productivity.
BUDGET 2002 MEASURES
2. In general terms there is very little
in the budget which targets productivity specifically. The exceptions
are the R&D tax credit and the pilot measures to improve access
to training schemes. Other changes are likely to be neutral or
have only a small direct impact on productivity. Continuing the
policy of achieving macroeconomic stability and providing the
appropriate environment for firms to invest and innovate are of
more importance. Hence the government's continuing commitment
to providing a more competitive less regulated environment is
3. Britain falls behind the US and major
European economies in the percentage of GDP devoted to R&D.
Hence the R&D tax credit and its generous rate will be welcome
in stimulating productivity growth. Research suggests that in
the long run the R&D tax credit will lead to a fairly large
stimulus to R&D and hence to underlying productivity growth.
4. Developing workforce skills. An interesting
development in Budget 2002 is that the government has recognised
that, despite improvements in education and training, there remains
a substantial proportion of the workforce with low or no skills.
Thus a third of the workforce, close to nine million people, have
qualifications below level 2. Although much has been achieved
in improving the educational attainment levels of young persons,
there is a recognition that it is necessary to update the skills
of those already in the workplace in order to achieve faster improvement
and close the skills gap with our major competitors. The government
has also recognised that market failures can hinder attempts to
increase skill levels of these persons. Thus there is the problem
of who appropriates the gains from training, the need to inform
persons of the range of training options available and meet additional
costs borne by small businesses. The Budget 2002 therefore suggests
a pilot scheme which can be used to gauge the impact on these
constraints. The proposed scheme will pay the costs of training
workers, encourage paid leave for training and give financial
aid to firms who will bear the cost of the foregone output and
so seems on the surface to be a useful proposal. However, to make
a significant impact on the skills gap the uptake needs to be
high. But if this happens the cost of the scheme may be far in
excess of the £1 billion forecast. A conservation estimate
of the cost of two weeks training, which takes accounts of the
costs of training, paying the employees while they are being trained
and compensating employers is about £1,000 per year. If all
low skilled workers were to receive training, the scheme would
cost about £8-9 billion. It is probably not realistic to
assume that all low skilled would be involved in any one year,
and may even not be desirable so the above figure may be an overestimate.
Against this two weeks training my not be sufficient. The general
point is that the government cannot easily make up for decades
of under-investment in workforce skills in a few years. Nevertheless
this scheme is a step in the right direction.
5. Reduction in Red TapeThe are a
few measures which are designed to aid business in reducing their
tax burden and simplifying the tax system leading to reductions
in the administrative burdens on firms. These should increase
productivity although, as most are targeted at small firms, the
impact on the aggregate productivity gap is likely to be small.
6. Increasing national insurance contributionsthe
increase in the employer's rate in the short term may have an
impact on jobs. If firms substitute capital for more costly labour,
in particular high technology capital, then this would serve to
raise productivity. Against this the tax is levied proportionally
more on high paid (and higher skilled) workers which may have
adverse incentive effects on firms' willingness to hire these
workers and hence lower productivity growth. On balance it is
not clear what the direct impact of this will be on productivity
but it is likely to be small.
7. Public sector productivity. The Budget
2002 suggests a continuing commitment to raising public sector
productivity. Since the public sector accounts for about one fifth
to one quarter of economic activity, ant measure which raises
productivity in this sector, in theory should have an impact on
aggregate productivity. In practice, the method employed to measure
public sector productivity in the national accounts means that
any improvements will not show up in published growth figures.
The productivity gap with other countries will similarly be unaffected
as output of this sector is largely measured by inputs in all
countries. This does not mean that improvements here are unimportant.
Rather there is an urgent need to carry out research into the
extent to which productivity in the public sector has improved
over time and how Britain compares to its main competitors. This
should consider not just the immediate impacts of policy changes
but also any long term consequences, for example, the impact on
the morale of public sector workers.
8. Targeting the NHS could have a direct
effect on productivity by increasing the health of the workforce
and so reduce absenteeism. But the impact is unknown and likely
to only occur in the very long run. The announced changes should
also have a direct effect through raising productivity in the
health service but, as with public sector productivity in general,
the impact will be difficult to measure.
9. Public Infrastructure. Increased public
expenditure has an indirect impact on productivity through raising
the effectiveness of public infrastructure, in particular transport
infrastructure. The Budget states that the government is committed
to the public investment share of GDP but does not show any commitment
to transport specifically.
10. Trend growth: Recent Developments and
Prospects. The Treasury has revised upwards its forecast of trend
output growth by 0.25 percentage points which has large implications
for the public finances. The forecast depends on trends in both
labour productivity and labour input. In the case of the former
the estimate is reasonably conservative, and within the range
produced by other forecasting bodies. The rate is however somewhat
higher than the actual rate achieved in recent years. Against
this it make no allowance for impacts from the new economy, increases
in the skill base of the workforce, or impacts from the R&D
tax credit which are all likely to raise labour productivity growth.
However there remains considerably uncertainty regarding the components
which feed into labour productivity forecasts. The second element
is the assumption of an increase in both the employment rate and
the working age population. These forecasts are very dependent
on assumptions on immigration patterns on which there is also
a considerable degree of uncertainty. Given these uncertainties
the upward revision seems to a reversion of the government's usual
If the pilot schemes on developing workforce
skills are found to be successful then will adequate finance be
made available to fund a general scheme?
Is there a commitment to research further the
extent of improvements in public sector productivity and undertake
If there is increased expenditure on rail transport
will this be at the expense of other transport areas, eg investment
in roads. If so what are the long term implications of this?
Given that we are currently at full employment,
increases in employment in the NHS will most likely in the short
term come through immigration. Is the government examining the
regulatory and certification system to facilitate this?
What are the implications for the public finances,
if any, of raising the trend growth rate projection?