• Research shows pre-recession productivity was 7.4% below potential because of insufficient business dynamism
• Findings identify three structural issues holding back economic growth

New research published by Nesta has identified three unexpected factors holding back productivity growth in Britain in the decade before the financial crisis. These deep-seated problems seem to have worsened since 2009, casting new light on the ‘productivity puzzle’ – why growth has been slower than expected since the recession. Understanding and addressing these, it argues, could be worth at least £96 billion to British GDP every year.

In The Other Productivity Puzzle: Business dynamism and productivity growth before the crisis, researchers analysed ONS data on all existing and new businesses in Britain between 1998 and 2007, looking at their productivity, size and growth in unprecedented detail. In particular, the research looked at the changing relationship between productivity and business size.                            

The report identifies the three main issues contributing to the long term decline in productivity over the decade:

• The British economy became significantly worse at allocating resources to the best businesses over the period: The research measured the “allocative efficiency” of the economy over the period – the extent to which the best (most productive) companies were larger than the worst (least productive) in each sector of the economy. The model indicates whether the best businesses were scaling up. The research showed that allocative efficiency fell sharply in Britain from 1998 to 2007. If Britain’s productive resources were as efficiently allocated at the end of the period as they had been at the beginning, productivity would have been 7.4 percentage points higher. This is equivalent to £96 billion of lost GDP each year.
• Many good companies went out of business: A surprisingly high number of businesses that left the market were ones that showed above-average productivity. For every ten low productivity firms that left the market, six high-productivity ones did too. Had they not left the market, British productivity would have been up to six percentage points higher in 2007. Although it is to be expected that some high-productivity businesses will go bust even in the best of circumstances, the rates observed from 1998 to 2007 seem high. 
• Most start-ups are not particularly special from an economic point of view: The average new British business was no more productive than the average existing business, either at its foundation or after five years of existence. While some new firms contributed positively to labour productivity growth during this period, this was offset by the negative contribution of other new firms.

These three issues could be the result of a wide range of factors, including a poorly functioning financial system, unfavourable trading or regulatory conditions for innovative new entrants, or the impact of technological change on business longevity.

The research covers the decade to 2008, but current research suggests that these problems are unlikely to have improved, given widely reported difficulties in access to finance since the crisis.1

Stian Westlake, Executive Director of Policy and Research, Nesta, comments: “The results of this research surprised us, suggesting there was something rotten in the economy long before the 2008 crisis hit, and it is unlikely things have improved since. Unless Britain becomes a better place for good businesses to scale up, our productivity woes are likely to deepen, making the recovery a very unsatisfactory one.”

Nesta’s research into British productivity complements its wider work into how innovation can drive growth.

-Ends-

Read The Other Productivity Puzzle: Business dynamism and productivity growth before the crisis and the complete working paper.

Footnote:

1.       ‘The UK productivity puzzle’, Bank of England Quarterly Bulletin 2014 Q2

For all media enquiries please contact Laura Scarrott in Nesta’s press office: [email protected] / 0207 438 2697

About Nesta: We are the UK's innovation foundation. We help people and organisations bring great ideas to life. We do this by providing investments and grants and mobilising research, networks and skills. We are an independent charity and our work is enabled by an endowment from the National Lottery.