2SMEs and Productivity
What is productivity and why does it matter?
5.Productivity in its simplest terms is the total output produced per input within an economy.16 The OECD more specifically sees productivity as how efficiently inputs, such as labour and capital, are used to produce a given level of input.17 Raising productivity is a key Government priority and core to the UK’s Industrial Strategy: “By improving productivity while keeping employment high, we can earn more—raising living standards, providing funds to support our public services and improving the quality of life for all our citizens”.18 The Institute for Directors have also argued that increased productivity is the “only way to sustainably increase individual income—and ensure long-term economic growth, and improvement in living standards”.19
The UK’s overall productivity gap
6.The Office for National Statistics (ONS) has noted that UK productivity has not grown as expected for some time, including the first two quarters of 2018.20
Chart 1: Output per Hour and Output per Worker - Q1 1994 to Q2 2018
Source: Office for National Statistics, Labour productivity, UK: April to June 2018, (October 2018), p 5
7.The ONS published figures in April 2018 that showed that the UK has had a productivity gap with the majority of its G7 competitors for some time.21
Chart 2: G7 Countries GDP per Hour Worked
Source: Office for National Statistics, International comparisons of productivity, (April 2018).
Chart 3: G7 Countries GDP Per Worker 1995–2016
Source: Office for National Statistics, International comparisons of productivity, (April 2018).
The ONS notes that amongst G7 countries, the UK has the largest “productivity puzzle”, in terms of why its productivity has taken so long to recover from the financial crisis (2007–08). While the difference between post-financial crisis productivity and pre-financial crisis productivity in 2016 was 15.6 per cent for the UK, the average for the rest of the G7 was 8.7 per cent.22 This prompted Andy Haldane, Chief Economist at the Bank of England, to refer to the period after the financial crisis as the “’lost decade’ and counting” in which UK productivity “essentially flat-lined”.23 He has questioned whether the UK’s productivity gap will ever be closed.24
8.The UK has also performed worse than many OECD countries in terms of labour productivity growth, with growth particularly weak in manufacturing:25
Chart 4: Labour Productivity before/after Financial Crisis -Annual Growth in GDP Per Hour Worked Manufacturing and Business Services
Source: OECD, OECD Compendium of Productivity Indicators 2018, (2018), p 17
9.In addition to the differing performances of the manufacturing and service sectors, the ONS has also noted that there are regional variations across the UK in terms of productivity per head. While London and the South East perform well above the overall UK average, regions such as the West Midlands, East Midlands, Yorkshire and The Humber, the North East, Northern Ireland and Wales are performing considerably below.26 These regional variations are the highest amongst OECD countries.27 This has been acknowledged by the Government and its increasing emphasis on ‘rebalancing’ the UK economy.28
Small businesses and the ‘Long Tail’ of UK productivity
10.Small businesses have become a focus for understanding why UK productivity is below most of its international competitors. Commentators have pointed to the ‘long tail’ of unproductive small businesses,29 which are acting as a drag on the rest of the economy.30
Chart 5: Distribution of Productivity by Firm, Size Density
Source: Institute of Directors, Lifting the Long Tail: The Productivity Challenge through the Eyes of Small Business Leaders, (October 2018), p 6.
For instance, the ONS have found that 90% of the firms in the bottom 10% of the labour productivity distribution–“the laggards”–were micro-firms employing less than 10 people.31 In contrast, the top performing quartile of corporates are roughly two to five times more productive than the bottom quartile and this gap between such companies has widened compared to other countries, such as Germany and France.32 Moreover, the ‘long tail’ of unproductivity has been historical and pre-dates the 2007–08 financial crisis.33 This ‘long tail’ was acknowledged by the Government when it published its Industrial Strategy in November 2017:
Our relatively weak productivity performance is, to a significant degree, a problem of composition: we have some of the most productive businesses, people and places in the world but also a ‘long tail’ of underperformance. Britain’s top businesses are among the most admired in the world, but if the long tail of lower productivity persists, it will hold back UK growth, wages and living standards.34
11.In May 2018, the Government launched a productivity review on what actions could be most effective in improving the productivity and growth of small and medium-sized businesses.35 The Minister told us that on productivity: “as we all know, we are not there. It is an ongoing process …. There is still more work to do”.36
12.The UK is falling behind many of our competitors on productivity and its performance has been particularly weak since the financial crisis of 2007–2008. Productivity is weakest amongst a ‘long tail’ of small firms and micro-businesses, particularly in manufacturing and in a number of regions outside London and the South East. The Government has acknowledged the challenge of weak productivity and the problems it poses in terms of growth, wages and living standards. It is therefore right that it has made productivity a central plank of its Industrial Strategy and is committed to rebalancing the UK economy away from London and the South East. We welcome the Government’s Productivity Review and we await its outcome. We recommend that the Government’s Productivity Review sets out how it will promote the improvement of productivity across the whole of the UK economy to ensure that it is sustainable and equitable. This should include policies designed to reduce imbalances between small businesses in different sectors and regions, with relevant metrics, such as those indicating progress in reducing the productivity gap between London and the South East and other regions.
What does productivity mean to small businesses?
13.Research published in January 2018 found that about 15% of SMEs surveyed did not know what productivity was, 29% did not know how to measure it and 37% said that they did not have time to measure it.37 This was confirmed by a number of witnesses we heard from. The Institute of Directors, for example, referred to what it termed as “productivity illiteracy”, whereby few SMEs were aware of their own productivity and whether there was a gap.38 We were told that a lack of understanding about productivity meant that many SMEs were unable to identify what they might need to make them more productive,39 and misjudged their own performance relative to their peers.40 The Federation of Small Businesses said that that often SMEs were too focused on their own businesses in terms of growth and profits to think about productivity and what it meant for them and the wider economy.41 The inability or reluctance of many SMEs to measure their productivity is in spite of the availability of online tools, such as those provided by the ONS42 and Be the Business.43 The key question is therefore why so many SMEs do not measure their productivity and how they can be convinced that doing so will be beneficial. The Minister acknowledged that, until recently, productivity had not been a “buzzword” and that it was a challenge for small businesses to identify what their productivity was.44 She told us that the Government was engaged in dialogue with stakeholder organisations, such as the Federation of Small Businesses, to raise the profile of productivity with small and micro businesses.45
14.The concept of productivity is still not widely understood by SMEs and most would struggle to measure it or recognise the benefit of taking action to improve it. The Government should connect and engage with SMEs, both directly and through representative bodies, to ensure that businesses have a more meaningful understanding of productivity, why it matters to them and why they should invest time in measuring and acting upon it. We recommend that available tools to measure productivity, such as those developed by the Office for National Statistics and Be the Business, should be clearly visible on a single portal for SMEs. The Government should ensure that data analytics are used to track how these tools are being used and to ascertain if they need to be recalibrated to encourage wider use.
16 BEIS, Business Productivity Review, (May 2018), p 9.
17 OECD, Defining and Measuring Productivity, (accessed 1 November 2017). See also: OECD, OECD Compendium of Productivity Indicators 2018, (2018), pp 9–10. See also: Michael Mankins, Great Companies Obsess over Productivity Not Efficiency, Harvard Business Review, (March 2017).
18 BEIS, Industrial Strategy: Building a Britain for the Future, (Cm 9528; November 2017), p 6. See also House of Commons Library, Productivity in the UK, (November 2017), pp 9–10.
19 IoD, Lifting the Long Tail: The Productivity Challenge through the Eyes of Small Business Leaders, (October 2018), p 5. See also: Andy Haldane, The UK’s Productivity Problem: Hub No Spokes, Bank of England, (June 2018), p 2; Andy Haldane, Productivity Puzzles, (March 2017), p 2.
20 ONS, Labour productivity, UK: April to June 2018, (October 2018), p 5.
21 Source: ONS, International comparisons of productivity, (April 2017). See also: Chris Gile, Britain’s Productivity Crisis in Eight Charts, Financial Times, (August 2018).
22 ONS, International comparisons of UK productivity (ICP), final estimates: 2016, (April 2018).
23 Andy Haldane, The UK’s Productivity Problem: Hub No Spokes, Bank of England, (June 2018), p 2.
24 As above, p 3. See also House of Commons Library, Productivity in the UK, (November 2017), pp 12–15.
25 OECD, OECD Compendium of Productivity Indicators 2018, (2018), p 17.
26 ONS, Regional gross value added (balanced), UK: 1998 to 2016, (December 2017). The Regional GVA per head figures for 2016 are: UK (£26,339); London (£46,482); South East (£28,683); Scotland (£24,800); East of England (£24,041); South West (£23,091); North West (£23,068); West Midlands (£21,823); East Midlands (£21,185); Yorkshire and The Humber (£20,678); Northern Ireland (£19,997); North East (£19,218); Wales (£19,140).
27 OECD, Reducing regional disparities in productivity in the United Kingdom, (2018), p 8.
28 See: BEIS, Industrial Strategy: Building a Britain fit for the future, (Cm 9528; November 2017), pp 137–141;
29 See: Delphine Strauss, Is ‘long tail’ of small businesses to blame for poor UK productivity?, Financial Times, (August 2018).
30 IoD, Lifting the Long Tail: The Productivity Challenge through the Eyes of Small Business Leaders, (October 2018), p 6.
31 ONS, Understanding firms in the bottom 10% of the labour productivity distribution in Great Britain: “the laggards”, 2003 to 2015, (July 2017), p 2.
32 IoD, Lifting the Long Tail: The Productivity Challenge through the Eyes of Small Business Leaders, (October 2018), p 6.
33 Andy Haldane, The UK’s Productivity Problem: Hub No Spokes, Bank of England, (June 2018), pp 5–6.
34 BEIS, Industrial Strategy: Building a Britain for the Future, (Cm 9528; November 2017), p 20.
35 BEIS, Business productivity review: call for evidence, (May 2018). The consultation closed in July 2018 and it is expected that it will produce its response before the end of 2018 and it will inform the next stage of the Industrial Strategy.
36 Q280 Kelly Tolhurst MP, Parliamentary Under-Secretary of State, Minister for Small Business, Consumers and Corporate Responsibility.
37 Close Brothers, The Power of Productivity Measuring, understanding and improving productivity for SMEs, (January 2018), p 5. See also: University of Gloucester, Improving productivity in UK small-medium sized enterprises: a research study, (2017), pp 17–19.
40 Q93 Tony Danker (Be the business).
41 Q94 Ruby Peacock (FSB). See also Q96 Rana Harvey (Monster Group UK)
42 See: ONS. How productive is your business?, (July 2018).
43 See: Be the Business, Benchmark your business, (accessed 2 November 2018).
44 Q280 Kelly Tolhurst MP, Parliamentary Under-Secretary of State, Minister for Small Business, Consumers and Corporate Responsibility.
45 Q281 Kelly Tolhurst MP, Parliamentary Under-Secretary of State, Minister for Small Business, Consumers and Corporate Responsibility.
Published: 5 December 2018