United Kingdom: Selected Issues
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International Monetary Fund
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Publication Date:
03 Mar 2003
eISBN:
9781451814170
Language:
English
Keywords:
ISCR; CR; right; price; investment; nominal interest rate; capital-output ratio; U.K. TFP; productivity growth; TFP gap; U.K. gap; Productivity
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This Selected Issues paper examines the factors determining housing prices in the United Kingdom. Based on econometric evidence, the paper assesses whether recent housing price increases can be explained by fundamentals or whether they represent a temporary overshooting of housing prices, characteristic of a bubble. The paper estimates a simple error-correction model that describes the dynamics of real housing prices since the 1970s. Estimation results suggest that earnings and interest rates are the key determinants of housing prices, and that changes in real housing prices exhibit a large degree of persistence.

Abstract

This Selected Issues paper examines the factors determining housing prices in the United Kingdom. Based on econometric evidence, the paper assesses whether recent housing price increases can be explained by fundamentals or whether they represent a temporary overshooting of housing prices, characteristic of a bubble. The paper estimates a simple error-correction model that describes the dynamics of real housing prices since the 1970s. Estimation results suggest that earnings and interest rates are the key determinants of housing prices, and that changes in real housing prices exhibit a large degree of persistence.

II. Cross-Country Overview of Growth Patterns 1970–20001

A. Introduction

1. This chapter examines the comparative growth performance of the United Kingdom in relation to a peer group of economies. In this context, the United Kingdom shows a significant gap in labor productivity. Improving the U.K. productivity performance is one of the main economic objectives of the authorities, as laid out, inter alia, in HM Treasury (2000). The sources of this productivity gap and the appropriate policies to close it have been the subject of public debate and lively academic research in recent times.

2. We study the United Kingdom within a sample of eighteen industrialized countries during the last 30-40 years and discuss the findings in the context of the ongoing public policy debate. We apply standard growth accounting to a dataset primarily based on the Annual Macroeconomic Database (AMECO) and to a country sample considerably wider than that of other recent research on the subject.2 Still, the picture that emerges broadly confirms the conclusions of most of the recent academic research: Although the U.K.’s lag in GDP per working-age person is minor with respect to most countries in the sample, except the United States, this largely reflects higher employment rates and hours worked in the United Kingdom than in most other European countries. When output per hour worked is considered, the United Kingdom lags behind most countries in the sample by considerable amounts. In turn, this kg corresponds to differences in total factor productivity (TFP) and, to a lesser extent, a lower capital-labor ratio.

3. The paper is structured as follows. Section B presents the main evidence that can be inferred from observable variables—including the existence of a persistent differential in labor productivity between the United Kingdom and most economies in the sample—and discusses the evolution of these variables over time. Section C introduces the growth accounting methodology used to attribute the productivity gap to its components: TFP and, broadly speaking, capital intensity It discusses the relative advantages of different decompositions of the productivity gap and the results from these decompositions. Sections D and E discuss the possible factors underpinning the TFP and capital stock gaps respectively. And finally, Section F offers some conclusions.

B. The Output and Productivity Gaps

4. GDP per working-age person is perhaps the most immediate measure of an economy’s productivity in the use of its endowment of non-reproducible resources—the most important of which is labor in modern economies. The related magnitude GDP per capita is more directly associated to welfare considerations—arguably the ultimate goal of efficiency in the use of resources—but it depends on factors, such as the age composition of the population, which are considered beyond the reach of economic policies, at least in the short to medium term. GDP per working-age person is also the observable magnitude most closely related to the output measure typically modeled in growth theory, where all the labor endowment is assumed to be potentially available for market production and is used to normalize total output.3

5. In the second half of the 1990’s, the U.K.’s level of GDP per working-age person was only slightly below most other countries in the sample, although the gap with respect to some countries such as the United States was significant (about 50 percent, see Table 1). The gap with respect to France and Germany was about 5 percent and slightly negative vis-à-vis Italy.4 Over time, the gap has declined with respect to the majority of countries in the sample since the early 1980’s. Over the whole 1960-2001 sample period, the United States maintained a wide lead in GDP per working-age person with respect to all countries in the sample (Figure l).5 The lead vis-à-vis the United Kingdom was little changed at about 50 percent of the U.K.’s level. Most other European countries, including France, Germany, and Italy, started in 1960 at a level similar to the United Kingdom. These countries, however, experienced substantial growth in GDP per working-age person over the 1960-1980 period (see Table 3) and narrowed the gap with the United States while leaving the United Kingdom behind. Subsequently, since early in the 1980’s, the growth of continental-European countries in output per working-age person declined below that of the United States and the United Kingdom, resulting on a partial reversion towards the U.K. level and a reduction of the U.K. gap with respect to these countries.

Figure 1.
Figure 1.

GDP per Working-Age Person

(1995 prices, in PPP $US)

Citation: IMF Staff Country Reports 2003, 047; 10.5089/9781451814170.002.A002

Source: AMECO (EC) Database; and staff calculations.

6. This evolution of the GDP per working-age person reflects, in turn, the combined dynamics of labor productivity and average labor input per working-age person. The broad picture on labor productivity (measured as output per hour worked) is that the United Kingdom lost ground with respect to most European countries until well into the 1980’s as these countries caught up with the United States; and since then, the United Kingdom maintained its relative position and in some cases regained some ground (Figure 2). Since 1970 to the mid-1990’s, the United Kingdom narrowed its gap with the United States, albeit generally at a lower pace than other European countries. Finally, since about 1995, labor productivity in the United States grew at a faster pace than in the United Kingdom and most other large economies in the sample Thus, the United States appears to be pulling ahead for the first time since the beginning of the sample period (1970) and possibly since much earlier—although this acceleration has taken place only for a few years and it is still too early to consider it a trend.6

7. Regarding average annual hours worked per working-age person, by the end of the sample period (in 1996–2001), the United Kingdom belongs in a high labor input group with Japan, the United States, Canada, Australia, Iceland and New Zealand (Figure 3). The high labor input in the United Kingdom corresponds primarily to high employment rates—currently abou 75 percent, one of the highest in the sample—and also to relatively high hours worked per employee, at least compared with other European countries. In most continental European countries, including France, Germany and Italy, labor input per working-age person is relatively low (roughly &of U.K. and U.S.levels), whereas Nordic-European countries are somewhere in the middle. This is, of course, why continental European countries with high levels of labor productivity (such as France, Belgium, Germany, and the Netherlands) do not exhibit a significant lead with respect to the United Kingdom in GDP per working-age person, while the United States—a high labor productivity and high labor input economy—has a large lead in GDP per working-age person over the United Kingdom and other countries in the sample Specifically, the U.K.’s catch-up to continental European levels of GDP per working-age person:(or per capita) since the early 1980’s was mainly due to increases in average labor input per person (which was declining in the continent), while productivity growth was broadly similar.7

Figure 2.
Figure 2.

GDP per Labor Unit

(Logarithms, 1995 prices, in PPP $US)

Citation: IMF Staff Country Reports 2003, 047; 10.5089/9781451814170.002.A002

Source: AMECO (EC) Database; OECD; and staff calculations.
Figure 3.
Figure 3.

Average Hours Worked per Working-Age Person

(Hours per year)

Citation: IMF Staff Country Reports 2003, 047; 10.5089/9781451814170.002.A002

Source: AMECO (EC) Database; OECD; and staff calculations.

8. Thus, the evidence indicates that the U. K. economy has a significant deficit in terms of labor productivity levels relative to most peer economies, although this may not be apparent through comparisons of GDP per working-age person (or GDP per capita). This conclusion is supported by recent research, despite somewhat different methodologies and data sources.8 The literature indicates that there was already a major U.S. productivity lead over the United Kingdom before World War II, particularly in manufacturing. On the other hand, Germany’s and France’s overtaking of the United Kingdom in terms of productivity levels is a more recent phenomenon that probably took place in 1950-1970.9 At the start of the post-war period, the United Kingdom’s labor productivity was about 55 percent of U.S. labor productivity, compared with about 40 percent for French and German labor productivity (O’Mahony (1999)). Thus, catch-up and technological imitation could have spurred part of the faster productivity growth in continental Europe vis-a-vis the United Kingdom in the early post-war period. Nevertheless, Crafts (2002) estimates that even when the “catch-up and reconstruction bonus” is discounted, U.K. productivity growth lagged behind continental European countries through the 1970’s—-a “growth gap” that did not close until the 1980’s, when many continental European countries had reached a productivity level similar to the United States. Since the 1980’s, although the deterioration of the U.K. relative labor productivity performance was halted (with some catching up in the 1990’s), the level gap has remained wide.

9. Many factors seemed to have contributed to the opening of the U.K. productivity gap during the period under review. Although an exhaustive survey of these factors is beyond the scope of this paper, the following are among those that have elicited some measure of consensus and attracted most research efforts.10 Crafts (1996) argues that supply-side policies during the 1950’s through the 1970’s, while sidestepping necessary structural reforms, focused on poorly-targeted subsidies to investment—which, in turn, was mainly physical fixed investment with little positive externalities and where the social returns were not likely to exceed private returns (Oulton and O’Mahony (1994). Blundell and others (2003) and Crafts (1996) point out that a turbulent and confrontational industrial relations environment from the 1950’s through the 1980’s and macroeconomic instability also contributed to deter investment and technological innovation.11 Based on a sample of U.K. companies, Nickell and others (1997) finds that the structure of firm ownership in the United Kingdom, with dispersed shareholders and weak constraints on management has militated against better productivity performance. Nickell and others (1997) and Nickell (1996) also find that weak competition was also a factor in the poor productivity performance.

C. Some Growth Accounting

10. In order to discuss further the U.K. productivity performance, it is useful to allocate productivity levels among constituent factors.12 Following standard growth accounting methodologies, we postulate a Cobb-Douglas production function

Y t = A t K t α L t ( 1 - α )   ( 1 )

where Yt, Kt and Lt denote output, capital, and labor input respectively in year t. As before, labor input is measured in hours worked. That is, L = Eh, the product of the number of employees by (an index of) average hours worked per employee. The factor At represents total factor productivity (TFP), an index of the efficiency with which labor and capital are combined in the production of output. Under this formulation, since At is calculated as a residual, the contribution from human capital (e.g., workforce skills) is implicitly subsumed into TFP. The parameter α represents the output elasticity with respect to capital and is set to 0.3.13

11. Under these assumptions, labor productivity can be expressed as the product of TFP and a function of the capital-labor ratio.

Decomposition   I :   Y t + L t = A t ( K t   /   L t ) α   ( 2 )

When comparing productivity levels across countries, this decomposition allows splitting the productivity differential into the part that is due to the use of more capital per hour worked and the part that is due to more efficient use of given resources (i.e., TFP)—implicitly considering these two magnitudes independent of each other. Specifically, when comparing the United Kingdom to another country, the TFP contribution to the labor productivity differential represents the part of the labor productivity gap that would be closed if TFP levels were equalized between the two countries while keeping constant the capital stock per hour worked in each of them. This decomposition of labor productivity (referred here as Decomposition I) has received the most attention in the current U.K. debate on the causes of economic performance (see O’Mahony and de Boer (2002).

12. The empirical results of Decomposition I are reported in Table 7 for the initial decade of the sample period (1971-1980) and for 1996-2000. They show that a deficit in TFP is the major cause of the U.K. productivity gap relative to other sample countries. The gap in capital stock per hour worked is also positive with respect to all countries except New Zealand, but it is relatively minor with respect to the United States (with which nevertheless a large labor productivity gap exists) and Canada. A low capital-labor ratio in the United Kingdom plays a more significant role in relation to continental European economies such as France, Germany, Italy, and the Netherlands. Over the sample period, the United Kingdom has generally achieved some modest catch-up in labor productivity with respect to other European countries, mainly by narrowing the TFP gap, whereas the relative productivity deficit that can be attributed to a low capital-labor ratio has generally increased somewhat, except with respect to Sweden (see Figures 4 and 5).

13. An alternative decomposition of the sources of the U.K. labor productivity gap can be obtained by expressing it as a function of TFP and the capital-output ratio.

D e c o m p o s i t i o n I I : Y t / L t = A t 1 / ( 1 - α ) ( K t / Y t ) α / ( 1 - α ) ( 3 )

Under Decomposition II, the fraction of the labor productivity gap allocated to TFP represents the increase in labor productivity that would follow from closing the TFP gap, if the capital-output ratio remained constant. To see why this measure is useful, consider an economy that increases its TFP, and hence output, while the investment ratio (investment as a proportion of GDP) remains unchanged. Since the increase in output will lead to a larger stock of capital, the capital-labor ratio will increase. Thus, Decomposition I will allocate part of the increase in output per hour worked to an increase in the capital-labor ratio. In contrast, Decomposition II will allocate the full increase in labor productivity (after the transition period) to the original increase in TFP that triggered the process. Of course, Decomposition I is more useful when increases in the capital-labor ratio (and hence in the capital stock) are considered independent from exogenous increases in TFP and output—even if only for analytical purposes. Decomposition II is more relevant if capital-output ratios tend to remain roughly constant when TFP and output increase——with capital-labor ratios increasing accordingly.14 Indeed, growth theory does suggest that capital-output ratios should be stable, at least along the balanced-growth path. Also empirically, capital-output ratios do not present an identifiable trend for most countries, although some countries in the sample experienced shifts and oscillations in this ratio during the sample period.

Figure 4.
Figure 4.

Total Fatter Productivity (TFP)

(In logarithms)

Citation: IMF Staff Country Reports 2003, 047; 10.5089/9781451814170.002.A002

Source; AMECO (EC) Database; OECD; and staff calculations.
Figure 5.
Figure 5.

Capital per Unit of Labor

(In 1998 prices, in FPP $US)

Citation: IMF Staff Country Reports 2003, 047; 10.5089/9781451814170.002.A002

Source: AMECO (EC) Database; OECD; and staff calculations.

14. Table 7 also reports the results of performing Decomposition II for the countries in the sample (see also Figure 6). As it could be expected, even a larger proportion of the U.K. labor productivity gap is allocated to insufficient TFP levels. In 1996-2000, lower capital stock is a relevant factor (say, above 5 percentage points of the productivity gap) only vis-àvis Germany, Japan, Italy, and the Netherlands, whereas the capital-output ratio gap is negative with respect to Australia, Belgium, Canada, Ireland, Norway, and the United States. In the case of the United States, for example, the labor productivity gap is 42 percent, of which 50 percentage points are due to a comparative deficit in TFP, while a negative-8 percentage points are due to a capital-output ratio gap. This should be interpreted as indicating that if TFP in the United Kingdom reached the levels of the United States while the capital-output ratio remained at its current value, labor productivity in the United Kingdom would exceed the United States by 8 percent—or, alternatively, the United Kingdom could reduce its capital-output and investment ratios while staying at U.S. labor productivity levels.

D. The Gap in TFP

15. Increasing the level of TFP in the United Kingdom is ultimately the key component in raising labor productivity. The empirical evidence presented here as well as in other studies indicates that the major source of the U.K.’s low labor productivity levels is a correspondingly low level of TFP. Closing the TFP gap with the United States would raise labor productivity between 33 percent and 50 percent depending of the associated response of investment rates (Table 7). Despite the larger capital stock gap, the TFP gap is also the major cause of U.K. labor productivity differentials with other European economies. Studies based on methodologies that do not rely on growth accounting or an aggregate production function—such as those based on firm-level microeconomic evidence, or sectoral analyses—confirm the importance of TFP in explaining U.K. productivity differentials.15 Moreover, TFP growth constitutes the most direct means to improve welfare—presumably the ultimate goal—as it entails expanding the output that can be obtained from any given level of resources. Thus, higher output per capita could be obtained (or more leisure could be afforded) without sacrificing consumption to maintain permanently higher investment ratios.

Figure 6.
Figure 6.

Capital-Output Ratios

Citation: IMF Staff Country Reports 2003, 047; 10.5089/9781451814170.002.A002

Source: AMECO (EC) Database; OECD; and staff calculations.

16 Although the specific factors underpinning TFP growth and TFP differentials are notoriously difficult to identify, there is mounting evidence of the critical role played by some of them. The problem is that growth theory and growth accounting analyses based on an aggregate production, while emphasizing the role played by TFP, throw little light on the underlying causes of TFP differentials. This is because TFP is computed (and, in effect defined) as a residual from equation (1) and thus, implicitly encompasses all factors that influence output other than physical capital and labor. Beyond the traditional interpretation as technological knowledge, it also includes many intangibles such as economic policies, the quality of labor and management, business practices, and institutional and legal features.16 Studies of the U.K. productivity performance, trying to see through this TFP “black box,” have singled out and underscored the importance of a number of factors influencing U.K. TFP, including its differential vis-à-vis other countries.

17. Research and development (R&D). There is wide agreement that R&D activity is crucial in raising productivity. Even for economies that are not at the technological frontier, imitation and catch up is not costless, as existing technologies need to be assimilated and adapted to the specific characteristics of markets and economic conditions. Using R&D spending as an indicator, Crafts and O’Mahony (2001) conclude that the United Kingdom shows a significant gap with respect to the United States and Germany, and less so with respect to Japan and France. The gap with the United States is particularly pronounced in manufacturing. HM Treasury (2000), based on OECD data, also argues that the U.K. economy has an important deficit in this area with respect to the United States, France, and Germany and that the differential widened over the 1990’s. Crafts and O’Mahony (2001), using estimated elasticities of output with respect to R&D spending, conclude that virtually all the U.K. gap in TFP with respect to the United States can be ascribed to the differential in R&D spending between the two countries. A related issue is whether R&D spending results in productivity spillovers beyond the firm that undertakes the expenditure This, in turn, would imply that, in the absence of remedial measures, R&D is likely to be undersupplied, as the social return would exceed the private, appropriable return. Although the debate on the existence of spillovers is far from closed, a substantial number of empirical studies find corroborative evidence.17 By combining company accounts data and industry information in five countries (France, Germany, Japan, United Kingdom, and United States), O’Mahony and Vecchi (2002) find evidence of both a relation between output growth and R&D spending (except in Japan) and of productivity spillovers of R&D spending.

18. Human capital Differentials in the stock of human capital appear to underpin TFP differentials between the United Kingdom and other European countries, but less so with respect to the United States. Based on the workforce composition by educational attainment, Crafts and O’Mahony (2001) considers that most of the TFP gap with respect to Germany and France can be attributed to a deficit of intermediate skills in the United Kingdom (Table 8). Other studies also show a significant contribution of workforce skills to productivity growth in the United Kingdom. For example, Lau and Vaze (2002) estimates that increases in labor force skill contributed with about 26 percent of total labor productivity growth in 1995-2000: and Haskel and Pereira (2002), using matched establishment and worker data, finds a strong association between the position of a business in the productivity distribution and use of employees with high human capital—which in turn, appears more related to education than to work experience.

Table 8.

Workforce Qualifications, 1998

(As percent of the workforce, total economy)

article image
Source: Crafts and O’Mahony (2001).

19. Competition environment Although from a theoretical standpoint the effect of competition on TFP is ambiguous, factual evidence for the United Kingdom points strongly to a positive effect.18 Based on a sample of U.K. firms, Nickell (1996) finds that competition, as measured by increased number of competitors or by lower levels of rents, is associated with a significantly higher TFP growth.19 Based on U.K. firm-level data as well, Nickell and others (1997) finds further evidence of positive effects of competition on TFP growth. It also finds a positive effect on TFP from the existence of a dominant shareholder and financial market pressures, suggesting that competition acts as a substitute for shareholder control and lenders’ oversight in spurring and focusing management efforts at improving efficiency and innovation—thus, mitigating agency (principal-agent) costs, considered one of the causes of the U.K. sluggish productivity performance.20 These results are consistent with evidence that innovations tend to occur more frequently in firms with larger market share. Blundell and others (1999) reports evidence that, within an industry, the number of innovations and patents is strongly correlated with market share but also that less competitive industries (lower import penetration or higher concentration) had fewer innovations in the aggregate. It argues that competition prompts pre-emptive innovation among market-share leaders to retain their position. In addition, the direction of causality between innovation and market share could plausibly be that innovative firms capture market share displacing more conservative ones and, at any point in time, this “competitive selection” results in a larger market share of innovative firms. In other words, in addition to causing incumbent’s preemptive innovation, competition also contributes significantly to TFP growth by the exit of inefficient firms, their replacement by more innovative entrants, and the expansion of the latter’s market share. Micro-data studies indicate that the entry and exit of firms and the expansion of more efficient establishments accounted for between one third and half of the productivity growth in the United Kingdom during the 1990’s and an even larger share of TFP growth.21

20.Spillovers from new physical capital. A possible source of TFP is that investment in certain types of capital may enhance the productivity of labor above and beyond what is implied by their measured contribution to the capital stock. This could occur if investment in some types of capital produced efficiency gains in the use of other resources or positive spillovers in other firms (e.g., through network externalities). The most obvious candidate for these effects in recent years is investment in ICT equipment. However, the evidence on the contribution to U.K. TFP from ICT capital investment (i.e., ICT usage as opposed to ICT production)is mixed and tends to point to a modest, if any, increase in TFP,22 Investment in ICT equipment has probably contributed significantly to overall labor productivity—specially when deflators are corrected for possible mismeasurement. But until now, the contribution of ICT in the United Kingdom seems to have been almost exclusively through capital deepening (higher capital-labor ratios) and higher productivity in ICT-producing industries, rather than by enhancing TFP economy-wide.

E. The Gap in Capital Stock

21. The current public and academic debate on the causes of U.K. low labor productivity has emphasized the role of the U.K.’s low capital stock.23 There are a number of factors supporting this view. First, the United Kingdom lags behind comparable economies in terms of its capital-labor ratio. Although this lag appears quantitatively less important than the lag in TFP, it is still significant. Table 2 and Figure 5 show that, in the 1990’s, the U.K. capital-labor ratio was below all other countries in the sample except Australia and New Zealand. And Table 7 shows that according to the Decomposition I of labor productivity, the low U.K. capital-labor ratio accounts for a substantial part of the productivity gap (although less than the TFP gap, as discussed above). Second, even if the primary goal were to increase TFP, this would still imply investment in new capital equipment. Although some theoretical analysis may model TFP as “manna from heaven,” there is abundant evidence that increasing TFP involves associated increases in the capital stock. This new capital may be required, for example, to take advantage of new technologies and higher skills or to permit the reorganization of work and management practices.

22.Some considerations, however, argue for tempering the emphasis on the U.K. capital gap. Most of the evidence of the U.K. relative shortfall in capital stock is based on comparisons with continental European countries (which also dominate our sample) and Japan. These countries appear to have followed a path to higher productivity driven to a large extent by high capital intensity. Japan and some continental European countries—notably Germany, Italy, and the Netherlands—exhibit particularly high capital-output ratios, even when compared to countries that have higher productivity. In fact, the capital-output ratios of Australia, Belgium, Canada, Ireland, Norway, Sweden, and the United States are all below that of the United Kingdom despite large productivity leads in the case of many of these countries (Tables 1-2) Thus, a cross-country comparison offers no evidence that closing the U.K. productivity gap will require a higher capital-output ratio As discussed above, increasing TFP and output per hour worked while keeping the capital-output ratio close to its current value would entail a higher capital-labor ratio. But the latter does not need to reach the high levels prevailing, for example, in Germany or Italy. Further, it is unclear that the high capital-output and capital-labor ratios prevailing in many continental European countries are an efficient technological response to economic conditions rather than a result of labor market rigidities or other distortions.24

23 The evidence suggests that a large part of the U.K.’s capital-labor ratio gap reflects a low stock of government capital. The paucity of data in this area (particularly crosscountry) is still a serious obstacle in reaching conclusions. Nevertheless, O’Mahony and de Voer (2002) and O’Mahony (1999) estimate that U.K. capital-labor ratios in market sectors (defined to exclude the general government) show a smaller gap than in the overall economy. They conclude that the overall capital gap is particularly pronounced in the government sector. This is consistent with other studies, including the companion paper “U.K. Investment: Is There a Puzzle?” in this Selected Issues volume. This raises the question of how much of a boost in productivity can be expected from closing the U.K. gap in public capital. An increase in the government capital stock would presumably increase productivity in the public sector—in the activities and delivery of public services where the new capital is used. But the extent to which higher public investment results in higher private sector productivity is hardly a matter of consensus among economists. Although few observers would argue against productivity spillovers from, for example, well-targeted public investment in transportation infrastructure, the empirical evidence of spillovers from general public capital is inconclusive. On the one hand, based on U.S. data, Lynde and Richmond (1992), for example, finds that public capital is a significant input in reducing private sector costs and that private and public capital are complements rather than substitutes. Among studies that find positive effects, the elasticity of private-sector TFP with respect to public capital is often found to be about ⅓. On the other hand, other studies find no significant (and on occasion negative) effects. For instance, with U.S. and Netherlands data, Sturm and Haan (1995) finds no evidence of spillovers when first differences are employed—which it argues, ought to be employed since the relevant variables are neither stationary nor cointegrated.25

F. Conclusions

24. We have examined the growth performance of the United Kingdom against a wide sample of 18 advanced economies. The results indicate that, in terms of GDP per working-age person, the United Kingdom lags with respect to most economies in the sample—although the differential is not large, except with respect to the United States. When controlling for the high employment rates and per-employee hours worked, however, the resulting U.K. gap in output per hour worked (labor productivity) is substantial with respect to most countries in the sample and has remained so over time. While other large European economies achieved labor productivity levels similar to the United States during the 1980’s, the United Kingdom has maintained a gap of about 40 percent.

25. Growth accounting techniques used to decompose the labor productivity gap indicate that the main element behind the U.K. lag is low levels of TFP. From a policy standpoint, although the TFP measure encompasses a multiplicity of factors, a number of them appear to be crucial in fostering a catch up with comparable economies. Increasing R&D activity and enhancing competition would have a significant positive effect on entrepreneurship and innovation. These factors alone could explained most of the U.K. TFP lag with respect to the United States. In addition, the skill composition of the U.K. workforce is tilted towards the low end in comparison with other European countries, where intermediate skills are stronger—which, in turn, could explain a large part of the differential with respect to these economies.

26. U.K. capital stocks also show a comparative deficit with respect to some countries—although it is not very pronounced and the evidence is less conclusive. The capital-labor ratio of the United Kingdom is below most other countries in the sample. In contrast, the U.K. capital-output ratio is higher than in many other countries with higher labor productivity, including the United States. Thus, the evidence does not support the need to increase substantially the current investment rates (and consequently the capital-output ratio). In fact, the higher capital-output ratios of some countries in the sample could reflect inefficiencies in the use of resources The U.K.capital stock and capital-labor ratio, however, will need to increase in parallel with and as part of the process of increasing TFP. Much of the U.K.’s gap with regard capital-labor ratios appears to be concentrated in the public sector. Thus, it is critical that higher public investment be efficient, if it is to help close the U.K.’s productivity gap.

Table 1.

Growth Accounting: International Comparison of Levels (I)

(UK=100, 1995 US dollars at 1995 PPP exchange rates)

article image
Sources: AMECO database; OECD; and staff calculations.

One unit of labor is defined as 2,088 hours of work (one year of 5-day weeks, 8-hour days).

Table 2.

Growth Accounting: International Comparison of Levels (II)

(UK=100).

article image
Sources: AMECO database; OECD; and staff calculations.

One unit of labor is defined as 2,088 hours of work (one year of 5-day weeks, 8-hour days).

Table 3.

Growth Accounting: International Comparison of Growth Rates (I)

(In percent)

article image
Sources: AMECO database; OECD; and staff calculations.

Growth rates are spliced to avoid a discontinuity at the time of unification, Growth rates are West Germany for 1960—1991 and for unified Germany thereafter.

One unit of labor is defined as 2,088 hours of work (one year of 5-day weeks, 8-hour days).

Table 4.

Growth Amounting: International Comparison of Growth Rates (II)

(In percent)

article image
Sources: AMECO database; OECD; and staff calculations.

Growth rates are spliced to avoid a discontinuity at the time of unification. Growth rates are West Germany for 1960—1991 and for unified Germany thereafter.

One “unit of labor is defined as 2,088 hours of work (one year of 5-day weeks, 8-hour days).

Table 5.

Growth Accounting: International Comparison of Levels (II)

(1995 US dollars at 1995 PPP exchange rates)

article image
Sources: AMECO database; OECD; and staff calculations.

One unit of labor is defined as 2,088 hours of work (one year of 5-day weeks, 8-hour days).

Table 6.

Growth Accounting: International Comparison of Levels (I)

article image
Sources: AMECO database; OECD; and staff calculations.

One unit of labor is defined as 2,088 hours of work (one year of 5-day weeks, 8-hour days).

Table 7.

U.K. Labor Productivity Gap and Its Components

(Gap with respect to the UK, in percent of UK level)

article image
Sources: AMECO database; OECD; and staff calculations.

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1

Prepared by Julio Escolano.

2

The AMECO database is maintained by the Directorate General for Economic and Financial Affairs of the European Commission. The countries included in the sample are Australia, Belgium, Canada, Denmark, Finland, France, Germany, Iceland, Ireland, Italy, Japan, the Netherlands, New Zealand, Norway, Spain, Sweden, the United Kingdom, and the United States. To allow cross-country comparability, data are in 1995 US dollars, based on Eurostat’s purchasing parity standard exchange rates. Hours worked are obtained from the OECD database. As a matter of convention throughout this paper, for the purposes of numerical calculations and their presentation in figures and tables, one labor unit is defined as 2,088 hours of work (one year of 40-hour weeks).

4

The narrow gap relative to Germany partly reflects the effects of German unification.

5

For readability, Figures 1-6 do not show all countries in the actual sample. Tables 1-7, however, report the results for all countries in the sample.

6

In particular, the most recent data from the U.K. Office for National Statistics, based on OECD data, do not show this widening of the U.K. productivity differential with respect to the United States.

7

The same conclusion is reached, for example, in Card and Freeman (2002).

9

See Crafts (1991), and Crafts and O’Mahony (2001).

10

The literature covering this field is too abundant to attempt any comprehensive enumeration of sources. Recent overviews include, among others, Blundell and others (2003), Card and Freeman (2002), Crafts and O’Mahony (2001), MacKinsey Global Institute (1998), Nickell (2002), and O’Mahony (2002).

11

For example, Bean and Crafts (1996) estimates that during 1945–1979, the U.K. framework of industrial relations reduced total factor productivity growth by 0.751. 1 percent per year.

12

A summary of the results of the growth accounting calculations is presented in Tables 1-7.

13

This is the value generally used in the growth accounting literature and is adopted here to facilitate international comparisons. Although α is a technology parameter, under standard equilibrium assumptions it equals the remuneration of capital as a share of total income, which is typically used to calibrate its value. Golling (2002) presents evidence that, when self-employed income is apportioned according to the reported shares for corporate income, 0.3 is a focal value for most countries. In particular, this value is very close to the capital income share in the United Kingdom and the United States. In continental-European countries, it appears that the capital income share as reported in the national accounts is somewhat above 0.3. This however, may reflect market imperfections (e.g., labor market rigidities, non-wage labor costs, etc.) rather than different available technologies, which appears implausible. If the true value of α were above 0.3 in some countries, the calculations presented here would underestimate TFP in those countries.

14

Hall and Jones (1999) argues this point. For the opposite viewpoint, see O’Mahony and de Boer (2002). Decomposition II is widely used in the growth literature (see, for example, Mankiw et al. (1992), Hall and Jones (1999), and Kehoe and Prescott (2002)

15

For example, Crafts and Mills (2001) uses econometric methods to analyze the manufacturing sector while relaxing some standard assumptions in aggregate growth theory (eg, perfect competition). It concludes that there is no reason to reject the benchmark rankings of British and German TFP performance estimated by conventional growth accounting. See also Baily and Solow (2001) and MacKinsey Global Institute (1998).

17

See Griliches (1992) and Jones and Williams (1998). The latter finds that, owing to spillovers, optimal R&D investment is at least two to four times actual investment. OECD (2002) reports evidence that R&D has a large long-term effect on TFP.

18

This ambiguity is well conveyed by the Schumpeterian idea of “creative destruction.” While market power offers entrepreneurs the possibility of reaping the rents from innovation, competition-including fluid entry and exit of firms-provides a sharper incentive to innovate and is necessary for the innovations to prevail and spread, contributing to generalized growth and renewal ofthe innovation cycle (Nickell (1996), Blundell and others (1999))

19

OECD (2002) discusses the effect of product market competition. Based on existing evidence for OECD countries, it argues that competition has positive and sizable effects on TFP through innovation and technology diffusion.

20

Nickell (2002), Crafts and O’Mahony (2001).

21

See Disney and others (2000) and Barnes and Haskel (2000, 2001, and 2002).

22

See Oulton (2002) and Kodres (2001).

24

The conjecture is that that labor market distortions may lead to higher capital intensity than would otherwise be dictated by efficiency considerations. Chapter III, (“U.K. Investment: Is There a Puzzle?”) finds a significant positive effect of employment protection practices on investment rates in a panel of countries. Blanchard (1997) argues that, in continental Europe, as real wages failed to adjust to the productivity slowdown and supply shocks ofthe 1970’s, firms reacted by moving away from labor This eventually led to increases in unemployment and adoption of capital intensive technologies. Caballero and Hammour (1998) also finds evidence in this direction—for example, a strong positive correlation between the increase in dismissal restrictions and the increase in the capital-labor ratio.

25

Other studies have focused on government size, finding a negative effect on growth(e.g.,Dar and AmirKhalkhali (2002). This strain of the literature, however, highlights the distortive effects of higher taxes or deficits associated with higher government spending (see Tanzi and Zee(1997) rather than the direct effect ofpublic capital on the private production possibility frontier.

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Cover IMF Staff Country Reports
United Kingdom: Selected Issues
Author:
International Monetary Fund
Volume/Issue:
Volume 2003: Issue 047
Publisher:
International Monetary Fund
ISBN:
9781451814170
ISSN:
1934-7685
Pages:
60
DOI:
https://doi.org/10.5089/9781451814170.002
Figure 1.

GDP per Working-Age Person

(1995 prices, in PPP $US)
Figure 2.

GDP per Labor Unit

(Logarithms, 1995 prices, in PPP $US)
Figure 3.

Average Hours Worked per Working-Age Person

(Hours per year)
Figure 4.

Total Fatter Productivity (TFP)

(In logarithms)
Figure 5.

Capital per Unit of Labor

(In 1998 prices, in FPP $US)
Figure 6.

Capital-Output Ratios