Productivity is tied by red tape

Just hours after Adair Turner, director-general of the Confederation of British Industry, warned on the eve of the CBI annual conference against industry talking itself into a recession, yet more hard evidence emerged of the problems facing manufacturers. On Monday, the Chartered Institute of Purchasing and Supply said that output, orders and prices had plunged […]

Just hours after Adair Turner, director-general of the Confederation of British Industry, warned on the eve of the CBI annual conference against industry talking itself into a recession, yet more hard evidence emerged of the problems facing manufacturers.

On Monday, the Chartered Institute of Purchasing and Supply said that output, orders and prices had plunged to record lows in October, reflecting a sharp downturn in demand for manufactured goods both for export and domestic consumption. Almost a third of the 318 manufacturers questioned reported lower production than in the previous month.

The respected CIPS manufacturing index fell for the seventh month in a row, registering its lowest reading since the survey began in January 1992. Employment was also at its lowest ever, with most job cuts coming from compulsory redundancies.

Also on Monday, Ford’s chairman and chief executive, Sir Alex Trotman, said the company’s 21 British plants were at least 20% less productive than Ford’s plants in the US. The implied warning followed the threat by BMW chairman Bernd Pischetsrieder that he would close Rover’s Longbridge plant unless a 30% productivity gap with its German counterparts was closed.

That Britain’s output per capita is behind its main rivals is undeniable. In a report published last week by McKinsey Global Institute, British workers’ output was said to lag that of the the US, the global benchmark, by 40% and western Germany by 20%.

The report adopted an upbeat tone, claiming that solving the problem of low labour productivity would realise the untapped growth potential in many key industries and see growth rates over the next 10 years well ahead of the Group of Seven average. There is a long way to go however; Britain is at the bottom of the G7 league in terms of output per capita.

But refreshingly, the report rejects traditional reasons for Britain’s failures. While it agrees that low capital investment and poor skills are undoubtedly factors in the performance of the economy, it argues that these are secondary effects rather than root causes. The authors believe that low labour productivity is a direct result of the restrictive regulations which govern markets and land use, which also affect investment and pricing.

Regulations constrain competition by limiting the ability of best-practice operators to enter or expand. In turn this reduces the competitive pressure for other industry participants to raise their productivity, the report argues.

In other cases, regulations prevent adoption of best practice or render it uneconomic.

Although the UK is one of the most deregulated economies in Europe, it retains a plethora of regulations governing the use of land and property that are intended to protect the countryside, town centres and the nation’s heritage in general. These powers of regulation are widely distributed and often highly devolved. Their direct and indirect effect is to restrict productivity-driven growth.

These conditions also lie behind Britain’s low capital investment, poor skills and sub-scale operations, the report claims.

Low capital investment, runs the argument, is the result of the lack of opportunities for profitable investment.

The report’s authors concede that regulations are not the only barrier to best practice. In fact, managers often use regulatory restrictions and lack of competitive intensity as excuses not to improve productivity, even when this is not in their companies’ best interests.

The authors believe than in many cases, neither regulatory nor macroeconomic factors need prevent managers from adopting best practice. It is often up to them to judge whether to compete intensively on the basis of enhanced productivity, or to accept a satisfactory profit margin at lower levels of productivity.

One of the reasons that the UK economy can deliver high employment and low labour productivity is due to its flexible labour market. With low wages, employers can tolerate lower productivity. By contrast, countries with less flexible labour markets, such as France and Germany, have priced low-skilled jobs out because the minimum cost of labour to employers is too high to sustain them.

The report uses the automotive industry to explain how regulatory barriers can hit productivity.

It says competitive intensity in car manufacturing has been constrained by voluntary trade restrictions that limit Japanese manufacturers’ share of key European export markets (see chart, left). These restrictions have encouraged Japanese manufacturers to keep their prices in line with other European producers, rather than using their productivity advantage to cut prices and compete for a greater market share.

The result has been persistently low productivity in the whole sector and a high price umbrella under which relatively unproductive companies have been able to continue operating with restricted competitive pressure.

So what can be done? According to the report: ‘The UK needs product market and land-use reforms that match and capitalise on the labour and capital market reforms that have already been achieved.’

The UK must preserve its established strengths, especially from European law. These strengths, according to the report, are labour-market flexibility, well developed capital markets and macroeconomic stability.

Suggested actions include the adoption of a consistent model of taxation and financial market regulation to allow companies to make long-term commitments; to ensure that all industry players understand what constitutes global best practice, the impact it can have and the actions they must take to close the gap; and to improve the commercialisation of academic research.

To ensure the availability of start-up and growth capital for high technology businesses, the report calls for the development of an educated investor base. It also argues that changes to planning regulations would remove barriers to the formation of natural clusters of entrepreneurial ventures.

‘The performance gap between the UK and other countries is wide, but if regulatory and competitive barriers were removed, many of the remaining barriers to the adoption of best practices could be overcome relatively quickly,’ surmises the report.

Driving Productivity and Growth in the UK Economy, McKinsey Global Institute. www.mckinsey.com