Select Committee on Treasury Minutes of Evidence

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

  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.


  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 important.

  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 Tape—The 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 contributions—the 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 cautious approach.


  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 international comparisons?

  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?

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