Article

Some Factors Influencing the United Kingdom’s Economic Growth Performance

Author(s):
International Monetary Fund. Research Dept.
Published Date:
January 1978
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THE POOR GROWTH PERFORMANCE of the U. K. economy, which was the subject of much discussion in the 1960s, 1 has continued in the 1970s. The annual rate of growth of real gross national product (GNP) declined from an average of 2.8 per cent in the period 1960–70 to 1.6 per cent in the period 1970–77, and in both these periods it was about half that of the weighted average of the other six major industrial economies (Table 1). When similar international comparisons are made for the growth of industrial production, the paucity of the United Kingdom’s performance is even more striking, particularly with reference to its record in the 1970s. By 1977 industrial production in the United Kingdom was only 3 per cent above its level in 1970, 2 while in the other major industrial countries, industrial production had increased on average by 27 per cent over this period.

Table 1.Major Industrial Countries: Growth Rates of Gross National Product (GNP) and Industrial Production, 1960–70 AND 1970–77(Annual average compound growth rates)
Real GNPIndustrial

Production 1
1960–701970–771960–701970–77
United Kingdom2.81.62.80.4
France5.73.95.83.4
Germany, Fed. Rep.4.92.04.61.9
Italy5.72.87.23.2
Japan10.75.513.53.5
Canada5.24.76.24.1
United States3.93.24.93.5
Weighted average (excluding the United Kingdom) 25.13.55.93.2
Sources: International Monetary Fund, International Financial Statistics (May 1977, December 1977, and September 1978).

Includes output from the mining and quarrying, manufacturing, construction, and utilities sectors.

Weighted according to shares of individual countries in GNP and in industrial production, respectively.

Sources: International Monetary Fund, International Financial Statistics (May 1977, December 1977, and September 1978).

Includes output from the mining and quarrying, manufacturing, construction, and utilities sectors.

Weighted according to shares of individual countries in GNP and in industrial production, respectively.

There has been much debate as to what have been the major factors explaining the United Kingdom’s disappointing economic growth performance. While some writers have emphasized the slow rate of accumulation of factor inputs, particularly of physical capital in industry, 3 as a major factor hindering the growth of British production, others have stressed the inefficient use or allocation of existing productive capacity as being important in explaining the United Kingdom’s relatively slow rate of economic growth. 4 In what follows, an attempt is made to identify some of the factors causing the United Kingdom’s slow rate of economic growth, especially since the early 1960s, taking cognizance of the ideas put forward in recent literature on the subject.

Viewed from the side of capital or using the Harrod-Domar approach to explaining an economy’s growth process, the rate of economic growth (g) can be broken up into the proportion of production devoted to gross investment, the investment ratio (s), and the apparent productivity of new capital formation, the gross incremental output/capital ratio (q). That is, the rate of growth of production can be expressed as the product of the quantity and quality of new capital formation

where Y is aggregate production and ΔK is gross investment or new physical capital formation.

The data in Table 2 indicate that both the investment and gross incremental output/capital ratios in the United Kingdom for the periods 1960–70 and 1970–77 were quite low compared with those in other major industrial countries. In both periods, the apparent productivity of gross investment in the United Kingdom was estimated to be less than two thirds of the average in other major industrial countries. The rate of fixed capital formation in the United Kingdom since 1960 has averaged about 19 per cent of gross domestic product (GDP), about 4 percentage points below the average investment ratio in the other major industrial countries. The relatively slower rate of capital formation in the United Kingdom is indicated by estimates that show that the average life of the capital stock is about 34 years, being almost double that in countries such as France, the Federal Republic of Germany, Sweden, and the United States and more than triple that in Japan. 5 These international comparisons also bring out the relative constancy of the investment ratio for most countries between the two time periods and indicate that the slower rate of growth of output in the 1970s reflected a substantial decline in the apparent productivity of new capital formation.

Table 2.Major Industrial Countries: Investment and Gross Incremental Output/Capital Ratios, 1960–70 and 1970–77
Gross Fixed Capital Formation as a Percentage of GNPGross Incremental Output/Capital Ratio 1
1960–701970–771960–701970–77
United Kingdom17.820.40.160.08
France24.023.40.240.17
Germany, Fed. Rep.25.223.00.190.09
Italy20.720.50.270.14
Japan33.132.30.320.17
Canada22.222.90.230.21
United States17.817.40.220.18
Arithmetic average (excluding the United Kingdom)23.823.30.250.16
Sources: International Monetary Fund, International Financial Statistics (May 1977 and September 1978).

Derived as a residual by dividing the annual average growth rate of real GNP by the average investment ratio.

Sources: International Monetary Fund, International Financial Statistics (May 1977 and September 1978).

Derived as a residual by dividing the annual average growth rate of real GNP by the average investment ratio.

I. Factors Accounting for the United Kingdom’s Low Rate of Capital Formation

capacity to invest

In broad terms, an economy’s rate of capital formation will be determined by the economy’s capacity to invest in the form of the resources available to finance investment and/or by the willingness to invest. The resources available for investment will in turn be determined by the economy’s domestic savings performance and its ability to attract capital from overseas. Detailed savings data in a comparable form for some major industrial countries are available only for the years 1963 to 1975 (Table 3). These data indicate that the rate of net domestic savings in the United Kingdom over this period was considerably lower than in all other major industrial countries except the United States. Net domestic savings as a proportion of GDP averaged 9.1 per cent in the United Kingdom over the period 1963 to 1975, while in major industrial countries with higher saving ratios it ranged from 11.3 per cent in Canada to nearly 25 per cent in Japan. Furthermore, it appears that differences in domestic saving ratios were to a large extent associated with different household saving ratios. Both the domestic saving and household saving ratios in Japan, for example, were well above twice the corresponding ratios in the United Kingdom. Although the household sector’s saving ratio in the United Kingdom has shown a strong rise since 1971, the increase in savings from this source has been more than offset by the marked fall in the rate of saving by the government and corporate sectors, so much so that net domestic savings, after providing for stock appreciation as a proportion of national income, fell from 12.3 per cent in 1965 to 5.4 per cent in 1975 (Chart 1).

Table 3.Selected Major Industrial Countries: Saving Ratios and Labor Income Share, 1963–75
Net Domestic Saving
Of which




Total




Households
Corporate and

quasi-corporate

enterprises


Compensation of

Employees as a

Percentage of

National Income
(As a percentage of GDP)
United Kingdom9.14.41.966.1
Germany, Fed. Rep.15.68.42.558.3
Japan24.915.33.653.7
Canada11.34.53.862.2
United States7.55.41.864.0
Sources: Organization for Economic Cooperation and Development, National Accounts of OECD Countries, 1974, Vol. 2, and 1975, Vol. 2 (Paris).
Sources: Organization for Economic Cooperation and Development, National Accounts of OECD Countries, 1974, Vol. 2, and 1975, Vol. 2 (Paris).

Chart 1.United Kingdom: Components of Domestic Savings 1 as a Percentage of National Income, 1965–75

Source: Organization for Economic Cooperation and Development, National Accounts of OECD Countries, 1975, Vol. 2 (Paris).

1 After providing for depreciation and stock appreciation.

2 Includes nonprofit institutions serving households.

One needs next to account for the factors contributing to the United Kingdom’s relatively low domestic saving ratio, especially of that in the household sector. It has been argued in the economic literature that wage and salary earners tend to have a lower propensity to save than do profit earners and that a change in the factor distribution of income will tend to affect the overall saving ratio. 6 While there is much intuitive support for this proposition, it has not been subject to any rigorous empirical testing for U. K. data. 7 One can note, however, that over the period 1963 to 1975 labor income in the United Kingdom represented a higher proportion of national income than in other major industrial countries (Table 3). The countries with the lowest domestic saving ratios—namely, the United Kingdom, the United States, and Canada—were also the only economies where compensation of employees as a percentage of national income exceeded 60 per cent. On the other hand, the fall in the share of profits in domestic incomes in recent years in the United Kingdom has been accompanied by substantial rises in the personal saving ratio. Notwithstanding, most commentators have attributed the rise in the personal saving ratio to such factors as the need to reconstitute real cash balances following their erosion by inflation and the uncertainty generated by higher rates of unemployment and inflation, and to increased contractual savings (mainly contributions to pension funds and life assurance premiums) induced in part by the British tax system, rather than to the change in the factor distribution of income. 8

It has been contended that the U. K. authorities have conducted their short-term demand management policies in such a way as to produce a bias toward consumption as against investment. Lord Kahn and Michael Posner, in a memorandum submitted to the Expenditure Committee of the House of Commons in July 1974, 9 noted that when moving from a “stop” to a “go” policy, the U. K. authorities have mainly used fiscal expansion in the form of reductions of taxation, but have relied largely on monetary and credit restrictions when moving back from the “go” to the “stop” policy phase. On the basis of this, they argue that “fiscal expansion (cutting rates of taxation) operates, on the whole, by benefiting consumption; while the restriction of the availability of credit operates, on the whole, by discouraging investment. Thus investment is constantly restrained in booms and consumption encouraged in slumps. The economy has been the victim of a highly perverse ratchet effect.” 10 In this connection, the most recent attempts to arrest the rapid growth of monetary aggregates and to reduce the public sector borrowing requirement (for example, in the latter months of 1976) were centered around restrictive monetary measures and cuts in public sector capital expenditure, while subsequent efforts to reflate the economy have encompassed mainly reductions in income taxes.

A number of writers in attempting to explain the high personal saving ratio in Japan in the postwar period have emphasized that the Japanese economy seemed to benefit from a “virtuous circle” in which a high growth rate of income contributed to a high saving ratio, which in turn facilitated a high growth rate of output. 11 This explanation is consistent with theories about consumer behavior that hypothesize that consumption habits of previous years strongly influence consumption in the current year. By the same token, the inference could be drawn that the United Kingdom has been locked in a low growth rate/low saving rate circle, which has severely hampered the capacity to invest.

Limited data also indicate that the relatively poor savings performance of the corporate sector in the United Kingdom has contributed to the relatively low rate of domestic savings. The contribution of the corporate sector in the United Kingdom to the domestic savings effort, as elsewhere, has fallen quite sharply since the early 1960s, a development that appears to have been associated with the falling rate of return on capital employed in this sector. Savings of companies fell from 44.7 per cent of total domestic savings in the period 1963–66 to 19.0 per cent in 1967–70 and further to 13.1 per cent in 1971–75 (Chart 1). The fall in the internally generated funds of corporations has led to greater reliance on external funds to finance investment. This has been reflected in a fall in the ratio of funds raised through rights issues to debt capital from an average of 69.3 per cent in the period 1966 to 1970 to 25.1 per cent in the following six years. Some of the factors accounting for the erosion of corporate profits are discussed in the following subsection.

It can be argued that even if a country’s domestic savings performance is poor, resources for investment in an open economy, like that in the United Kingdom, can be easily obtained by borrowing from abroad. That is, the real constraint to investment will be the willingness to invest. This appears to have been true in the United Kingdom up to about 1973, where despite the poor domestic savings performance and an array of controls on external capital outflows only a small percentage of funds was obtained from external sources. In the three years 1974–76, however, with domestic savings falling in the face of higher gross capital formation, external borrowing rose sharply. The latter development contributed to a weakening of the external payments position and to higher nominal interest rates, which in turn eventually had detrimental effects on the rate of private investment. 12 It is in this sense that the domestic savings effort can indirectly constrain investment. It is noteworthy that Japan and the major industrial countries of Europe, which achieved high rates of capital formation over the period 1962–75, had relatively strong domestic savings performances and were net lenders to the rest of the world.

willingness to invest

Within the constraints set by the availability of investible resources, the actual rate of capital formation will be determined by the willingness of entrepreneurs and other entities making investment decisions to deploy the investible surplus in actual capital formation. The desire to invest will in turn be determined by a multitude of factors. Keynes, in The General Theory of Employment, Interest and Money, postulated that the inducement to invest will be determined by the relationship between the marginal efficiency of capital (the expected rate of profit on a contemplated new investment) and the rate of interest, with the rate of investment being pushed to the point on the investment-demand schedule where the marginal efficiency of capital in general is equal to the market rate of interest. 13 More recent studies have refined this relationship and have related investment demand to the valuation ratio, which is defined as the ratio between the rate of return on capital employed and the cost of capital. 14 In these studies, the actual rate of return on existing capital assets is used as a surrogate for the expected rate of profit on a prospective investment, since it is argued that if current rates of profit are changing, enterprises not only will have more or less internally generated funds to invest but also are likely to have more or less incentive to undertake further investments, given the cost of capital. 15

There is considerable evidence suggesting that the rate of return on capital employed in U. K. industry has been falling, especially since the mid-1960s. The pretax rate of return, which averaged 10.8 per cent in the 1960s, fell to an average of 8.2 per cent over the next four years, declined sharply to 4.6 per cent in 1974, and further to 3.5 per cent in both 1975 and 1976 (Table 4). The posttax rate of return recorded a similar decline and would have fallen to zero by 1974 but for tax relief on profits derived from increases in the value of stocks. The fall in company profitability in the United Kingdom is indicated also by the decline in the share of gross trading profits of companies net of stock appreciation as a proportion of domestic income from an average of 13.8 per cent in the 1960s to an average of 11.1 per cent over the next four years, and further to an average of 6.4 per cent in the three years 1974 to 1976.

Table 4.United Kingdom: Rates of Return, Cost of Capital, and Profit Shares in Industrial and Commercial Companies, 1960–76(In per cent)
Rates of Return on Capital Employed in

Industrial and Commercial Companies

After Deducting Stock Appreciation 1
Gross Trading Profits of

Companies Net of Stock

Appreciation as a

Proportion of Domestic

Income
PretaxPosttax 2Posttax Real

Cost of Capital 3
196013.29.78.815.9
196111.48.18.314.5
196210.47.66.313.7
196311.39.25.814.7
196411.79.36.514.7
196511.26.65.314.2
19669.85.55.712.9
196710.25.95.013.0
196810.05.33.912.7
19698.84.14.011.7
19707.83.44.410.7
19718.34.34.611.6
19728.84.35.111.6
19737.84.56.110.5
19744.62.2 46.66.8
19753.53.3 45.96.0
1976 53.52.9 46.86.5
Sources: Bank of England, Quarterly Bulletin (June 1977); U. K. Central Statistical Office, Economic Trends (various issues).

Ratio of earnings (gross trading profits plus rent received less depreciation and profits owing to stock appreciation) to the average capital stock in the period. Capital stock and allowances for capital consumption are valued at the current replacement cost.

After deduction from profits of taxes on interest and dividends in the hand of recipients, as well as direct company taxes. Only current investment incentives are taken account of, and the impact of past investment incentives on the companies’ actual tax bill has not been allowed for, since the computations of the actual rate of return are intended to be “forward looking.”

The real cost of capital is defined as the rate at which the companies’ future earnings are discounted by the capital market in valuing the securities on which those earnings will accrue, whether in the form of interest, dividends, or retentions. In the Bank of England, Quarterly Bulletin (June 1977), it is estimated by dividing “forward looking” posttax profits (after allowance for stock relief) by the financial valuation of the capital stock.

Adjusts for tax relief on stocks.

Provisional estimates.

Sources: Bank of England, Quarterly Bulletin (June 1977); U. K. Central Statistical Office, Economic Trends (various issues).

Ratio of earnings (gross trading profits plus rent received less depreciation and profits owing to stock appreciation) to the average capital stock in the period. Capital stock and allowances for capital consumption are valued at the current replacement cost.

After deduction from profits of taxes on interest and dividends in the hand of recipients, as well as direct company taxes. Only current investment incentives are taken account of, and the impact of past investment incentives on the companies’ actual tax bill has not been allowed for, since the computations of the actual rate of return are intended to be “forward looking.”

The real cost of capital is defined as the rate at which the companies’ future earnings are discounted by the capital market in valuing the securities on which those earnings will accrue, whether in the form of interest, dividends, or retentions. In the Bank of England, Quarterly Bulletin (June 1977), it is estimated by dividing “forward looking” posttax profits (after allowance for stock relief) by the financial valuation of the capital stock.

Adjusts for tax relief on stocks.

Provisional estimates.

Whether the rate of return on investments in the United Kingdom has been lower than in other countries, and has been a factor causing the relatively slower rate of capital formation in that country, is worth exploring. Given the caveat that one should exercise considerable caution in comparing data on company profitability across countries, there is evidence suggesting that the rate of return on corporate capital in the United Kingdom has averaged a lower level and declined more sharply than in other major industrial countries. The data in Table 5 indicate that Italy was the only country where the gross rate of return on corporate capital was anywhere near as low as in the United Kingdom. Although gross rates of return reached abnormally low levels in most industrial countries in the years 1973–75, the United Kingdom and Italy were the only countries in which there appears to have been a strong underlying decline in profitability since the early 1960s. In evidence submitted by the Bank of to the Wilson Committee in 1977, it is noted that company profitability in the United Kingdom had declined more sharply than in other countries. 16

Table 5.Major Industrial Countries: Developments in Corporate Profitability, 1960–76(In per cent)
United

Kingdom
FranceFed.Rep.

of

Germany
ItalyUnited

States
CanadaJapan 1
(Gross rate of return)2
19605.89.513.15.615.315.0
19615.49.312.66.018.914.7
19625.29.012.15.717.015.6
19635.69.111.65.317.416.512.5
19645.59.512.05.118.117.912.8
19655.49.211.75.318.818.111.9
19666.19.611.45.618.717.312.4
19674.89.610.95.517.615.714.0
19684.710.012.55.717.115.614.7
19694.210.412.95.515.615.414.3
19703.610.012.44.914.214.014.7
19713.710.211.74.314.714.014.2
19723.510.311.34.215.515.213.0
19733.19.611.54.014.717.910.9
19742.28.210.93.313.221.711.9
19752.05.710.63.013.518.513.0
(Gross profit share) 3
196323.329.127.230.028.127.141.6
196423.229.527.429.728.528.741.4
196522.329.227.231.629.528.239.7
196620.430.227.232.729.227.341.1
196720.930.327.831.828.226.342.1
196820.731.328.932.427.627.043.6
196919.232.328.632.226.026.543.7
197017.132.627.629.424.324.743.7
197117.932.526.926.425.324.841.8
197217.832.526.626.126.226.040.5
197316.831.926.125.425.028.836.8
197412.332.825.623.023.630.236.6
197511.432.326.022.324.627.837.6
1976 411.432.728.022.225.127.240.8
Source: Organization for Economic Cooperation and Development, Towards Full Employment and Price Stability: A Report to the OECD by a Group of Independent Experts (Paris, June 1977), pp. 305–307.

Fiscal years beginning April 1 of the year specified.

Gross rate of return is defined as the ratio of gross property income to total assets (the United States, Japan, the United Kingdom) or tangible assets (France, the Federal Republic of Germany) or gross capital stock (Canada, Italy, the Netherlands, Sweden). The numerator is adjusted for inventory valuation in all the countries, and the denominator only for the United States, France, and the United Kingdom.

Gross profit share is defined as the gross property income share in the corporate value added.

Preliminary estimates by OECD staff.

Source: Organization for Economic Cooperation and Development, Towards Full Employment and Price Stability: A Report to the OECD by a Group of Independent Experts (Paris, June 1977), pp. 305–307.

Fiscal years beginning April 1 of the year specified.

Gross rate of return is defined as the ratio of gross property income to total assets (the United States, Japan, the United Kingdom) or tangible assets (France, the Federal Republic of Germany) or gross capital stock (Canada, Italy, the Netherlands, Sweden). The numerator is adjusted for inventory valuation in all the countries, and the denominator only for the United States, France, and the United Kingdom.

Gross profit share is defined as the gross property income share in the corporate value added.

Preliminary estimates by OECD staff.

A major factor contributing to the relatively low level of company profitability in the United Kingdom appears to have been the relatively high proportion of value added of companies taken by labor costs in the United Kingdom. Comparable data are not available for the corporate sector as a whole on the share of labor costs in value added for major industrial countries. Figures for the manufacturing sector, however, indicate that the share of company income going to labor in the United Kingdom is high compared with most other industrial countries. During the period 1960–75, compensation of labor employed in the manufacturing sector as a proportion of domestic product originating in that sector averaged more than 70 per cent, and by 1975 it had increased to 75 per cent. In the United States, labor’s share in the output of the manufacturing sector also averaged more than 70 per cent, while in Italy the share was 67 per cent and had risen to about 74 per cent by 1975 (Table 6). In the other major industrial countries, however, the share of manufacturing output absorbed by labor was lower, especially in France, the Federal Republic of Germany, and Japan.

Table 6.Major Industrial Countries: Shares of Labor Compensation in the Domestic Product and Labor Productivity Growth of the Manufacturing Sectors, 1960–75(In per cent)
Labor’s Share of Domestic Product 1Annual Growth Rate of

Labor Productivity 2
196019751960–751960–75
United Kingdom66.774.870.63.3
France42.448.745.25.4
Germany, Fed. Rep.51.763.657.65.5
Italy57.973.566.75.7
Canada67.667.167.23.9
United States70.673.371.12.6
Japan48.259.954.58.2
Source: Derived from data prepared by the U. S. Department of Labor, Bureau of Labor Statistics, Office of Productivity and Technology (May 1978).

Compensation of employees, including adjustments for payroll and employment taxes, as a proportion of gross domestic product at factor cost originating in the manufacturing sector.

Labor productivity computed by dividing gross domestic product at factor cost by labor hours worked.

Source: Derived from data prepared by the U. S. Department of Labor, Bureau of Labor Statistics, Office of Productivity and Technology (May 1978).

Compensation of employees, including adjustments for payroll and employment taxes, as a proportion of gross domestic product at factor cost originating in the manufacturing sector.

Labor productivity computed by dividing gross domestic product at factor cost by labor hours worked.

In accounting for the decline in the profitability of British industry, one cannot attribute it to the growth in real average labor earnings outstripping that of labor productivity in the manufacturing sector (Table 7). In this sector, the annual average growth rate in output per person employed was 3.2 per cent over the period 1963–75, while that of the real product wage was 2.9 per cent. The divergence between the growth of real average earnings and of labor productivity appears to have been the reverse for industrial and commercial companies outside the manufacturing sector, because increases in earnings were only a little below or in line with those in the manufacturing sector, while productivity growth was appreciably less. The latter development was particularly pronounced in the 1970s when the growth of labor productivity in the nonmanufacturing sector was less than one third of that in the manufacturing sector.

Table 7.United Kingdom: Annual Compound Growth Rates of Labor Productivity and Real Product Wage, 1963–75(In per cent)
Manufacturing SectorNonmanufacturing Sector 1Whole Economy
Productivity 2Product

wage 3
ProductivityProduct

wage
Productivity 2Product

wage 4
1963–753.22.91.92.52.22.6
1963–703.64.02.43.02.83.3
1970–752.61.40.81.41.41.4
Sources: U. K. Central Statistical Office, Economic Trends (various issues); data prepared by the U. S. Department of Labor, Bureau of Labor Statistics, Office of Productivity and Technology (July 1977)

Estimates for this sector are derived as a residual.

Output per person employed.

Computed by dividing the index of average labor earnings in the manufacturing sector by the value-added deflator.

Computed by dividing the index of average earnings by the GDP deflator.

Sources: U. K. Central Statistical Office, Economic Trends (various issues); data prepared by the U. S. Department of Labor, Bureau of Labor Statistics, Office of Productivity and Technology (July 1977)

Estimates for this sector are derived as a residual.

Output per person employed.

Computed by dividing the index of average labor earnings in the manufacturing sector by the value-added deflator.

Computed by dividing the index of average earnings by the GDP deflator.

In the U. K. manufacturing sector, the sharpest fall in company profitability appears to have taken place since 1973, when prices of inputs of fuels and materials to industrial companies rose much faster than the prices of manufacturing output at a time of decelerating sales turnover. While wholesale prices of materials and fuel purchased by the manufacturing industry rose by 119.5 per cent over the three years from the second quarter of 1973, wholesale prices for the home sales of manufactured output and of the unit value of manufactured exports increased by 78.5 per cent and 89.2 per cent, respectively (Chart 2). The inability of British manufacturers to fully pass on cost increases in higher output prices in recent years can be ascribed in part to the increasing price competition in world trade in manufactures and to uncertainties about prospective demand, domestic price controls, and other restrictive regulations, which have effectively limited freedom in price setting. 17

Chart 2.United Kingdom: Developments in Prices and Costs in the Manufacturing Sector, 1962–77

(Percentage change over preceding year)

Sources: U. K. Central Statistical Office, Economic Trends (various issues); data prepared by the International Monetary Fund, Research Department.

Even though the growth of real average labor earnings in the manufacturing sector has not risen appreciably more rapidly than labor productivity, it could still be said that the failure of real wages to adjust to the 1973–75 upheaval in material and input costs contributed to the sharp decline in company profitability from 1973 onward. That is, the brunt of the adjustment to the rise in commodity prices and fuel costs was borne by profits. In this context, the share of gross property income in corporate value added in the United Kingdom fell by 5.4 percentage points between 1973 and 1975, whereas in the other major industrial countries the change in the gross profit share over the same period ranged from a fall of 3.1 percentage points in Italy to an increase of 1.2 percentage points in Japan. It was only from the last quarter of 1975 to the third quarter of 1977 that there was a significant reduction in real wages, which helped to alleviate pressure on profit margins; over this period, real wages fell by about 8 per cent.

The rate of growth of labor productivity in the manufacturing sector in the United Kingdom has been well below that of all other major industrial countries except the United States (Table 6). The relatively slow growth of labor productivity in British industry coupled with the slow growth in installed capacity has meant that manufacturers have experienced difficulties in supplying orders, especially in periods of buoyant demand. In Chart 3 it is shown that in each of the business upswings since 1960, the annual increase in labor productivity in the manufacturing sector reached a peak of just under 8 per cent and then fell back sharply. The marked deceleration in the growth of labor productivity following each cyclical upswing was due partly to supply constraints, such as shortages of component parts and technical manpower impinging upon the growth of manufacturing output. Consequently, British manufacturers in general have not been able to lower their average unit costs to the same extent as rival overseas producers through having longer production runs. Furthermore, the fragmented structure of British industry, caused in part by government support of ailing plants, has resulted in a duplication of capital capacity in many sectors of industry and has contributed to higher overhead costs per unit.

Chart 3.United Kingdom: Output per Person, 1961–76

(Percentage change over preceding year)

Sources: U. K. Central Statistical Office, Economic Trends (various issues).

The fall in the profitability of investment appears also to have been associated with an underlying decline in the marginal physical productivity of capital. Although the capital stock has tended to become increasingly underutilized with each cyclical trough, there appears to have been a secular decline in output per unit of capital since the mid-1960s for both the whole economy and the manufacturing sector (Table 8). The sharper fall in capital productivity in the 1970s in the United Kingdom than in other major industrial countries appears to be another factor explaining the steeper decline in profits in the United Kingdom. A discussion of the factors accounting for this decline and the low incremental output/capital ratio in the United Kingdom is presented in the next section of the paper.

Table 8.United Kingdom: Indices of Output per Unit of Capital, 1965–76 1(1965 = 100)
Whole EconomyManufacturing

Sector
1965100.00100.0
196697.998.0
196795.695.1
196895.498.2
196993.498.1
197091.495.0
197189.391.4
197288.594.1
197390.095.9
197486.490.8
197581.983.3
197681.882.6
Sources: U. K. Central Statistical Office, Economic Trends (October 1976) and Annual Abstract of Statistics, 1976.

Indices of gross domestic product divided by indices of the gross capital stock for the whole economy and for the manufacturing sector, respectively.

Sources: U. K. Central Statistical Office, Economic Trends (October 1976) and Annual Abstract of Statistics, 1976.

Indices of gross domestic product divided by indices of the gross capital stock for the whole economy and for the manufacturing sector, respectively.

While the low and declining rate of profitability of U. K. corporations may have contributed to the relatively low rate of capital formation, especially in the manufacturing sector, the incentive to invest has been also influenced by the cost to companies of the finance needed to acquire or to form physical capital. In a recent Bank of England article, it is estimated that the real cost of capital for industrial and commercial companies in the United Kingdom 18 declined appreciably in the 1960s, the fall being in line with the posttax rate of return on capital (Table 4). Thereafter, it rose quite sharply, and in the three years 1974–76 it was considerably above the posttax rate of return on capital.

In the United States, where the rate of capital formation has also been disappointing, the differential between the rate of return on corporate capital and its cost appears to have shown similar developments to that in the United Kingdom (Chart 4), although the fall in the differential has been less pronounced in the 1970s. Similar data are not available for other major industrial countries. In a recent report by the Organization for Economic Cooperation and Development (OECD), however, it is stated that “it is possible that through the 1950s and 1960s any fall in the rate of return on capital was offset by a fall in the real cost of capital reflecting a falling risk premium on equities and in some cases tax concessions. More recently, however, this movement to lower risk premiums may have been reversed … and this has most probably more than outweighed the influence of any fall in the real interest rate on the cost of borrowing.” 19

Chart 4.United Kingdom and United States: Difference Between Rate of Return on Corporate Assets and Cost of Capital, 1960–76

(in per cent)

Sources: Bank of England, Quarterly Bulletin (various issues); U. K. Central Statistical Office, Economic Trends (various issues); Federal Reserve Bank of New York, Quarterly Review (Autumn 1977).

It appears that the fall in the rate of return on capital employed and developments in the cost of capital go some way toward explaining the low rate of fixed industrial investment in the United Kingdom. The Bank of England, in reporting on their econometric work on the determinants of investment, say “the results … have not been particularly encouraging … though in some cases, q [the ratio of the rate of return to the cost of capital] has proved to be just as successful as conventional accelerator models in explaining the behaviour of investment.” 20 And the OECD (1976) says “the slower growth of the net capital stock since 1955 has been associated with a decline in the rate of return on capital in manufacturing from about 13.5 per cent in the late 1950s to about 7.4 per cent in the 1970/74 period… . It seems that, on average over the period, for every one per cent decline in the rate of return there has been a decline of almost one quarter per cent in the rate of growth of the net capital stock after allowing for cyclical movements. 21

Further evidence of the relative unprofitability of undertaking capital formation in British domestic industry is provided by the relatively high number of company take-overs and overseas investments by U. K. enterprises in recent years. With the cost of new capital formation being high relative to the financial valuation of existing capital assets (a low valuation ratio), enterprises find take-overs of existing assets more attractive than undertaking new investment. According to a recent article by Matthews and King, the relatively high number of company mergers in the United Kingdom has produced as many manufacturing firms with over 40,000 employees as in the rest of the European Communities. 22 They point out that the increase in the size of firms has been reflected in an increase in multiplant operations rather than growth in plant size. Meeks and Whittington in their study of the behavior of giant companies in the United Kingdom from 1948 to 1969 found that giant companies grew more rapidly than the rest of the company sector over the period 1964 to 1969, despite their lower rates of profit, and devoted a higher proportion of their expenditure to take-overs. They observe that “the typical Giant spent more on takeovers than on net new investment in fixed assets.” 23 Also, net direct investment abroad by U. K. companies, including unremitted profits, has increased substantially since 1972, the average in the years 1973 to 1976 being more than three times as great as in the previous four years.

One of the difficulties with the investment demand functions estimated by the OECD and the Bank of England is that they do not seem to adequately capture changes in risk premiums. In an effort to overcome this problem, an attempt was made to estimate demand for investment functions for the United Kingdom for annual data over the period 1963–75, by taking account of variations in risk premiums. The risk premium was computed as the difference between yields on corporate debenture and loan stocks and yields on government stocks. A fairly close relationship was indicated between the rate of change of the capital stock in the manufacturing sector and the adjusted rate of return on capital employed in the manufacturing sector lagged one year and the real cost of capital. Similar results were obtained where the posttax rate of return on capital employed by industrial and commercial companies was inserted as an independent variable. These regression results were as follows:

where I is gross investment in the manufacturing sector, K is the net capital stock in the manufacturing sector, Pm is the rate of return on capital employed in the manufacturing sector, 24P is the posttax rate of return for industrial and commercial companies, R is the risk premium measured as the difference between yields on corporate bonds and government securities, and C is the real cost of capital. 25

The estimated equations explain only about 65 per cent of the variation in private investment demand and capital formation in the manufacturing sector, but this is perhaps to be expected insofar as the investment demand functions do not directly include a quantitative estimate of demand expectations. This omission probably also biases the values of the coefficients in the equations. In addition, the rate of capital formation in the private sector is influenced, in the absence of changes in profit expectations and the real cost of capital, by such factors as changes in the cost of labor relative to that of capital and changes in relative prices of other factor inputs. Notwithstanding, it does seem that changes in the rate of return on capital employed can exercise a considerable influence on variations in private investment demand in the United Kingdom, especially in the manufacturing sector (Chart 5), even though it is difficult to pick up this influence econometrically.

Chart 5.United Kingdom: Rate of Return on Capital Employed and Rate of Fixed Capital Formation of Industrial and Commercial Companies, 1963–76

(In per cent)

Sources: U. K. Department of Trade, Trade and Industry (October 8, 1977); U. K. Central Statistical Office, National Income and Expenditure (various issues).

1 Fixed assets valued at current replacement costs. Profits are net of stock appreciation and depreciation allowances but not of taxes.

2 Gross domestic fixed capital formation of industrial and commercial companies as a proportion of their net capital stock of fixed assets.

3 Fund staff estimates for 1976.

In summing up this section, it could be said that the slow rate of capital accumulation in the United Kingdom, relative to that in other major industrial countries, has been due to both a low and declining capacity and a lack of willingness to invest. The low ability to invest has reflected a poor domestic savings performance over most of the postwar period. Rapid increases in labor costs per unit of output have reduced the flow of internally generated funds in the corporate sector and have increased the flow of income to the less thrifty or less investment-prone segments of the population. In this connection, the diminution of profits, arising from the growth of real wages outstripping that of labor productivity, appears to have been most pronounced for enterprises outside the manufacturing sector. With labor and capital costs—and more recently, material and fuel costs—rising rapidly in the face of limited capacity to raise output prices and to expand company turnover because of domestic price controls and strong international competition, profits have been squeezed and the incentive to invest consequently has diminished. In addition, the fall in corporate profit rates seems to have been associated with an underlying decline in the marginal physical productivity.

II. Factors Contributing to the Low Apparent Productivity of Gross Investment

An economy’s rate of economic growth will depend not only on the rate of capital formation but also on the output return on that capital formation. The gross incremental output/capital ratio is used in this paper to measure the apparent productivity of new capital formation. This ratio in the United Kingdom has consistently been below that in other major industrial economies over the last 20 years. Only in the Federal Republic of Germany since 1960 has the apparent productivity of gross investment fallen to a level comparable with that in the United Kingdom (Table 2).

Since the gross incremental output/capital ratio is calculated as a residual and reflects all influences contributing to economic growth other than the rate of capital formation, it is somewhat difficult to determine the major factors accounting for the relatively low output return on new capital formation in the United Kingdom.

It is possible that the low apparent productivity of gross investment in the United Kingdom has resulted from more capital formation being allocated to less productive sectors than in other major industrial countries. The data in Table 9, however, indicate that in the United Kingdom relatively low proportions of capital formation have taken place in the more capital-intensive sectors, such as in residential building and in government services. A relatively high proportion of capital formation in the United Kingdom has taken the form of investment in machinery and equipment. In most industrially advanced countries, productivity is generally the highest for capital deployed in the manufacturing sector. Limited data suggest that the proportion of capital formation allocated to the manufacturing sector in the United Kingdom has not been abnormally low. What is evident from international comparisons, however, is that capital formation in the manufacturing sector in the United Kingdom as a proportion of the domestic product of that sector has been quite low compared with other countries (Table 10). Moreover, the estimated output return on new capital formation in the U. K. manufacturing sector seems to have been particularly low by international standards, being less than two thirds of the average of the gross incremental output/capital ratio in the manufacturing sector for four other countries over the period 1962–75. 26 Furthermore, the differential in the marginal output/capital ratios between the United Kingdom and other major industrial countries has recorded a marked widening in the 1970s.

Table 9.Selected Industrial Countries: Allocation of Gross Fixed Capital Formation, 1962–75(As a percentage of total gross fixed capital formation)
Manufacturing

Sector
Government

Services
Machinery and

Equipment
Residential

Building
United Kingdom19.614.435.919.2
Italy8.030.030.5
Belgium23.812.835.325.9
Sweden19.117.326.725.3
Canada14.417.725.221.9
United States23.318.828.823.2
Japan21.628.221.8
Germany, Fed. Rep.35.223.4
France13.331.1
Sources: Organization for Economic Cooperation and Development, National Accounts of OECD Countries (various issues).
Sources: Organization for Economic Cooperation and Development, National Accounts of OECD Countries (various issues).
Table 10.Selected Industrial Countries: Investment and Gross Incremental Output/Capital Ratios for the Manufacturing Sector, 1962–75
Investment Ratio

(In per cent)
Gross Incremental

Output/Capital Ratio
1962–691970–751962–751962–691970–751962–75
United Kingdom13.413.413.40.270.060.19
Japan24.221.722.70.570.200.43
Sweden16.515.816.10.110.360.25
Belgium17.516.617.00.420.280.37
Canada15.415.415.80.390.260.35
United States12.916.814.90.31–0.060.12
Average (excluding the United Kingdom)17.317.217.30.360.210.30
Sources: Organization for Economic Cooperation and Development, National Accounts of OECD Countries (various issues); Bank of Japan, Economics Statistics Monthly (various issues).
Sources: Organization for Economic Cooperation and Development, National Accounts of OECD Countries (various issues); Bank of Japan, Economics Statistics Monthly (various issues).

What factors explain the relatively low gross incremental output/capital ratio in the U. K. manufacturing sector? Has new capital formation been poorly allocated or utilized within the manufacturing sector? An examination of the growth of the capital stock in the various types of manufacturing industry for the United Kingdom over the period 1962–75 reveals that the capital stock in so-called heavy (basic metals and metal products) industries grew at a considerably slower rate than that in other manufacturing industries. The gross capital stock at replacement cost in the “iron and steel” and “other metals, engineering, and allied” industries increased at annual average rates of 2.6 per cent and 2.7 per cent, respectively, over the period 1962–75, while the capital stock in other manufacturing industries rose at an annual average rate of 3.4 per cent. In fact, it was in the food, drink, tobacco, and chemical sectors that the capital stock grew most rapidly. Similar data on capital formation within the manufacturing sector do not seem to be available for other major industrial countries; however, data on changes in the composition of output in the manufacturing sector of certain industrial countries suggest that capital resources have been allocated to the metals, metal fabrication, machinery, and transport equipment industries at a more rapid rate than in other manufacturing industries. Only in the United Kingdom, and perhaps in Italy, was the growth rate of production in so-called heavy industries below that of the manufacturing sector as a whole 27 (Table 11).

Table 11.Selected Industrial Countries: Real Growth Rates of Manufacturing Industry and Selected Components, 1962–75(Annual average compound rates of domestic product in per cent)
United

Kingdom
ItalyBelgiumSwedenCanadaJapan
Total manufacturing2.46.55.34.85.115.3
Fabricated metal products, machinery, and equipment2.04.57.46.77.315.9
Basic metals–0.47.24.15.34.217.0
Sources: Organization for Economic Cooperation and Development, National Accounts of OECD Countries (various issues).

At current prices (1962–74 only).

Sources: Organization for Economic Cooperation and Development, National Accounts of OECD Countries (various issues).

At current prices (1962–74 only).

It is in the heavy and chemical industries that the scope for obtaining high output returns on new capital formation would seem to be greatest, since such industries have been the most technologically dynamic and have given the greatest opportunities for achieving economies of scale. The products of these industries have also experienced the most rapid growth in world trade over the postwar period. A study by Pratten suggests that scale economies are most likely to be attained in industries producing chemicals, petroleum, paper, basic metals, and some types of metal fabrication (e.g., automobiles). 28 From the demand side, evidence indicates that the products of heavy industry are subject to relatively higher income elasticities than are other industrial products. Maizels, in his study Industrial Growth and World Trade, estimated that for the period 1897–1957 for seven to ten countries the elasticity of real value added per capita with respect to per capita real national income was 1.26 for manufacturing as a whole, 1.52 for basic metals, 1.96 for metal products and machinery, 2.44 for chemicals, 0.54 for textiles, and 0.78 for food and tobacco. 29

The United Kingdom’s lack of capital capacity in rapidly growing world industries has been most conspicuous at times of cyclical upswings in the world economy, when the U. K. manufacturing sector has been unable to satisfy fully the large increases in demand for certain finished manufactured goods. This was most evident in the boom of 1973 when U. K. manufacturers could not meet the demand for such vital products as steel, castings, electric motors, specialist machine tools, and diesel engines. Panić has in fact argued that this lack of supply capacity has led also to the United Kingdom having a higher income elasticity of demand for imports of manufactures than that of other major industrial countries, especially for finished goods. 30 He estimates that the income elasticity of demand for imports of manufactures was 3.09 for the United Kingdom over the period 1957–72, compared with 2.14 for the Federal Republic of Germany, and 2.19 for France. 31 Panić and Rajan in an earlier study found that the U. K. trade performance deteriorated relatively faster in the commodity groups, for which world demand was growing rapidly, than in those in which it was growing slowly. 32 And the OECD in its 1978 economic survey of the United Kingdom states “there is indeed some very impressionistic evidence which suggests that it is precisely in those industries in which investment efforts have been relatively low since the beginning of the decade that foreign penetration has advanced most rapidly.” 33 Consistent with this line of argument is the hypothesis of Bacon and Eltis that boom periods in the British economy since 1965 have tended to become shorter because of the slower growth of productive potential resulting from the slowdown in industrial investment. 34 With each successive boom, the limits to supply have been approached more quickly. This has led to an upsurge in imports and an administered halt in the boom because of the need to correct a widening balance of payments deficit. 35 Bacon and Eltis pointed out that 40 per cent of Britain’s machine tool requirements were supplied from abroad in 1974, compared with 20 per cent in 1955. 36 Thus, it seems that low capital expenditure in potentially dynamic areas of the manufacturing sector has contributed indirectly to truncating periods of rapid economic expansion, and consequently has reduced the overall rate of economic growth over longer periods of time.

Not only has the U. K. industry been at a relative disadvantage during periods of peak demand but also the low rate of capital formation in technologically advanced industries in the U. K. manufacturing sector has both prevented the rapid diffusion of new technologies into the productive process via so-called embodied technical progress and contributed to the decline in the ability of British industry to compete internationally in markets for more sophisticated products at times of slacker demand. The United Kingdom’s lack of investment in the development of sophisticated products appears to be indicated by data collected by the National Economic Development Office that show that unit values of U. K. exports within most product groups tend to be lower than those in the Federal Republic of Germany and France, especially in the engineering sector, while the reverse appeared to be true for unit values of imports. 37 Relative to other major industrial countries, the United Kingdom seems to be slipping downstream in the product cycle, producing cheaper and less sophisticated goods with a lower rate of return. The same goods, like textiles, which the United Kingdom exported to former British colonies, are now often produced by these countries and other developing economies in the first stages of their industrialization. 38 Thus, it appears that the United Kingdom with its low value-added industries has been more vulnerable to low-cost competition.

In the postwar period with world trade in manufacturing expanding at a more rapid rate than world output of manufactures, all major industrial countries other than the United Kingdom and the United States seem to have taken advantage of this situation through expanding their exports of manufactures at a faster rate than that of output, especially through increasing the heavy industry composition of such exports (Table 12). Once manufacturers in countries such as Japan, Italy, and France have penetrated foreign markets with their products, they have been able to spread their fixed costs over higher outputs and, thus, have reinforced their competitive edge in world markets. The inability of U. K. manufacturers to penetrate export markets is indicated by the fact that in the period 1960–76 the U. K. share in the volume of the manufacturing exports of the 11 largest OECD countries declined from 15.3 per cent to 8.3 per cent (Table 13). The poor performance of British manufactured exports has been most evident with regard to exports of machinery and transport equipment, which have lagged considerably behind those of world exports in these commodities (Table 14). The relatively high income elasticity of U. K. demand for imports and the relatively low elasticity of U. K. exports with respect to foreign trade suggest also that U. K. production of manufactures is of goods that are growing relatively slowly in world trade. At the same time, data on import penetration from 1968 to 1976 show that domestic market penetration has been most pronounced in industries producing machinery and transport equipment.39

Table 12.Major Exports of Industrial Countries: Rates of Growth of Output and Exports of Manufactures, 1955–68 AND 1963–76(Annual average rates of growth)
1955–681963–76
Index of

output in

manufacturing
Exports of

manufactures

(volume)
Index of

output in

manufacturing
Exports of

manufactures

(volume)
United Kingdom3.13.12.25.8
France5.78.95.610.1
Germany, Fed. Rep.5.99.54.69.2
Italy8.817.75.810.1
Canada5.39.05.3
United States4.14.23.17.5
Japan14.216.49.713.5
Sources: Organization for Economic Cooperation and Development, The Growth of Output, 1960–1980: Retrospect, Prospect and Problems of Policy (Paris, 1970); Cambridge University, Economic Policy Review, No. 3, Department of Applied Economics (Cambridge, March 1977), p. 67; statistics prepared by the U. S. Department of Labor, Bureau of Labor Statistics, Office of Productivity and Technology (July 1977).
Sources: Organization for Economic Cooperation and Development, The Growth of Output, 1960–1980: Retrospect, Prospect and Problems of Policy (Paris, 1970); Cambridge University, Economic Policy Review, No. 3, Department of Applied Economics (Cambridge, March 1977), p. 67; statistics prepared by the U. S. Department of Labor, Bureau of Labor Statistics, Office of Productivity and Technology (July 1977).
Table 13.Major Industrial Countries: Market Shares of Total Manufactured Exports of the Eleven Largest Members of the Organization for Economic Cooperation and Development, 1959–76(In per cent)
United

Kingdom
FranceFed. Rep.

of

Germany
ItalyCanadaUnited

States
Japan
By value
195917.49.219.24.45.321.36.7
196911.28.219.57.36.319.311.2
19739.49.522.16.85.116.112.8
19768.79.820.67.017.214.7
By volume
196015.38.417.84.223.15.4
19709.77.918.16.517.410.7
19768.38.417.86.517.214.1
Sources: National Institute of Economic and Social Research, National Institute Economic Review (November 1975), p. 73 and (August 1977), p. 96; Cambridge University, Economic Policy Review, No. 3, Department of Applied Economics (Cambridge, March 1977), p. 63.
Sources: National Institute of Economic and Social Research, National Institute Economic Review (November 1975), p. 73 and (August 1977), p. 96; Cambridge University, Economic Policy Review, No. 3, Department of Applied Economics (Cambridge, March 1977), p. 63.
Table 14.World and United Kingdom: Rates of Growth of Exports of Selected Manufactures, 1959–73(In per cent per annum)
WorldUnited Kingdom
Chemicals14.011.0
Textiles10.08.3
Metals12.08.0
Nonelectric machinery14.010.4
Electric machinery16.09.1
Transportation equipment13.07.6
Sources: National Institute of Economic and Social Research, National Institute Economic Review (November 1975), p. 72; U. K. Central Statistical Office, Annual Abstract of Statistics (various issues).
Sources: National Institute of Economic and Social Research, National Institute Economic Review (November 1975), p. 72; U. K. Central Statistical Office, Annual Abstract of Statistics (various issues).

The question arises as to why a greater amount or proportion of capital formation has not flowed into the more technologically dynamic and more export-oriented manufacturing industries in the United Kingdom. One hypothesis sometimes put forward is that U. K. producers tend to treat exporting as a peripheral activity, a tendency that may be based in part on the past unprofitability of exporting. 40 It is contended that U. K. enterprises have exhibited a tendency to shift more resources into exports at times of domestic recessions, which have usually been in phase with recessions in the world economy, and to switch them back to the home market when domestic demand recovers. The loss of U. K. export market shares appears to have been least in periods of slack world demand for manufactures (Chart 6). While there have been fairly marked short-term fluctuations in the relative profitability of exporting and of selling in the domestic market since the mid-1950s, there does not seem to have been any period, with the possible exception of the years 1974–77, 41 in which there has been a sustained improvement in relative export profitability of a magnitude that would induce producers to reorient their activities toward the export market (Chart 7). Moreover, with the decline in the overall profitability of industry since the early 1960s, a large increase in the relative profitability of exports would be required to coax out more capital formation for export-oriented production. It is further contended that with an increase in export profit margins, resulting from a devaluation in the pound sterling, manufacturers have tended to aim at maximizing short-run profits through keeping the foreign currency prices of the products unchanged rather than by using their improved price competitiveness to gain market shares and to enhance longer-run export profitability. This behavior of exporters may be indicative of their belief or experience that improved export profitability arising from devaluations is unlikely to be sustained, partly because of subsequent upward pressures on domestic wages and prices. 42 It has also been argued that investment in export-oriented and import-competing industries has been discouraged because changes in relative costs and prices vis-à-vis foreign competitors have not been sufficient to offset nonprice competitive factors that have caused other major industrial countries to gain market shares at the expense of U. K. producers. 43

Chart 6.Relationship Between Change in U. K. Share of World Exports of Manufactures and Growth in World Exports of Manufactures, 1951–75

(In per cent)

Source: U. K. National Economic Development Office, International Price Competitiveness, Nonprice Factors and Export Performance (London, April 1977).

Chart 7.United Kingdom: Relative Export Profitability Index, 1961–77 1

(1970 = 100)

Source: International Monetary Fund, Research Department.

1 Ratio of indices of unit value of U. K. exports of manufactures to U. K. wholesale prices of output of manufactures.

The output return on new capital formation will depend also on the efficiency with which it is combined with and used by other factors of production. Efficient use of plant and equipment may be limited by a shortage of complementary factor inputs. It was fashionable in the mid-1960s to attribute the sluggish growth of British secondary industry to the slow growth of labor supply available for employment in the nonagricultural sector. 44 However, this hypothesis seems to have been abandoned in recent years by its former adherents, especially as the coexistence of high unemployment and the slow growth of secondary industry became more pronounced. For example, Kaldor in 1975 said, “I was wrong in thinking in 1966 that … her [the United Kingdom’s] comparatively poor performance was to be explained by inability to recruit sufficient labour to manufacturing industry rather than by poor market performance due to lack of international competitiveness… . In particular, I would now place more, rather than less, emphasis on the exogenous components of demand, and in particular on the role of exports, in determining the trend rate of productivity growth in the United Kingdom in relation to other industrially advanced countries.” 45 In fact, it has been argued that restrictive labor practices in the United Kingdom have led to an overmanning of plant and equipment and a consequent depressing of the output return on capital. 46 Recent years have been characterized by organized groups of workers being preoccupied with resisting changes intended to improve productivity because of the fear of unemployment rather than by employers being preoccupied with problems of labor shortages.

While there does not seem to have been any shortage of unskilled labor to effectively man new capital equipment at least in the latter part of the postwar period, a number of writers have argued that there has been a shortage of technical manpower and managerial talent, especially of engineers, in the U. K. economy. 47 In the afore-mentioned article by Matthews and King on how to regenerate British manufacturing industry, it was stated that “the real bottlenecks in this country (not necessarily abroad) are in skilled labour and managerial talent.” 48 Recent studies by the National Economic Development Office indicate shortages of mechanical engineers in certain industries. 49 In a detailed but earlier study of 68 factories in the U. K. electrical engineering industry, however, a group of writers found no convincing evidence to support the conclusion that there is a general shortage of scientists and engineers in British industry, but at the same time warned against generalizing the results of their study. 50

Have British managers been less productive than their overseas counterparts in the management of capital equipment and/or have they been guilty of making poor investment decisions? It is difficult to determine to what degree management and labor are responsible for the poor output return on investment in the United Kingdom. Matthews and King contend that “the evidence suggests that when British managements seek to raise productivity by the use of modern methods and equipment, they find themselves obliged to accept conditions as to manning, operation or pay that cancel out much of the advantage of making changes and are not insisted upon by the employees of their competitors abroad. Managers have also had to devote much more time to dealing with labour disputes at the expense of innovatory tasks of prime importance to economic growth.” 51 Some writers argue that British management seems to be only slightly less efficient than North American management. Although North American firms operating in the United Kingdom do not achieve levels of productivity equal to those that they attain in North America or in the Federal Republic of Germany, their levels of productivity tend to be somewhat higher than the average of locally owned companies. 52 Pratten contends that the greater interdependence between managing directors and work operations in British corporations is a factor contributing to management’s poorer relative performance. 53 He argues that the managers of most German and Swedish companies are supervised by boards of directors of which the managing director is the only director who is active in the day-to-day management of the company. If the board finds that a managing director is incompetent, he is replaced. On the other hand, in the United Kingdom it is difficult to change managing directors, because most work in the business. Furthermore, it is more difficult for them to take a dispassionate view, and factions can develop. It is further contended by Pratten that managements’ efficiency in the use of capital equipment in the United Kingdom is rendered difficult by restrictive labor practices that often result in the overmanning of machines. 54 However, it is argued by Eric Moonman, Chairman of the All-Party Parliamentary Management Committee, that the relatively poor performance of U. K. managers in the home market also reflects their relative lack of qualifications and their low level of motivation. 55 He adds that the failure of the best qualified graduates to come into industry reflects very largely the poor image that industry has in Britain. In particular, the production and marketing aspects of business have not attracted the elite. In fact, Sir Henry Phelps Brown argues that the U. K. educational and class system has done the country a disservice by diverting ability away from industry. 56 The aversity of industry to potential managers and the poor motivation of actual managers probably also reflects the relatively poor pay of British managers. The findings of the recent Royal Commission on the distribution of income and wealth indicated that the real disposable income of British managers has been declining steadily since 1969 and that they earn considerably less than their counterparts in France and the United States. 57 These findings are supported by data that suggest that there has been an increase in recent years in the emigration of U. K. managers to overseas corporations. 58

One also should consider whether the highly publicized labor disputes in U. K. industry have resulted in capital equipment being less utilized or more idle than in other major industrial countries. However, an international comparison of the number of days lost per 1,000 employees as a result of industrial disputes over the period 1965–74 reveals that considerably more days were lost in the United States, Canada, and Italy than in the United Kingdom; only Japan, the Federal Republic of Germany, and France seemed to be relatively free from industrial disputes (Table 15). The United Kingdom’s reputation of being unusually strike-prone seems to derive from the much publicized record of a few dispute-prone industries, that is, mining, automobile manufacture, shipbuilding, and the servicing of docks, and the tendency for labor disputes to be more disruptive because of the relatively greater vertical integration of U. K. industry.

Table 15.Major Industrial Countries: Working Days Lost Per Thousand People Employed, 1965–74 1(Days per year)
Average
1965–691970–741965–74
United Kingdom3001,186743
France 2242300274
Germany, Fed. Rep.109050
Italy1,5841,7461,665
Canada1,5561,7321,644
United States1,2301,3801,305
Japan198288243
Source: U. K. Department of Employment, Employment Gazette (December 1975), p. 1276.

The number of working days lost is the aggregate of days lost by workers both directly and indirectly involved. The latter include workers put out of work, although not parties to the disputes at the establishments where the disputes occurred; repercussions on workers at other establishments are not taken into account.

The year 1968 is excluded from the averages.

Source: U. K. Department of Employment, Employment Gazette (December 1975), p. 1276.

The number of working days lost is the aggregate of days lost by workers both directly and indirectly involved. The latter include workers put out of work, although not parties to the disputes at the establishments where the disputes occurred; repercussions on workers at other establishments are not taken into account.

The year 1968 is excluded from the averages.

It is also possible that the low capital productivity in the United Kingdom may have resulted from a relatively high underutilization of capital equipment caused by a relatively low level of domestic demand. The pressure of demand, which theoretically can be defined as the difference between potential supply of goods and services, as determined by the productive capacity of the economy, and the actual demand for goods and services is in practice difficult to measure. To the degree that indices of capacity utilization are comparable, it does not seem that the average utilization of capital capacity in the manufacturing sector of the United Kingdom has been lower than in other major industrial countries to the extent of being an important factor accounting for the relatively low marginal output/capital ratio in the United Kingdom (Table 16).

Table 16.Major Industrial Countries: Output Gap1in Manufacturing Sectors, 1960–76(As a percentage of potential output)
United

Kingdom
FranceFed. Rep.

of Germany
ItalyCanadaUnited

States
Japan
19601.6–1.61.7–4.3–10.4–10.32.1
1961–2.0–1.01.9–2.5–11.5–13.97.0
1962–5.4–0.7–0.4–0.2–8.1–9.71.6
1963–5.60.3–3.4–1.1–6.6–6.0–1.9
1964–0.40.9–0.7–7.1–2.7–2.7–1.0
1965–0.7–1.91.7–9.10.52.2–9.8
1966–2.0–0.5–2.2–7.21.46.1–9.2
1967–4.7–2.7–9.7–4.0–2.62.0–1.8
1968–1.8–3.1–4.6–6.7–2.73.61.5
1969–1.3–0.71.7–0.9–1.82.44.3
1970–3.40.12.71.2–8.3–7.05.6
1971–6.50.2–0.7–3.9–7.8–9.0–2.9
1972–6.40.4–2.8–5.3–6.6–3.5–5.8
1973–0.41.1–1.4–0.7–2.71.50.1
1974–1.8–0.2–2.82.4–1.9–4.6–8.4
1975–11.2–11.5–12.1–12.8–10.8–14.9–24.4
1976–12.9–9.1–8.4–7.6–10.7–7.9–19.2
Average output gap (1960–76)–3.8–1.8–2.3–4.1–5.5–4.3–3.7
Sources: Derived from data in Jacques R. Artus, “Measures of Potential Output in Manufacturing for Eight Industrial Countries, 1955–78,” Staff Papers, Vol. 24 (March 1977), pp. 1–35, revised and updated in Jacques R. Artus and Anthony G. Turner, “Measures of Potential Output in Manufacturing for Ten Industrial Countries, 1955–80” (unpublished, International Monetary Fund, May 12, 1978).

Actual output less potential output.

Sources: Derived from data in Jacques R. Artus, “Measures of Potential Output in Manufacturing for Eight Industrial Countries, 1955–78,” Staff Papers, Vol. 24 (March 1977), pp. 1–35, revised and updated in Jacques R. Artus and Anthony G. Turner, “Measures of Potential Output in Manufacturing for Ten Industrial Countries, 1955–80” (unpublished, International Monetary Fund, May 12, 1978).

Actual output less potential output.

There are, of course, many other factors that will determine the differences in the efficiency with which capital and other factor inputs are used in the United Kingdom and other major industrial countries. Some of these factors, such as different attitudes to work and authority and the intensity of work effort, appear to be quite important, but unfortunately they are difficult to quantify. In concluding this section, however, it can be said that an important factor explaining the relatively low incremental output/capital ratio in the United Kingdom appears to have been the very low output return obtained on new capital formation within the manufacturing sector. This low return seems to have resulted from an allocation of new capital formation within this sector that was different from that in other major industrial countries. In the United Kingdom, there has been a relatively greater flow of capital resources into lagging industrial sectors, such as textiles, food, and beverages, and relatively less into the more dynamic export-oriented heavy and science-based industries. Accordingly, U. K. industry has not been able to take full advantage of the marked upswing in world trade in manufactures over the postwar period. This tendency has manifested itself in a loss of export market shares and rising import penetration, which in turn have led to periodic balance of payments constraints on the growth of output. It is possible that in certain industries the shortage of complementary factor inputs, such as skilled manpower at the technician and engineer levels, together with inefficient management, may have contributed also to depressing output returns on new capital formation.

III. Concluding Remarks

The poor economic growth performance of the United Kingdom has continued in the 1970s, especially with respect to industrial production. The slow advance of aggregate production in the U. K. economy can be attributed to the interrelated phenomena of a low rate of capital accumulation and a low output return on new investments. The slowdown in the growth of GDP in the United Kingdom in the 1970s coincided with the falling gross incremental output/capital ratio, particularly in the manufacturing sector. The poor domestic savings performance and, more important, the low incentive to invest, reflected in part by low and falling company profitability, contributed to the sluggishness of investment activity. The lower level of corporate profitability in the United Kingdom has resulted from a relatively high proportion of value added being absorbed by labor costs. The fall in U. K. company profitability, especially in the 1970s, seems to have resulted in part from real labor earnings in the nonmanufacturing sector rising at a faster rate than labor productivity and from the falling physical productivity of capital. In addition, the initial failure of real wages to bear any of the brunt of the adjustment to the increase in raw material and fuel prices over the period 1973–75, coupled with the limited capacity of British industry to raise output prices commensurately with input prices in the face of domestic price controls and strong international competition, contributed to the marked decline in domestic profits.

The United Kingdom’s relatively low output return on new capital formation has resulted partly from a relatively smaller proportion of capital resources being allocated to the more dynamic manufacturing industries of the world economy. This tendency appears to have been induced in part by the lack of any sustained increase in the relative profitability of exporting, at least up to 1973. It is also debatable whether government policy in the form of supporting so-called ailing industries has reduced significantly the efficiency with which capital resources have been deployed. Furthermore, labor relations problems and uncertainties about demand prospects caused by stop-go stabilization policies and related balance of payments problems appear to have contributed to a reluctance to modernize the capital stock in potential growth industries.

The international comparisons indicate also that many of the factors contributing to the United Kingdom’s poor economic growth performance since 1960, namely, low rates of increase of labor productivity and of the capital stock and poor domestic savings performance, were evident in the United States. The deceleration in the growth of the Italian economy in the 1970s appears to have been associated with a similar sharp fall in company profitability, as happened in the United Kingdom, caused largely by a growth of real labor costs well in excess of productivity. Finally, the international comparisons reveal that the slowing down of the major industrial economies in the 1970s, or at least until 1976, can be attributed to a substantial fall in the apparent productivity of new capital formation rather than to any discernible reduction in the proportion of GNP that these economies have allocated to fixed capital formation.

REFERENCES

Mr. Manison, economist in the European Department, is a graduate of Melbourne University. Prior to his Fund employment, he undertook postgraduate studies and taught at Monash University, in Australia.

Manufacturing production in the United Kingdom increased by only 4 per cent between 1970 and 1977, while the volume of imports of manufactures increased by 90 per cent over this period.

The different propensities to save of wage and profit earners, for example, form integral parts of the growth models of Joan Robinson and Nicholas Kaldor in which the rate of growth of output is dependent upon the factor distribution of income. See Kaldor and Mirrlees (1962).

For the United States, F. Thomas Juster and Lester D. Taylor found that for the period 1953 to 1973 the personal propensity to save out of property income was higher than that out of labor income. See Juster and Taylor (1975).

See Townend (1976) and “Investment in Britain” (1977).

Ibid., pp. 71–72.

During 1975 and 1976, it was strongly argued by a number of economists that rising public sector expenditure was “crowding out” private capital formation. See, for example, Bacon and Eltis (1976).

Keynes (1936), pp. 135–37.

See, for instance, Bank of England (1976).

Angus Maddison writing in the mid-1960s argued that the entrepreneur will use past experience as a guide in assessing the profitability of an intended investment. “After a few years of high and steady expansion of demand, he will change his assessment of these macroeconomic risks and respond by raising his rate of investment. He will, in fact, become concerned with the risks of not investing, i.e., lack of capacity to meet expanding demand with consequent loss of market share to competitors, and rising labor costs due to inadequate investment to raise productivity and offset rising wages.” See Maddison (1964), p. 50. However, with the low rate of return realized on investments in recent years, the risk premium associated with investing has risen, with companies becoming increasingly concerned about the risk of being caught with excess capacity in a downswing. See Greenspan (1977). In articles in the June 1976 and June 1977 issues of the Bank of England’s Quarterly Bulletin, the actual rate of return on existing capital assets is used as a proxy for the expected rate of return on a prospective new investment.

The Bank of England in explaining the fall in company profitability in the 1970s in the United Kingdom in its evidence submitted to the Wilson Committee noted that “the deficiency of final demand in this country, which prevailed for much of the time, was no doubt one reason why the rise in final prices lagged so far behind the rise in costs; but more important was the strenuous attempt to keep prices down despite increasing costs, first by voluntary restraint and later by statutory control. Historic cost accounting tended to mask the severity of the squeeze that this imposed on profit margins, to the point that companies, in many cases, did not immediately notice the approaching dangers.” See Bank of England (1977b), p. 312.

The real cost of capital is defined as the rate at which the capital market discounts future company earnings. It was estimated by dividing “forward-looking” posttax profits (after allowance for tax deductions for stock appreciation) by the financial valuation of the capital stock. See Bank of England (1976).

Gross rate of return on capital employed valued at replacement cost. Data were obtained fromU. K. Department of Trade (1976).

For source of cost of capital and rate of return data for industrial and commercial companies, see Table 4.

A survey of investment in Britain conducted by the Economist in November 1977 indicated that the gross incremental output/capital ratio in the manufacturing sector in the United Kingdom over the period 1962–72 averaged 0.20, while in Japan, the United States, the Federal Republic of Germany, and France it was about 0.35. See “Investment in Britain” (1977).

One exception was in the chemicals industry, which is often considered to be a heavy industry, where the rate of capital formation in the United Kingdom was relatively high by international standards.

Ibid.

OECD (1978), p. 25.

Houthakker and Magee in a statistical study of 12 countries found that the U. K. income elasticity of demand for imports was about one third higher than that for the United Kingdom’s exports. In other countries, the ratio between the income elasticity of demand for imports and that for exports was lower, with the extreme opposite being Japan, where the export elasticity was estimated to be three times that of the import elasticity. Thus, to maintain equilibrium in the balance of payments on current account, the United Kingdom’s growth rate of GDP would have to be slower than that of other major industrial countries. See Houthakker and Magee (1969).

In a paper, “The Impact of Colonialism and Independence on Export Growth in Britain and France,” Ian Livingstone found that both the United Kingdom and France suffered considerable export losses when their colonies became independent, but that France had been more successful than the United Kingdom in finding alternative markets for its exports. See Livingstone (1976).

Profits from exporting, as distinct from those derived from domestic sales and overseas investments, are estimated to have amounted to only about 15 per cent of industrial profits in the 1970s.

The recent improvement in relative export profitability and the slowdown in world trade appear to have been important factors allowing the United Kingdom to maintain export market shares in manufactures since 1973.

Hans Schmitt argues, for example, that the success of British devaluation of 1967 was diminished by the determined resistance of the work force, which did not permit room for investment and exports through permitting a reduction in their real wages. See Schmitt (1977).

The United Nations, in its study of the growth performance of major industrial countries, says, “there … seems to be some tendency for relatively high rates of return to capital inputs—as represented by low ICORs—to be associated with relatively high rates of growth of labour force and for high ICORs to be associated with relatively slow growth of labour supply.” Kaldor in his lecture in 1966, which discussed the slow rate of growth of the United Kingdom relative to other advanced economies, says, “it is the existence of an elastic supply curve of labour to the secondary and tertiary sectors which is the main pre-condition of a fast rate of development.” See United Nations (1964), Ch. 2, p. 19, and Kaldor (1966), p. 30.

Kaldor (1975), pp. 895–96.

Lord Robbins has said, “1 see no escape from the conclusion that a substantial area of industry in this country is greatly overmanned; and, when one has discounted all other causes, restriction of function and job reservation seem to me to play a leading part.” See Robbins (1974), p. 15.

See the Times (September 28, 1977), p. 14.

Ibid.

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