Education, skills and productivity: commissioned research - Business, Innovation and Skills and Education Committees Contents

1. Introduction

In the decade leading up to the 2008-09 recession, average labour productivity (ALP) grew faster in the UK than in the US, France and Germany, thus helping to narrow the longstanding gaps in ALP levels between the UK and those three countries. However, in the wake of the UK's relatively poor productivity growth performance during and after the recession (Figure 1.1), ALP levels-measured by Gross Domestic Product (GDP) per hour worked-were estimated to be about a third lower in the UK in 2014 than in all three of the US, France and Germany (ONS, 2015).Figure 1.1: Average annual rates of growth in constant-price GDP per hour worked in France, Germany, UK and US, 1998-2014

Source: ONS Statistical Bulletin, International Comparisons of Productivity — First Estimates, 2014 (released 18 September 2015)

In this report we examine the extent to which these inter-country differences in productivity performance can be attributed to skill deficiencies in the UK relative to the other three countries, paying particular attention to national-institutional differences in the ways that skills are produced and developed in each country.

Researchers have identified numerous examples of mechanisms by which skills can contribute positively to economic performance, in particular, the role of skills in supporting the introduction of new technologies and in facilitating knowledge transfer (between regions, countries and industries) and in fostering innovation of different kinds (Lundvall, 1992; Bresnahan et al, 2002; Chun, 2003). However, skills can only make such positive contributions when they are applied in combination with other production inputs, for example, machinery, equipment, buildings, land and raw materials as well as intangible assets such as those deriving from investments in innovation.

Thus skills tend to feature only partially or indirectly in most attempts to explain the recent weakening of UK productivity performance. For example, Pessoa and van Reenen (2014) argue that the decline in UK labour productivity during and after the recession owed much to labour-both skilled and unskilled-having less physical capital to work with as firms substituted capital for labour in response to falling real wages and higher costs of capital. They estimate that average capital stocks per worker declined by 5% between the second quarter of 2008 and the second quarter of 2012, and that this accounted for around two thirds of the productivity decline during this period.

This 'capital shallowing' hypothesis has been disputed by several other researchers. For example, Oulton (2013) argues that the estimate of capital per worker used by Pessoa and van Reenen overstates the pre-crisis level of capital stock and therefore overestimates the post-crisis decline in the capital-labour ratio. In addition, recent growth accounting studies have found that weak labour productivity growth in the UK owes little to capital shallowing but instead is much more attributable to relatively poor performance in 'total factor productivity' (TFP, a measure of changes in value added per hour worked that cannot be attributed to increases in the quantity and quality of either capital or labour) (Goodridge et al, 2015; Murphy and Franklin, 2015). To a large extent the TFP measure captures the efficiency with which existing capital and labour resources (both skilled and unskilled) are utilised but it can also reflect unmeasured (or poorly measured) production inputs in growth accounting calculations. [1]

Potential insights into the links between skills and productivity trends emerge when a sectoral perspective is adopted. Dolphin and Hatfield (2015) report evidence of a structural shift from high-productivity to low-productivity work, especially over the last three years. They use shift-share analysis to decompose the UK productivity gap in relation to four other European economies (Germany, France, Netherlands, Belgium) and estimate that around half of the weakness in UK productivity growth since 2012 derives from structural shifts in the economy, with strong job growth in relatively low value-added, low-paid sectors of the economy. They argue that the proportion of over-qualified and/or over-experienced workers has increased and that many firms are making less use of the skills available to them than they were before the financial crisis.

However, in contrast to this assessment, other researchers report evidence of a reallocation of work-hours away from low-productivity industries and towards high productivity industries, consistent with growing employment of high-skilled workers in the creation of intangible assets related to research and innovation (Goodridge et al, 2013, 2014).

Indeed, recent growth accounting-based estimates suggest that labour productivity growth could have been even weaker in the UK in recent years had it not been for significant up-skilling of the workforce. Using skill measures based on formal qualifications, Rincon-Aznar et al (2015) estimate that, in the run-up to the 2008-09 financial crisis, growth in skills accounted for around 20% of total labour productivity growth in the UK. Between 2008-13 (that is, during and after the financial crisis), overall growth in labour productivity was negative on average—largely because of declining total factor productivity—but skills continued to make a positive contribution.

Thus, even if limited use of skills contributes to low productivity in some sectors of the UK economy, it cannot be argued that weak productivity growth in the UK is primarily due to skill deficiencies, nor that skill improvements on their own will ensure more rapid growth in productivity in the future. Nonetheless, investment in skills development—in conjunction with many other kinds of investment (in both tangible and intangible assets)—has an important part to play in fostering productivity growth. Hence it is instructive to look at how the UK compares with other countries in terms of, for example, the mix of high-level and intermediate skills that are produced and the different institutions underlying both general and vocational education and training, and to assess what policy implications (if any) these comparisons yield for the UK.

The report is ordered as follows. In Section 2 we describe the main differences between the UK, US, France and Germany in the composition of workforce skills. Section 3 then explores high-level skills issues with emphasis on university graduates' contributions to innovation and productivity growth and on graduate employability skills issues. Section 4 focuses on intermediate skills development, in particular, the roles played by technician-level training, apprenticeship training and full-time vocational schooling in the four countries. Section 5 assesses the extent of skills upgrading through continuing training of adult workers in each country. Section 6 summarises our main findings and considers what implications (if any) they have for UK policy-makers.

1   Growth accounting is a method of estimating the separate contributions of production inputs to growth in labour productivity. It does not take account of complementarities between production inputs. Total factor productivity is estimated as the residual growth in labour productivity which is not accounted for by growth in measured production inputs. Back

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Prepared 5 November 2015