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The Other Productivity Puzzle: Business dynamism and productivity growth before the crisis

This research looks at productivity growth in Britain from 1998 to 2007 and identifies some troubling findings about startups and business dynamism in Britain.

This research looks at productivity growth in Britain from 1998 to 2007 and identifies some troubling findings about startups and business dynamism in Britain.

Key findings

  • Most startups were 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.
  • 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 the high productivity exiting firms stayed in business, British productivity growth between 1998-2007 could have been up to 6 percentage points higher than it was.
  • Existing businesses were by far the main contributors to productivity growth. Productivity improvements in the existing population of firms contributed an estimated 15 percentage points to growth in labour productivity, accounting for over 90 per cent of Britain’s productivity growth between 1998-2007.
  • The British economy became significantly worse at allocating resources to the best businesses over the period. This is complex but important. The research measured the so called ‘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. This gives an idea of whether the best businesses are scaling up. The research showed that allocative efficiency fell sharply in Britain from 1998 to 2007 among firms with ten or more employees. 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 7.6 percentage points higher among firms of this size. This is equivalent to around £79 billion of lost GDP.

This research can help shed some light on the so-called ‘productivity puzzle’: the question of why British productivity growth has been so low since the recession and what can be done about it. While many potential explanations have been put forward, implicit in many of them is the idea that all was well and good prior to the recession.

This new analysis of British productivity performance in the decade prior to the recession suggests that all was not well, and in fact that Britain was already experiencing a productivity problem in 2007, another productivity puzzle that we need to understand.

Policy recommendations

  • There would be substantial productivity benefits if Britain made it easier for the best businesses to grow. Reducing barriers to growth and reversing the decade long decline in allocative efficiency could contribute to a significant increase in British productivity growth.
  • It is important to understand why a large number of above-average productivity companies are exiting the market, which may be a significant drag on British productivity, and whether anything can be done to mitigate this trend.
  • Quality matters more than quantity when looking at entrepreneurship. Therefore, policy makers should focus on supporting high-impact entrepreneurship rather than on increasing the overall number of entrepreneurs, which are often low productivity businesses.

Reseach summary re-issued in October 2015 following amendments in the original research.

Authors

Stian Westlake

Stian Westlake

Stian Westlake

Executive Director of Policy and Research

Stian led Nesta's Policy and Research team. His research interests included the measurement of innovation and its effects on productivity, the role of high-growth businesses in the e...

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Albert Bravo-Biosca

Albert Bravo-Biosca

Albert Bravo-Biosca

Director, Innovation Growth Lab

Albert is Director of the Innovation Growth Lab.

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