This is part of a series, ‘Economists Exchange’, featuring conversations between top FT commentators and leading economists about the coronavirus economic recovery
Bart van Ark holds one of the most challenging positions in economics. Having been lured from the US to the UK, he is the head of the new government-funded Productivity Institute, tasked with understanding the drivers of economic efficiency and providing the research underpinnings for raising living standards, building back better from the pandemic, levelling up economic performance in different parts of the country and creating the “high wage, high skill” economy promised by Prime Minister Boris Johnson.
At a time of global supply bottlenecks, an ageing population and UK-specific woes ranging from empty shelves in supermarkets to pigs being culled because abattoirs cannot find staff and a fuel crisis stemming from a shortage of lorry drivers, what might once have been an academic backwater could not be more central to the national debate, not only in Britain, but in most advanced economies.
The Productivity Institute has received £32m of funding, with the Economic and Social Research Council providing the largest government grant it has ever awarded. In return for the cash, the UK government’s research body has high ambitions and requires the institute to provide a “step-change in the quality and quantity of research available in the UK that directly informs government policy to improve UK productivity”.
If it achieves this aim, it would provide the foundation of a revival in UK economic performance and living standards built on the back of increasing efficiency and getting more out for what you put in, which is the core of improving productivity.
“Productivity isn’t everything, but in the long run it is almost everything,” Paul Krugman, the Nobel Prize-winning economist, said in 1994. Although Krugman coined the famous phrase, at the time van Ark was undertaking core research to understand why countries differ in their performance.
Working at Groningen University in the Netherlands and mentored by the distinguished economic historian Angus Maddison, van Ark helped build an economic database of the productivity performance of every country in the world, enabling him to have an unrivalled international perspective on what works in raising living standards and what has failed.
He took much of the research and data with him to the US in 2008, becoming chief economist of The Conference Board, the global business research organisation, where he stayed until 2020, before coming to the Alliance Manchester Business School to head up the new institute.
As we spoke, the UK was struck by acute labour shortages in sectors as diverse as truck driving and care work.
Chris Giles: If we step away from the current difficulties, why does productivity matter?
Bart van Ark: Ultimately, using our resources better and better, is really what is driving economic growth. So that’s one reason. The other reason is that we have huge ambitions for growing our economy, improving people’s living standards, increasing wellbeing and everything else. But it doesn’t come for free. Most resources are still scarce. And as a result, you need to think about what are you going to put in? How do you get to all these goals? And that’s not just a financial question. It’s also a question of how we allocate the resources in such a way that we can maximise outputs. That allocation question is really important for the productivity story — it will ultimately make it possible for us to get a lot more done with the resources that we have.
CG: It’s all very well to talk about getting the most out for what you put in, but what is productivity in a modern economy based on services?
BvA: In a very simple world, if you have a company or firm that’s producing just one product, and is only working using labour to do this, it’s simple. How much output does it procure and how many working hours are needed to produce it. The problem is that it gets very complicated if you have more than one output, and you have more than one input. And that’s, of course, the reality in many businesses.
And in an economy where 70 per cent or so of output is services, you then have to work out what is the output of the services and how do you measure it and ask do services have, by definition, slower productivity growth. There is some truth to that. When you look at the aggregate services sector, you won’t usually see productivity growth rates that are as high as manufacturing. However, we should not fall into a trap of thinking that services don’t show productivity growth because, when you think about what happened with digital technology, services have made incredible progress in terms of becoming more productive.
So, there’s definitely opportunity in the services sector to grow productivity, but it is true, and this is the link to the UK, that it hasn’t been very good at this, because somehow we managed in the UK to get on a low-productivity, low-value growth path in services.
CG: What fundamentally makes some countries better than others at productivity?
BvA: I think there are two key differences. The first one is the use of new technologies and innovation. That is one reason the US has had faster productivity growth for a long time: it’s to do with entrepreneurship, with lower regulations, with effective private-sector innovation systems. The other part of the productivity story isn’t about business itself, but how economies are able to spread the benefits of productivity growth more widely and by that I mean how it is diffused across society. If you look at the productivity of German firms, I wouldn’t say they’re outstanding compared with everyone else. But Germany is pretty good at diffusing technology across the country. Certainly in western Germany, you don’t have that many regions that are really way behind other regions.
CG: We talk all the time about new technology, but productivity has slowed since the financial crisis. How do you reconcile those two facts?
BvA: The causes of the slowdown have been a big issue of discussion. And the timing of it is particularly interesting, because the slowdown started sort of around 2005 and 2007, which, interestingly, is before the financial crisis. So, the reason why this happened is that technology comes in waves. And if you look at the latest period, information, communication technology had a really good ride in the 1990s and early 2000s, but this first wave of information technology lost its strength by the mid 2000s. And then we moved into second wave, which was really what I call the new digital economy which is ubiquitous access to the internet, the cloud, artificial intelligence and robotics.
What’s very interesting about the new digital economy technology is that consumers adopted it much faster than businesses. That’s because that latest technology really changes the way that firms operate. And a lot of companies struggle doing that. Some were faster and some failed, and some are slower. But I think as a result, we saw a much longer tail of less productive firms. Pretty much everywhere, we have seen that the gap between the most successful companies at the frontier of technology and the rest is increasing.
So, that gap was opening up and you had the financial crisis on top of it, which meant that demand and investment slowed down. And I think that’s added to slowing down the speed of the diffusion that we were talking about earlier. And low interest rates didn’t help because, even if they weren’t zombie companies, they did not have a price of capital or anything forcing them to take action.
CG: Why was the UK’s decline in productivity growth particularly serious?
BvA: I’d like to make a distinction between level and growth effects. We see that the UK has systematically had lower levels of productivity for decades. A lot of that is related to the fact that we systematically underinvest, partly in physical capital, but quite a bit of catching up has happened there. So I think a lot more of the under-investment happened in things like education, and human capital, in knowledge, which are highly concentrated but in a limited number of sectors, and also in firm capital in order to get companies to strengthen that absorptive capacity so that they can diffuse [the benefits] faster. So this systematic under-investment in the UK is something we need to address to get us out of the low-level trap.
And then there’s the growth effects. After the financial crisis, we’ve got in the UK on what I call a low-productivity, low-wages path. It’s not about immigration, it’s not everywhere in the economy, not in every sector, but particularly in the services sector and in long tails in manufacturing. Then you get into this negative cycle: low wages, slow training, low productivity and low value. So you need to get a driver in a country that is going to push you to upgrade.
CG: One of the things often suggested here, often on the political left, is to force companies just to pay more with higher minimum wages and they will raise productivity. Is that the answer?
BvA: It’s not a panacea, but there’s very little evidence that raising minimum wages has been counter-productive. So, it’s definitively part of the solution. However, if you just raise minimum wages and firms are not able to invest in new technologies and train their people, then it will ultimately pay itself back in the bottom line. You’ll see a lot of companies go away, and maybe they are the less productive companies, so you’ll get a positive productivity effect, but a smaller business sector, so that’s not going to help from the perspective of business and economic growth.
CG: Who is responsible for raising productivity — enabling countries to raise living standards, aim for net zero carbon emissions and other things society wants?
BvA: Productivity is done by the private sector. They have by far the biggest share in productivity growth. So, the role of the government is not necessarily to lead productivity growth — they should give businesses the opportunity to do. And sometimes that means getting out of the way which they have done in the UK, if you think of the regulatory environment for example, and things like that. Government has got out of the way to actually allow business to be more productive.
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But sometimes, government also needs to facilitate and push a little bit, and I think that’s particularly true when it comes to the social goods that we need to get businesses to become more productive and to spread those benefits more widely across society. The issue with every government is that some of these actions pay back over the long term. I think one of the big issues in the UK is that we try too often to change tack.
CG: Let’s think about the future. Economists tend either to be productivity optimists or pessimists. Where do you sit on this?
BvA: First of all, forecasting productivity can be hard. In my previous job at The Conference Board, I did that, but it’s incredibly difficult because there are so many factors playing into productivity growth that it’s really difficult to figure out cause and effect.
So thank God I’m not doing that any more, I can now think a little bit more from a perspective of what are the opportunities and can they be realised. I find myself on the optimistic side of this, but not overly optimistic. And I think the reason is that digital technology, and particularly the new digital economy, has proven potential.
We know that the leading firms are very good at this. Under the radar screen, under the aggregate level, there’s a lot happening where firms, industries, sectors are doing pretty well, and you see that it’s gradually beginning to grow.
The reason why I’m not overly optimistic, is that some of that has to do with the monetary and fiscal environment we’re in with too little investment, certainly for many years, and too-low interest rates, which I think are not good for productivity.
CG: Do you think that the pandemic therefore has something of a silver lining, forcing a new attitude in business?
BvA: The pandemic probably helped a little bit to move things along. We’ll see, but it’s again evident from some work that we’ve been doing that once you take out all the volatility we experienced during the pandemic, we again do see that companies that heavily invested in digital were able to work themselves through this pandemic faster.
They were able to pick up on digital technologies, get people working from home, kept doing things, whereas companies who had to reinvent the wheel just took more time. So I think it’s advancing things. We’ll see how the whole working-from-home thing is going to work. Again, I don’t think we’ll see huge productivity gains from it, but I think it has shown that technology can change the way people work, and I think ultimately that will be helpful for productivity growth.
CG: That modest advance you’re talking about is certainly needed in advanced economies because they are rapidly ageing; the labour force will be shrinking in many places. Productivity growth is going to have to do a lot of work, isn’t it?
BvA: Yes, the thing that won’t go away is the ageing of the population, and that means there’s even a bigger burden on the part of the population that is working. I ought to be careful that even people that don’t have a job are definitely productive for society, but the point is that the working population is going to become smaller and that means that they will have to increase their productivity in order to create enough benefits for the rest of society. That’s going to be tough. In addition to that, an ageing society means more demand on some of the most productively-challenged sectors, like healthcare for example.
CG: Why is healthcare so productively-challenged?
BvA: I’m fascinated by it because it’s such a big sector and it’s only going to get bigger. And having lived in the US, now here [in the UK] and having lived in the Netherlands, healthcare systems make a huge difference, but you need to make a distinction between what is happening at the medical end of things and what’s happening through the organisation of the healthcare service.
At the medical end, I think we have just seen, during the pandemic, that things can really move very quickly. There’s a great paper produced for the Productivity Institute, looking at what happened to productivity in Britain’s NHS during Covid-19, and part of that paper is how can it be that we saw a huge decline in productivity at the same time as we see all these people in the healthcare sector making huge technological changes. The point was, yes, sure, we got better at dealing with that crisis, and that gave us a few advantages, but the system as a whole almost collapsed. All the non-essential treatments got delayed.
In the Netherlands, insurers are to a large extent running the healthcare system, but government is playing a big role in terms of determining rates and everything. While in the US, which is completely private-sector-run, a large part of the population is not insured which made it incredibly unproductive, but giving some people really good care.
None of those models are ideal, they have very different implications for productivity growth, but why I’m so fascinated in the paper is that you get a crisis and you can see that the system starts to move.
CG: Another current crisis is that we’re seeing labour shortages showing up in specific industries. What’s that likely to do to productivity?
BvA: I think there are three ways we might respond to the current problems. First of all, we can wait until it’s too late and that means we have to raise wages in order to get people but we’re not able to ramp up productivity all that quickly. So we’ll see it on the bottom line, and more companies will fail. The second response is to go and massively automate, and think: let’s do without labour. In some of the sectors where you have the biggest shortage, we can’t do that because we’re not yet at the point where fuel tankers can be self-driving.
But the key issue is skills. So the third and best response is, yes, raise wages, massively invest in training, and make sure that you have a path for people to come and work for a company that will give them training and a career path. That’s the response we need to give. So I do think the labour shortage can make a difference, and businesses have to do a lot themselves. It’s not just government who’s going to solve this.
The above transcript has been edited for brevity and clarity
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