Years of schooling, ages 15–64 12.0 13.0 13.1 13.0
PISA score 496 510 505 482
Higher level qualifications (% workers) 11.7 8.2 18.6 27.6
Intermediate level qualifications (% workers) 67.3 71.7 37.0 25.3
Investment in intangibles (% market sector GDP) 7.9 7.2 10.5 11.5
R & D expenditure (%GDP) 2.2 2.5 1.8 2.7
Note: Investment is average of 1999–2003, Programme for International Student Assessment (PISA) scores are the average of mathematics and science in 2006.
Sources: Investment from OECD National Accounts database, schooling from Morrison and Murtin (2009), PISA score from OECD PISA 2006, qualifications from Broadberry and O’Mahony (2007), intangible investment from van Ark et al. (2009), R & D from OECD Main Science and Technology Indicators.
With regard to human capital, years of schooling of the United Kingdom working-age population had risen by almost three years in 2000 compared with 1970 which was a little bit more than the increases recorded in the other countries listed in Table 6.3. Cognitive skills of schoolchildren as measured by PISA scores were intermediate between France and Germany but well ahead of the United States. Qualifications of the labour force had improved considerably in the United Kingdom as well as its comparators with a continuation of the pattern with the United Kingdom having a larger share of higher level qualifications, boosted by an expansion of college education, but a much lower share of intermediate level qualifications than Germany. Interestingly, in 2000 a shortfall of physical capital contributed more than labour quality to the labour productivity gap of the United Kingdom with Germany (Table 6.4).
Table 6.4 Contributions to labour productivity gap (percentage points)
Labour quality Capital intensity TFP Total
USA/UK
1973 1.9 10.8 39.6 52.3
2000 0.4 12.6 11.3 24.3
Germany/UK
1973 9.5 5.4 –0.9 14.0
2000 3.7 11.7 1.4 16.8
Note: Capital intensity is based on tangible capital only; contributions are derived using a standard growth accounting formula.
Source: Broadberry and O’Mahony (2007).
After 1973, labour productivity growth slowed down in European countries with declines in the contributions both of capital deepening and also, especially, TFP growth, as is shown in Table 6.5. A notable feature of these growth accounting estimates is that the large advantage that France and West Germany held over the United Kingdom in terms of TFP growth during the Golden Age largely disappeared, and then was reversed in the next 40 years. In part, this reflected lower scope for catch-up in France and Germany as time went on but, it was also a result of relatively strong productivity growth in market services in the United Kingdom which carried a higher weight as these economies de-industrialized. Strikingly, after 1995, the capital deepening contribution to labour productivity growth in the United Kingdom exceeded that in Germany in the context of different rates of investment in ICT.
Table 6.5 Contributions to labour productivity growth, 1973–2007 (% per year)
Education Capital per hour worked TFP Labour productivity growth
France
1973–1995 0.2 1.2 1.5 2.9
1995–2007 0.3 0.7 0.9 1.9
Germany
1973–1995 0.3 1.1 1.3 2.7
1995–2007 0.0 1.0 0.7 1.7
UK
1973–1995 0.4 0.9 1.3 2.6
1995–2007 0.4 1.2 1.0 2.6
United States
1973–1995 0.3 0.5 0.4 1.2
1995–2007 0.3 1.2 1.1 2.6
Note: Estimates are for the market sector.
Sources: 1973–1995: O’Mahony (1999); 1995–2007: van Ark (2011). Education contributions from 1973 to 1995 are estimated based on years of schooling in Morrisson and Murtin (2009).
6.2 The Thatcher Experiment
The policies of the Conservative government, led by Margaret Thatcher which took office in 1979, remain highly controversial. In many respects, they represented a sharp break with the earlier post-war period and this was certainly true of supply-side policies relevant to growth performance. Reforms of fiscal policy were made, including the re-structuring of taxation by increasing VAT while reducing income tax rates and to restrain the growth of public expenditure, notably by indexing transfer payments to prices rather than wages, while aiming to restore a balanced budget. Industrial policy was downsized as subsidies were cut and privatization of state-owned businesses was embraced while deregulation, including most notably of financial markets with ‘Big Bang’ in 1986, was promoted. Legal reforms of industrial relations further reduced trade-union bargaining power which had initially been undermined by rising unemployment. In general, these changes were accepted rather than reversed by Labour after 1997.
In fact, before, during and after Thatcher, government policy moved in the direction of increasing competition in product markets. In particular, protectionism was discarded with liberalization through GATT negotiations, entry into the European Community in 1973, the retreat from industrial subsidies and foreign exchange controls in the Thatcher years and the implementation of the European Single Market legislation in the 1990s. It should be recognized that during the 1980s EU membership was an integral part of the Thatcher reform programme through its positive effects on competition, as is reflected in strong British support for the legislation to establish the European Single Market. The average effective rate of protection fell from 9.3 per cent in 1968 to 4.7 per cent in 1979, and 1.2 per cent in 1986 (Ennew et al., 1990), subsidies were reduced from £9bn (at 1980 prices) in 1969 to £5bn in 1979 and £0.3bn in 1990 (Wren, 1996a), and import penetration in manufacturing rose from 20.8 per cent in 1970 to 40.8 per cent by 2000. Trade liberalization in its various guises reduced price-cost margins (Hitiris, 1978; Griffith, 2001). The downward trend in the mark-up from the 1970s onwards appears to have intensified further after the early 1990s (Macallan et al., 2008). Rather surprisingly, an adequate reform of competition policy was delayed until the Blair government.
The Thatcher government saw itself as ending the trade unions’ veto on economic policy reform and many of the changes of the 1980s would have been regarded as inconceivable by informed opinion in the 1960s and 1970s; this was the point at which the post-war consensus was abandoned.3 Moreover, the early 1980s saw unemployment return to 1930s’ levels (Boyer and Hatton, 2002) which conventional wisdom had thought incompatible with re-election. So, how was the government able to break out of the constraints imposed by the political economy of the previous three decades? The answer probably lies in a combination of the economic failures of the 1970s, the Falklands War, political strife in the Labour Party, and a maverick Prime Minister who over-rode the doubts of the risk-averse majority of her colleagues. It was not so much that the determinants of government popularity changed but rather that its underpinnings were different from the simplistic beliefs of the 1960s. Thus, the correct specification seems to have included the change in unemployment rather than its level, while perceived government competence in economic management and personal economic expectations were important (Price and Sanders, 1993; Sanders, 1996). The Falklands popularity boost was the icing on the cake in 1983 while in 1987 unemployment was falling and by then economic expectations were buoyant.
The implementation of supply-side policy reform was far from perfect but, on balance, improved productivity performance. Privatization which reduced the share of GDP supplied by state-owned enterprises from 12 per cent of GDP in 1979 to 2 per cent in 1997 is a case in point. The evidence is that while TFP in these businesses improved significantly during the process of privatization there was no lasting effect on trend TFP growth (Green and Haskel, 2004). The longer-term problem was the familiar one of weak competition and weak shareholders. It proved very difficult to replace competition as an antidote to principal–agent problems through price-cap regulation (Helm and Tindall, 2009). Nevertheless, the productivity gap with the international peer group narrowed signific
antly between 1919 and 1995 (cf. Table 6.6).
Table 6.6 Levels of productivity (UK = 100 in each year)
France West Germany USA
Y/HW, 1979
Market sector 130 131 154
Manufacturing 133 147 190
Electricity, gas and water 166 158 301
Y/HW, 1996
Market sector 132 129 121
Manufacturing 130 126 171
Electricity, gas and water 120 84 163
TFP, 1979
Market sector 117 127 140
Manufacturing 118 133 168
Electricity, gas and water 92 119 170
TFP, 1995
Market sector 108 115 119
Manufacturing 103 108 142
Electricity, gas and water 87 75 115
Source: O’Mahony (1999).
Selective industrial policy fell out of favour. This was partly because the 1970s’ experience led to disillusionment and partly because international treaties and, in particular, EU rules on state aid constrained policy. Whereas in 1981/6 state aid was 3.8 per cent of manufacturing GDP by 1994/6 this had fallen to 0.9 per cent. DTI expenditure on industrial policy measures was £421.4 million in 1997/8 (prior to devolution) of which £121.9 million went on science and technology schemes, £171.3 million for support for small firms and £128.2 million on regional policy (Wren, 2001). By 2006, virtually all (91 per cent) state aid was based on horizontal rather than selective policies (Buigues and Sekkat, 2011). The switch from selective to horizontal industrial policies was appropriate but the horizontal policies themselves were questionable in some respects. Areas of concern include education, infrastructure, innovation and regulation.
An important step forward was made in terms of the expansion of university education where the proportion of 18-year olds enrolling roughly tripled between the early 1980s and mid-1990s. On the other hand, cognitive skills as measured by international test scores had improved only marginally by the late 1990s (Woessmann, 2016) despite the introduction of the National Curriculum in 1988. The United Kingdom net stock of public capital relative to GDP, and to the stock of private capital, fell sharply between 1980 and 2000 (from 63.9 to 40.3 per cent and from 61.5 to 37.0 per cent, respectively) and rates of public investment implied that these ratios would continue to fall over the long run to a level that is clearly suboptimal. To maintain the level of public capital to GDP at a growth maximizing level, investment of about 2.7 per cent of GDP per year would be needed (Kamps, 2005) but in the late 1990s the United Kingdom invested only 1.7 per cent of GDP. R & D fell to below 2 per cent of GDP but the United Kingdom did not follow the example of the United States and introduce an R & D tax credit although analysis suggested that the policy might raise United Kingdom TFP growth by about 0.3 percentage points per year (Griffith et al., 2001). The United Kingdom remained a lightly regulated economy by European standards but productivity-inhibiting land-use planning rules remained or were even tightened. For example, planning policy, by making land for retailing very expensive and by constraining retailers to choose less productive sites, has reduced the level of TFP in supermarkets by about 32 per cent in post-1996 compared with pre-1988 stores thereby significantly reducing the rate of TFP growth in the sector (Cheshire et al., 2015).
The Thatcher period was notable for a shift from direct to indirect taxation as marginal rates of personal income tax were reduced, the standard rate to 25 per cent and the top rate to 40 per cent by 1988, while the standard VAT rate increased from 8 to 15 per cent in 1979 and then 17.5 per cent in 1991. The disincentive effects that worried Tanzi (1969) were mitigated. Nevertheless, it is fair to say that United Kingdom policy was quite timid in making the sort of reforms that research suggests would be most effective in stimulating long-run growth. This could have entailed reducing the effective rate of corporate tax while extending the VAT base which remained very narrow by international standards (Owens and Whitehouse, 1996). The effective marginal rate of corporate tax actually rose steeply despite cuts in the headline rate as depreciation allowances were reduced (King and Robson, 1993).
The clear success story was the strengthening of competition. As an ‘out-of-sample test’, this reinforces the argument of Chapter 5 that weak competition undermined productivity performance in the Golden Age. Increased competition and openness in the later twentieth century went with better productivity performance. Proudman and Redding (1998) found that across British industry during 1970–1990 openness raised the rate of productivity convergence with the technological leader and, in a study looking at catch-up across European industries, Nicoletti and Scarpetta (2003) found that TFP growth was inversely related to PMR.4 The implication of a lower PMR score as compared with France and Germany was a TFP growth advantage for the United Kingdom of about 0.5 percentage points per year in the 1990s. At the sectoral level, when concentration ratios fell in the United Kingdom in the 1980s, there was a strong positive impact on labour productivity growth (Haskel, 1991). Entry and exit accounted for an increasing proportion of manufacturing productivity growth, rising from 25 per cent in 1980–1985 to 40 per cent in 1995–2000 (Criscuolo et al., 2004).5
The impact was felt at least partly through greater pressure on management to perform, and through firm-worker bargains which raised effort and improved working practices. Increases in competition resulting from the European Single Market raised both the level and growth rate of TFP in plants which were part of multi-plant firms and thus most prone to agency problems (Griffith, 2001). The 1980s saw a surge in productivity growth in unionized firms as organizational change took place under pressure of competition (Machin and Wadhwani, 1989) and de-recognition of unions, in the context of increases in foreign competition, had a strong effect on productivity growth in the late 1980s (Gregg et al., 1993). The negative impact of multi-unionism on TFP growth, apparent from the 1950s through the 1970s, evaporated after 1979 (Bean and Crafts, 1996).
The 1980s and 1990s saw major changes in the conduct and structure of British industrial relations. Trade union membership and bargaining power were seriously eroded. By 2001, only 19 per cent of private sector workers belonged to a trade union and the modal type was single unionism while collective bargaining covered only 30 per cent of private sector employees in 1998 (Gospel, 2005). Trade unions were recognized in only 24 per cent of workplaces in 1998 compared with 50 per cent in 1980 (Brown et al., 2008). Some of these changes were stimulated by increased competition in product markets and the associated reduction in the value of union membership. In addition, Conservative governments passed eight separate Acts whose cumulative effect was to end ‘voluntarism’ and remove most of the trade unions’ legal immunities. Inter alia, this legislation ended the closed shop and secondary picketing, introduced secret ballots on strike action and imposed large penalties on unions who failed to comply (Wrigley, 2002). This last provision encouraged employers to use the law and injunctions became frequent. By the end of the century, the adverse impact of trade unionism on productivity performance had disappeared (Metcalf, 2005).
The separation of ownership and control in quoted companies became still more entrenched during the 1980s and early 1990s. Although the dispersion of share ownership was similar to that of 1950 (Franks et al., 2009), the percentage of shares held by domestic financial institutions continued to increase reaching a peak of 62 per cent in 1993. Institutional investors were well-known at this time for their passivity.6 The evidence on share valuations indicates that they were also short-termist. Miles (1993) found that during the 1980s investors acted very myopically in terms of their discount rates and their unwillingness to give due weight to future cash flows. Moreover, the combination of short-termism and outside control tends to be persistent because unduly high discount rates mean a switch to inside control lowers the present value of the company (Morris, 1998). Given this short-termism, managers would rationally raise dividends at the expense of investment especially in projects with a long-term payoff, a strategy which reduced the risk of tak
eover (Dickerson et al., 1998).
Deregulation provided some amelioration of these problems, notably by improving the market for corporate control during the 1980s and 1990s. A key aspect of this was the advent of management buyouts often financed by private equity investors which was encouraged by relaxation of the rules on the financing of share buybacks. MBOs on average delivered large gains in TFP (Harris et al., 2005) and encouraged large ownership stakes for CEOs which addressed corporate governance problems. Private equity buyouts especially have delivered significant improvements in profitability and productivity (Toms et al., 2015). Nevertheless, the evidence is that the short-termism problem among quoted companies is still serious and has a significant adverse impact on investment (Davies et al., 2014) while management quality is still inferior to that in peer group countries such as Germany, Sweden and the United States (Bloom et al., 2016).
This review of the evidence suggests that Thatcherism was a partial solution to the problems which led to underperformance in the Golden Age, in particular, those which had arisen from weak competition. The reforms encouraged the effective diffusion of new technology rather than greater invention, and worked more through reducing inefficiency than promoting investment-led growth. Compared with the counterfactual of continuing with 1970s’ policies, in terms of Figure 1.1, there was some improvement in the Schumpeter line but not the Solow Line. Of the two key institutional legacies, corporate governance remained a serious problem despite some amelioration but reform of the system of industrial relations was implemented quite effectively.
6.3 The United Kingdom in the ICT Revolution
Table 6.5 shows that after 1995 American labour productivity growth rebounded, the United Kingdom kept pace, but Germany slowed and was below the United Kingdom and the USA, as were most European countries. The acceleration in American productivity growth was underpinned by ICT. Since the main impact of ICT on economic growth comes through its use as a new form of capital equipment, the development of this new general purpose technology gave Europe a great opportunity to raise productivity growth, but most countries have been less successful in responding than the United States. However, the United Kingdom did benefit more than most, as is reflected in Table 6.7. ICT has had considerable potential to improve productivity growth in some service sectors, especially finance and distribution and relatively good productivity performance after 1995 has been based on a strong contribution from market services.
Forging Ahead, Falling Behind and Fighting Back Page 12