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Wednesday 30 November 2022 at 6:00 am
Productivity is a puzzle with many different layers. When it becomes a mainstay in political speeches, it’s rarely for good reason. Much of the recent focus has been on why the overall economy, over the past decade, has been so slow. In the 1990s, productivity in the G7 countries grew by an average of 2.3 percent annually. The late 2000s were dominated by the financial crisis and recession, but even then productivity grew at a rate of 1.3 percent throughout the decade. When we look back to the 2010s, however, it dropped to just 0.9 percent.
Despite all the buzz, no one really knows why. Many opinions are inconclusive. But when we get down to the level of individual industries, the mystery really deepens.
British economist Sig Price did seminal work on this topic in the 1960s and 1970s. But the issue came to the forefront in the early 2000s with findings published by Chad Swyerson of the Chicago Booth Business School.
Even within very narrowly defined industries, Swerison found huge differences in productivity among individual firms. A company that was more efficient than 90 percent of all other companies in the same industry had a productivity level four times higher than one that was more efficient than only 10 percent of other companies.
The findings were updated and expanded by the US Bureau of Labor Statistics in 2020. The authors dryly noted that “we found large within-industry dispersion in labor productivity”. Furthermore, these differences had strong persistence over time.
How can this be? If some firms in the same industry were four times as efficient as others – and the difference between the very top and the very bottom was much greater – then surely the less productive firms would be driven out of business.
The forces of competition should enable the better firms to offer lower prices and better quality, causing the less efficient firms to gradually disappear. But this happens, at best, only gradually. Inefficient companies can last longer.
A reasonable inference from this is that the traditional drivers of competition in economics—price and quality—are less important in practice than in theory.
This is especially the case with relatively small companies. Their business may be too small to bother larger competitors. Social relationships can also be important. You’re at the same golf club as your supplier, or maybe both your dads even drank in the same pub when they were building businesses. It’s a problem that has long plagued Italy, which has been dominated by small and micro companies that rely on family ties rather than talent.
In the UK, the problem is particularly acute in low-income areas. The problem is not just in manufacturing, where productivity is easier to measure than in the service sector. A law firm, for example, that is below average in the center of Manchester is unlikely to survive. It has many obvious and easily accessible competitors. The same cannot be said of the one in Workington.
More competition is needed in our low productivity areas. This is not something that can be brought about by regulation. It is not price fixing and cartels that allow inefficient firms to survive.
There are great companies in these places, it’s just that there aren’t enough of them. A practical step that local authorities can take is to publicize them in the local press and online media, for example promoting them.
Effective competition is the solution to the long tail of low productivity firms. How to bring it about is a big challenge, which itself requires innovative thinking.
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