Productivity: still important for local growth

Productivity should be a prime target for local growth policy, even if job creation and employment are sometimes more immediate priorities.  This was the message from Professor Richard Harris when he addressed a seminar of government officials, academics and thinktanks at the National Institute of Economic and Social Research recently.

To support this objective, Richard Harris and John Moffat have produced new research, to be published in Regional Studies, providing a detailed analysis for each Local Enterprise Partnership (LEP) of productivity gain.  There are some surprising results. 

As well as the results on improvement within LEPs, they present findings on the drivers of local productivity, and the components of gain, and then draw implications for policy.

Productivity gain by LEP

The analysis by LEP shows intriguing patterns.  The analysis is one of change (rather than level).  Top improvers over the period (1997 to 2008) were in the middle of the country: the Black Country, Swindon & Wiltshire, and South East Midlands, but good performers occur in most parts of the country.  The chart below  shows these points. Similarly the less good performers are spread widely : Hertfordshire, Lancashire, Tees Valley, Cheshire & Warrington, Cornwall, Gr Edinburgh and Gr Manchester.  Total factor productivity (TFP) is used as the measure here (it is the additional outturn achieved by a company for given input of labour, capital and materials, beyond what would be expected for the ‘typical’ firm in that sector).  Annual growth in TFP was found to be 1.6%, which if continued over an extended period means national income would double every forty to fifty years.

LEP characteristics and productivity gain

Some characteristics of LEPs are associated with higher growth in productivity:  the largest LEPs in population terms (possibly a proxy for degree of urbanisation), those with greater reliance on skilled worker occupations, with higher proportions of workers with degrees or equivalent qualifications, and with highest levels of job density.  Considering TFP levels at the beginning of the period, there was a degree of convergence, with less productive LEPs having a slightly higher TFP growth on average than those placed higher at the beginning, suggesting an average of 14 years to halve the gap.

Components

The overall productivity gain in a LEP was disaggregated into 5 components arising from i. the entry or establishment of new plants or workplaces, ii. the exit of older ones, iii. productivity improvement within continuing workplaces, iv. expansion or contraction of continuing workplaces (between), and v. interaction between improvement within and expansion or contraction.

The study found that entry made the largest contribution: 1.3% gain nationally per annum out of an overall 1.6%.  Between workplace reallocation was the next largest accounting for 0.7% per annum growth.  There was little if any positive contribution from within workplace improvement, and workplaces that exit seemed to be relatively more rather than less productive, making a negative contribution to productivity gain.  These findings are in line with much of the literature (eg Disney et al 2003), and could seem surprising in that anecdotally within workplace improvement would seem to contribute an important part of overall gain.  However, the results suggest this is counterbalanced by within workplace deterioration in productivity so that overall the within component is negligible.

The main story across LEPs is also that entry of new workplaces provides the largest contribution in the great majority of areas – as in the national analysis.  Similarly the within component contributes little or nothing to productivity gain in most LEPs.  There is some variation, with a couple of LEPs having a substantial positive contribution from within workplace improvement (Glasgow, and Coventry), and several where reallocation between existing workplaces or even exits provide the largest positive contribution rather than entry.

Further data and research

It would be helpful to look at other firm performance data at a LEP level – churn amongst firms (entry, exit, contraction, expansion), job creation and destruction, and productivity level as well as gain.  Aston University researchers with the Enterprise Research Centre are planning some of that LEP level analysis, on churn and job creation, but other aspects, especially on productivity, would be worth pursuing as well.

With the dataset here, which has productivity over time for each LEP, together with a range of other relevant variables,  it would be possible to consider what distinguishes areas that continue to perform badly in productivity from those that manage to improve out of a relatively low position.

Implications for policy

According to Professor Harris, the two most important things a LEP can do for local growth based on his research are:  i)  to support firms in building their ‘absorptive capacity’, by which is meant their ability to obtain and use innovation and knowledge that is generated outside the firm; and ii) to help firms in improving their internal research and development and human capital.

There are positive gains from clustering of industries, with the present research suggesting that workplaces in service sectors benefit for local spillovers (with more mixed evidence for high-tech manufacturing) which supports policies to encourage clusters and facilitate collaborative working in service sectors and possibly others.

It is important to maintain a focus on productivity, not simply employment and local development

For national level policy, Richard Harris’ papers suggest that support for R&D (eg via tax credit) is justified by the evidence that engagement with R&D leads to higher TFP in general.  Capital grants are effective in raising productivity a) through attracting FDI (but they need to be focused on high productivity plants as opposed to being aimed at safeguarding or creating employment), and b) through enabling plants to upgrade their vintage of technology.

In summary, the main points are:

i)    keep a focus on productivity as well as jobs;  

ii)   support new and existing firms in developing absorptive capacity, and their capacity for internal innovation and for human capital creation, (which in turn suggests policies such as R&D tax credits and capital grants that focus on productivity are the right things to do, but not only these policies); 

iii)  encourage industry clusters in service sectors;  and

iv)  continue to develop the data sources and evidence base, initially through obtaining data on churn amongst firms in each LEP, on job creation and destruction, on productivity level and other factors, and obtaining research on factors that lead local areas to progress from low performance (employment or productivity or both), which other areas have not yet achieved.

Bob Butcher

29 November 2013