By Isaac Stables
The United Kingdom has a growth problem. Today, measured by GDP per capita, the UK ranks as the world’s 30th most wealthy nation: 8% below Germany, 11% below Japan, and over 20% below the United States. The roots of our less than stellar economic growth can be found in our underwhelming recovery from the 2007-08 recession. It took the UK until 2015 to recover from the damage wrought by the financial crisis. On the other hand, Germany was fully recovered by 2011, and the United States – where the crisis began – had recovered by 2012. Nobel-prize winning economist Joseph Stiglitz has labelled this the UK’s “lost decade of zero growth.” This article will explore the causes of this trend, as well as the means for its reversal.
Productivity has been cited as a key driver of growth since Robert Solow created his now-famous model in 1956. Since the crisis, UK productivity growth has stalled. The UK’s output per hour worked was 15.1% below the G7 average, and even further behind productivity leaders such as Germany. PwC analysis estimated that if the UK productivity matched that of Germany, the boost to the economy would be £180bn per year, or £5,800 per worker.
This has by no means always been the case. In the 60s, the UK was leading Europe for productivity measures such as GDP per hour worked. However, underinvestment in R&D and infrastructure since has contributed significantly to the UK’s productivity downfall, illustrated in Figure 1.
Figure 1. Source: Our World in Data.
While many advanced economies have seen productivity growth slow over the last decade, the UK’s slump is on the severe side. Britain’s productivity growth averaged 2.3% between 1980 and 2007 but has since crumbled to just 0.4% following the 2008 crisis. Now, seen in Figure 2, UK productivity is 25% below its pre-crisis trend projection.
Figure 2. Source: Office for National Statistics.
According to research by PwC, the evidence suggests that the productivity shortfall is due to low investment and research and development (R&D) spending. The UK’s average annual gross fixed investment is the lowest of all the G7 countries: The UK invested only 17% of GDP in 2019, compared to Germany’s 22% and France’s 24%. In terms of R&D, the UK invested just 1.7% of GDP, compared to 3.1% for Germany, and an OECD average of 2.4%. An unwillingness to invest has now led to an inability to grow.
The solution, therefore, is clear: the UK needs to increase its investment. This will not only stimulate growth via the demand-side in the short-run, but it also has the potential to create long-run supply-side growth bonuses by raising productivity. The UK government recognises this, and has the target to raise total R&D investment to 2.4% of GDP by 2027, and 3% in the longer term. Just last month, the UK government published it’s R&D ‘Roadmap’. But where should this money come from, and where should it go?
Economist Mariana Mazzucato argues that the answer is more government investment. The state is often caricatured as the antithesis to innovation by free-market economists: bogged down in bureaucracy and lacking profit incentives. The best the state can do is aim to stimulate private-sector innovation via tax cuts, subsidies and the like. However, in her book, “The Entrepreneurial State” (2013), Mazzucato argues that the state is the entity which takes the boldest risks and achieves the biggest breakthroughs.
For example, “all the technologies which make the iPhone ‘smart’ are also state-funded” she explains, “…the internet, wireless networks, the global positioning system (GPS), microelectronics, touchscreen displays and the latest voice-activated SIRI personal assistant.” However, it was Apple who then combined these ideas together and reaped the rewards. R&D investment is immensely costly and full of uncertainty – there is simply no knowing where the next profitable discovery will be found. This is precisely why major breakthroughs often do not occur in private companies: their resources are too limited, goals too short-term, and profits too important to shareholders.
The question of where this money should be directed is far more complex. In terms of industry, the list of possible destinations for increased R&D investment is plentiful. According to UK-Innovation Research Centre, every £1 of government R&D spending in the UK raises private sector output by 20p per year in perpetuity. In medical research, the returns are estimated to be even higher at 25p per year in perpetuity for every £1 invested.
The pharmaceutical and automobile industries currently dominate the R&D rankings, but a successful strategy must strike a balance between consolidating these pre-existing industries, while being open to new opportunities in emerging sectors. One sector potentially suffering from underinvestment is that of clean energy. Investment here would be key in assisting the UK in achieving its goal of decarbonising the economy, along with the increasing need for upgraded energy infrastructure: three birds, one stone.
In terms of geography, the UK has a golden opportunity to rectify large regional imbalances in productivity levels and R&D spending. Per capita, R&D investment is highest in the East of England at £1064 per head, compared to just £250 per head in Wales. Investment in these lagging regions is sure to generate the largest benefits: the UK economy could be boosted by £83 billion, or £2700 per worker, if regions with below-average productivity could make up half of the gap.
While UK debt has soared during the pandemic, the cost of debt-service has fallen with interest rates. The UK should take this opportunity to invest; restoring the UK’s growth is more urgent than balancing its finances. Over to you, Rishi.
Book: The Entrepreneurial State: Debunking Public vs Private Sector Myths, by Mariana Mazuccato (2013), Anthem Press.
The views expressed in this article are the author’s own, and may not reflect the opinions of The St Andrews Economist.