- Firms are growing and shrinking less in response to shocks
- This is bad news for both productivity and wages
As the next general election approaches, politicians say they have an unexciting prescription for the UK economy. Chancellor Jeremy Hunt is said to have put ’dullness’ at the heart of his tenure, while shadow chancellor Rachel Reeves has told the Financial Times: “I want to bring stability back to Britain’s economy because that is the only way we can bring back growth.” Yet economists at the Resolution Foundation think tank have a radical new remedy: economic change – and plenty of it.
The UK economy has had a turbulent 15 years, battered by the financial crisis, the uncertainty of Brexit, the pandemic and an energy price shock. But we can hardly say that the economy has undergone a period of seismic change. On two important counts, things have been remarkably static, according to Resolution. The pace of labour reallocation has slowed, meaning that firms are growing and shrinking far less than they used to in response to shocks. Even worse, the pace at which resources are moving between sectors has slowed to a nine-decade low.
Company-specific data shows companies’ hiring responses fell by 30 per cent following the financial crisis, suggesting that “UK businesses have become more rigid and less responsive to changes in the environment”. This translates to about 7.5mn ‘missing’ reallocated jobs, and a big drop in potential productivity.
The researchers calculate that if half of these reallocated workers boosted their new firms’ productivity even modestly, the gains could be significant: 4.5 per cent higher average productivity, enough to boost wages by £1,500 a year. This alone would offset about a quarter of the UK’s ‘missing productivity’ implied by the gap between today's rate and the pre-2008 trend (see chart). The conclusion is clear: “Spluttering economic change has an economic cost: lower productivity and wages.”
Less clear is what to do about it. The report recommends policies to ensure that capital and labour can flow to more productive firms, where good jobs are available. Possible remedies include removing stamp duty on residential and commercial transactions, and measures to encourage young and growing businesses, irrespective of size. Discounts in business rates and the VAT threshold are currently targeted at small firms – something that could discourage those firms from growing and creating jobs.
These are relatively uncontroversial steps, although may not be enough on their own. The research also stresses the importance of fostering competition, which could be done through a strong start-up culture, as well as policies to reduce the costs of international trade. Labour market reforms could also play a part. The researchers said that “boosting minimum standards for pay and conditions would force low-productivity firms and sectors to up their game or shrink”. A period of higher unemployment benefits could allow workers to find a better job with a better firm, rather than the first job that comes up, triggering a productivity boost.
But this greater dynamism would create costs as well as benefits. The researchers note that workers would (by necessity) lose jobs in the process, while some sectors would shrink as others grew. We could see surging unemployment, especially if changes happen quickly and are concentrated in certain areas. To really encourage change, we need something that looks a lot like Schumpeterian ‘creative destruction’ – the idea that innovation ultimately sees new production units replace the old. But with ‘creative destruction’ must come ‘destruction’ – and this would be a harder sell for politicians on an election footing.
As a result, less ambitious productivity policies will probably dominate over the next few months: think tweaks to encourage new methods in pre-existing firms. This could be a wasted opportunity. ‘Economic dynamism’ carries very real economic clout.
