Britain’s innovation challenge

Expansion of employment in higher value-added sectors

17 October 2019

By Thomas Aubrey

The Enterprise Research Centre has produced a report - 'Understanding value added per employee in six UK sectors: The insiders' view' - for the Centre for Progressive Policy to understand the underlying drivers of productivity growth across a handful of sectors. This blog by CPP Adviser, Thomas Aubrey, highlights the need to expand employment in higher value-added sectors. You can download a summary of the report below.

Although productivity growth across the developed world has fallen, the data is clear that productivity in the UK is lagging other industrialised countries. One of the challenges with policy development to improve productivity is that there needs to be some consensus as to what the underlying issues are.

But for the UK there is currently no consensus. Some have argued that the UK has a long tail of unproductive firms compared to other countries. Others argue that the UK has lower quality managers and that French and German workers do in in four days what British workers do in five. Other areas of focus include the inability of the UK training system to churn out enough technically trained people such as electricians and IT production engineers to meet current demand.

Given such a diverse set of opinions there is little chance useful policy might be designed to improve outcomes. One challenge with policy making is that national productivity data is generally unhelpful at best. What matters in the economy is the level of productivity within sectors and how big the sectors are, which aggregated data provides little insight into. This in turn should raise policy questions as how to improve the productivity of individual sectors and crucially how to shift more of the economy into higher value-added sectors.

A report by the Economic Statistics Centre of Excellence in 2018 began to shed some light on what is happening at the sectoral level. It highlighted that sectors have been hit in different ways by the within industry effect, which looks at changes in value added in the sector, and between industry effects which assesses changes in the relative size of each sector.

The within industry effects were particularly noticeable in the oil & gas sectors which saw a dramatic drop in the price of oil. The between industry effects were particularly noticeable in the financial services and oil & gas sectors which both saw significant drops in output since the financial crisis, negatively impacting productivity growth.

The policy challenge is therefore to understand the drivers of what raises overall value added per worker within sectors and how higher value-added sectors can expand to create more well-paid jobs. This was the focus of a recent report conducted by the Enterprise Research Centre for the Centre for Progressive Policy (CPP) to understand the underlying drivers of productivity growth across a handful of sectors.

The report provides quantitative and qualitative information on the relative performance of six sectors across the UK including oil & gas, banking, insurance, transportation equipment, beverages and pharmaceuticals. Together these six sectors account for around 15% of private sector output.

One of the major findings of the report is that for these six sectors, productivity levels are in most cases similar or higher than in other industrialised countries. Furthermore, an in-depth analysis of the pharmaceutical and transportation sectors shows little evidence of UK firms lagging behind international competitors in terms of productivity. This potentially indicates that UK policy ought to focus on how to increase the size of these higher value-added sectors. Such an approach might include policies to strengthen supply chain links and to ensure a sufficient supply of appropriately technically trained workers to enable larger clusters to develop. These two specific issues were raised in many of the interviews.

Another challenge for policy makers is that innovation and new product development such as aerospace engines or new drugs is hard to do and often does not generate sufficient short-term rewards for firms. Indeed, this was notable by its absence in the interviews, which may strengthen the argument to support innovation in high value-added sectors given the risk profile of such projects. The US has pioneered this form of state sponsored support for innovation through its departmental research programmes. Moreover, the OECD advocates countries to pursue an innovation strategy. Extensive analysis since Robert Solow’s original study on what drives productivity growth clearly shows innovation plays a central role in improving competitiveness and increasing living standards.

Finally, policy makers must be aware that firms don’t think in terms of driving up value added per employee, which is typically used by government as the main measure of productivity. Each sector has different metrics that chief executives strive for. These range from just surviving in the marine sector to driving increases in manufacturing and logistics for the pharmaceutical sector or meeting the delivery schedules of the major aerospace firms.

While the focus of the report is on the development of sectoral industrial strategies, there are nevertheless implications for a place-based approach.

Indeed, one of the major policy challenges for place is that high value-added sectors such as manufacturing have suffered disproportionately in the UK. The result of this is that the Midlands and the North of the country have seen a much larger slowdown in productivity due to the between industry effects compared to London and the South East. Indeed, within industry effect data shows that UK firms continue to increase value added per hour, it’s just that as a percentage of the economy it has shrunk. This wouldn’t have been an issue if these lost jobs had been replaced by higher value-added services, but they weren’t.

No doubt productivity will continue to dominate the headlines for years to come. But if government really wants to make a difference it must understand and assess the productivity challenge at much more granular levels, particularly on a sectoral basis as this report shows. This appears central in understanding how competitiveness might be improved, which in turn can have positive knock-on effects for the future of places.