Productivity is a puzzle with many different layers. When it becomes a mainstay in political speeches, it is rarely for a good reason. Most of the recent focus is on why it has been so slow, in the overall economy, for the last decade or so. In the 1990s, productivity in G7 countries rose at an annual average of 2.3 per cent. The end of the 2000s was dominated by the financial crisis and recession, but even then productivity grew at 1.3 per cent in the decade as a whole. When we look at the 2010s, however, this slumped to just 0.9 per cent.
Despite all the babble, no one really knows why. Many of the opinions are inconclusive. But when we delve down to the level of individual industries, the mystery really deepens.
The British economist Sig Prais did highly original work on the topic in the 1960s and 1970s. But it was only with the findings published by Chad Svyerson of the Chicago Booth Business School in the early 2000s that the issue came to prominence.
Even in very narrowly defined industries, Sveryson found huge differences in productivity across individual firms. The company which was more efficient than 90 per cent of all the other firms in the same industry had a productivity level four times higher than the one which was only more efficient than 10 per cent of the other firms.
The findings were updated and extended by the US Bureau of Labor Statistics in 2020. The authors noted dryly that “we found large within-industry dispersion in labour productivity”. Further, there was strong persistence in these differences over time.
How can this be? If some firms in the same industry are four time more efficient than others – and the difference between the very top and the very bottom was far more – then surely the low productivity firms will be driven out of business.
The forces of competition should enable the better firms to offer lower prices and better quality, leading to the gradual disappearance of the less efficient ones. But this happens, at best, only slowly. Inefficient firms can survive for long periods of time.
A reasonable inference to draw from this is that the traditional drivers of competition in economics – price and quality – are less important in practice than in theory.
This is particularly the case with relatively small firms. Their business may be too small for bigger competitors to be bothered with. Social ties might also be important. You are in the same golf club as your supplier, or maybe even both your fathers drank in the same pub when they were building up the businesses. Such has been a problem which plagued Italy for a long time, with a dominance of small and micro companies who relied on family ties rather than talent.
In the UK, the problem is particularly acute in low income areas. The problem is not just one in manufacturing, where productivity is easier to measure than in the service sector. A law firm, for example, in the centre of Manchester which is below average is unlikely to last. It has too many obvious and readily accessible competitors. The same cannot be necessarily said of one in, say, Workington.
More competition is essential in our low productivity areas. This is not something which can be brought about by regulation. It is not price fixing and cartels which are allowing inefficient firms to survive.
There are excellent companies in these locations, it is just that there are not enough of them. A practical step which local authorities can take is to promote them in the local press and online media, to publicise them as exemplars.
Effective competition is the solution to the long tail of low productivity firms. How to bring it about remains a major challenge, one which itself needs innovative thinking.