Misdiagnosis of Britain’s productivity problems is distracting policymakers from tackling the investment and leadership weaknesses holding firms back

A focus on the UK’s least productive firms risks distracting policy makers from the economy-wide under-performance on investment and management that is holding British businesses back as we enter a decade of major economic change, according to a new report for The Economy 2030 Inquiry.

The report assesses UK firms’ readiness for a decade of economic change. It is co-written by the Resolution Foundation and the Centre for Economic Performance at the London School of Economics, and funded by the Nuffield Foundation,

The report says that the performance of UK firms will prove vital if the country is to make a success of the next decade and overcome the living standards stagnation that has seen household incomes grown by just 9% in the 15 years since the financial crisis, compared to 50% in the 15 years prior to it.

However, the UK is approaching the 2020s with a big problem of low productivity, which is 16% higher in Germany, France and the US than the UK.

While everyone agrees on the need to address the UK’s productivity woes, the report warns that many are misdiagnosing the problem. Much of the UK productivity debate focuses on boosting the output of the UK’s ‘long-tail’ of unproductive firms.

While there is a huge productivity gap between firms – a worker in the top ten per cent of firms is 16 times more productive than a worker in the least productive tenth of firms – this gap is actually no different to other countries. Raising productivity among the 40% of workers in low-productivity firms by 10% would only raise overall productivity by 1.2%.

Another focus for those aiming to raise UK productivity has been to assume that British firms are seeing the same fall in dynamism that is a central feature of developments in the US.

However, in contrast to the US, UK firms’ dynamism has been relatively stable. The UK has a relatively high level of jobs going in shrinking firms and being added in expanding firms, even though movement of workers between jobs has slowed. This should help the UK adapt to some of the structural changes it will face in the 2020s, the report authors say.

Instead, the report says the key to addressing UK firms’ productivity woes is to focus on improving economy-wide inputs that firms use to drive growth. These include:

Greater investment. Total investment in the UK economy rose by only 1% in the five years to Q2 2021, compared to an average 16% rise in France, Germany and the US.
More ideas. The UK lags behind France, Germany and the US on R&D investment, and produces fewer than half as many patents per population.
Better leadership. Just 11% of UK firms are as well managed as the best quarter of US firms.
Further learning. Literacy among young people (aged 16-24) today is no higher than it is among older cohorts (aged 55-65) – a sharp contrast to the big generational improvements seen in France, Germany and the US, whose young cohorts have now overtaken the UK.

Finally, the report warns that while these types of investments are vital for improving firms’ productivity, they will lead to trade-offs.

Prioritising greater investment today to spur higher productivity in the years to come will also mean lower consumption and/or additional borrowing from abroad in the short-term, both of which bring major challenges.

The authors say the UK therefore needs an economic strategy that both focuses on the right routes to higher productivity, and faces up to the tough trade-offs involved in taking such an approach.

Greg Thwaites, Research Director at the Resolution Foundation, said:

“Britain is facing a decade of huge economic change from the triple impacts of Brexit, Covid and net zero. It will be UK firms that ultimately determine whether we navigate these changes in a way that leaves our businesses, pay packets and household incomes in a much better place by 2030.

“The UK entered the 2020s with an abysmal productivity record, and a misdiagnosis of why this is happening. Rather than focus on the UK’s long-tail of unproductive firms, we need to see economy-wide improvements to how firm invest and innovate, as well as how staff are managed and trained.

“These are not quick productivity fixes, and they are likely to cost money in the short-term. But they need to be pursued as part of a new economic strategy that will deliver stronger growth and higher living standards in the years to come.”