III THE PRODUCTIVITY GAP
13. The main objective of the Government's
industrial policy is to increase the country's prosperity. An
important means of achieving this objective is to improve the
UK's rate of productivity growth and, specifically, to reduce
the productivity gap with other leading industrialised countries.
It is important to recognise, however, that levels of prosperity
or living standards are not the same as levels of productivity.
GDP per head (the usual measure of living standards) is the product
of output per hour (labour productivity), average working hours
and the employment rate. This explains why France and Germany
have higher levels of labour productivity than the UK, but levels
of GDP per head are much closer: productivity differences are
largely offset by lower employment rates in France and Germany.
Similarly, if we consider productivity growth, Germany performed
better than the UK in the 1990s, but GDP grew more quickly
in the UK because its employment performance was far better than
that in Germany. Productivity is of course very important. But
we should not forget that in determining living standards so,
too, is the level of employment.
14. The debate about the 'productivity gap'
has mainly focussed on the performance of manufacturing. On the
basis of output per hour worked, manufacturing productivity in
the UK is 55% lower than in the USA and 30% lower than in France
and Germany. Total
factor productivity in manufacturing, taking into account stocks
of physical capital and skills, is also significantly lower than
in France (by 10%), Germany (20%) and the USA (43%).
And whereas manufacturing productivity in the USA increased by
41% between 1990 and 1999, the gain achieved in the UK was about
half of that.
15. No matter how manufacturing productivity
is expressed, the gap between the UK and our international competitors
is significant and shows few signs of narrowing. The Government
has the objective "to have a faster rise in productivity
than its main competitors over the next decade so that it closes
the productivity gap".
The Government's target is an ambitious one, given that policies
aimed at producing sustainable improvements in productivity will
need time to take effect. Our international competitors, who already
enjoy a productivity advantage over the UK, will also be seeking
productivity growth, making UK manufacturing's task all the more
difficult. Nevertheless, it is essential that Government, working
with industry, provides the necessary stimulus to encourage productivity
IV FACTORS AFFECTING PRODUCTIVITY
16. Analysis of the manufacturing productivity
gap by the National Institute for Economic and Social Research
(NIESR) indicates that the key determinants of manufacturing productivity
are physical capital intensity, skill levels within the workforce
and the effectiveness with which capital, labour and skills are
combined, as measured by total factor productivity. During the
course of our inquiry, we found a great deal of agreement that,
in addition, factors such as innovation and investment in research
and development (R&D), the effect of exchange rates on competitiveness
and the regulatory burden on industry, particularly on small and
medium-sized enterprises (SMEs), will affect UK manufacturing
productivity. The Government identified two additional factors,
which we will not address in detail in this Report. While we welcome
the long-term macro-economic stability to which the Government
is committed, we note that the stability achieved over the period
1997-2002 has not been accompanied by an increase in productivity
in the manufacturing sector. In fact, the reverse has applied.
The Government also told us that increased competitive pressure
is associated with improved efficiency and productivity growth.
The manufacturing sector has certainly seen increased competitive
pressure in recent years, but has not responded with productivity
17. A major factor contributing to
the productivity gap is the relatively low physical capital stock
to augment the productivity of labour. The CBI and others identified
this as a particular problem in the UK for decades.
NIESR calculated that in 1999, compared with the UK, capital investment
per hour worked was 80% higher in France, 34% higher in Germany
and 33% higher in the USA.
Even though, in the view of academics, the high capital investment
in France and Germany is partially attributable to comparatively
high labour costs in those countries, the UK has obviously lagged
far behind its major competitors in investment in manufacturing.
There has been a general downward trend in UK manufacturing investment
intensity over the past 25 years, falling from 13% over the period
1975-1980 to 11.5% in the period 1991-97.
More recently, investment during the third quarter of 2001 was
just less than £4 billion, a fall of 13% compared with the
same period in 2000.
18. The causes of this long-term trend have
changed over time. The CBI and others believe that historically
the volatility of the macro-economy has played a major part in
discouraging long-term investment in the sector.
More recently, the macro-economic policies of successive governments
have produced a sustained period of relatively low inflation and
a more stable economy, but liberalisation of markets and world
recession have forced companies to reduce prices in order to remain
competitive, leading to smaller profit margins, thus restricting
the ability of firms to make funds available for investment. This
may have reduced the effectiveness of Government incentives such
as 40% capital allowances for investment in plant and machinery
by small firms, and reforms in capital gains tax.
19. The CBI, the TUC, the Industrial Society
and EAMA identified the attitude of financial markets in the UK
as a major factor in the low investment performance of companies
of whatever size in the sector. The Industrial Society pointed
out that even for multi-national companies, financial institutions
in the UK expect higher rates of return from investment over shorter
periods than their counterparts in the USA or elsewhere in the
EU. As for support for SMEs, the Society was of the view that
"the institutional structure simply does not exist ... it
has not existed for 100 years."
The CBI and EAMA also drew attention to the difference in the
support from capital markets for SMEs in Germany compared with
the UK. Even when
financial support is forthcoming, it is often at a high cost to
the business. EAMA told us that, in addition to interest rates
being marginally higher in the UK, British banks often impose
extra interest charges, up to 5 per cent in some cases, to compensate
for what they see as the increased risk associated with smaller
firms. This is not
a problem confined to the manufacturing sector, as the Competition
Commission's recent review of banking services to SMEs has concluded.
But as a result, UK companies find investment more expensive to
service than their European or American competitors.
20. Another difference between patterns of
investment in the UK and other countries is the degree to which
venture capital is used for manufacturing investment. Less than
one per cent of SME finance is derived from venture capital, which
again is rather different from the situation in countries like
Germany and the USA. But it seems that this disparity may derive
as much from the reluctance of small firms to yield equity in
their business in return for capital investment as from the preference
among venture capitalists for higher-yielding investments with
shorter pay-back times than manufacturing can deliver.
The Government is trying to encourage the use of such resources
through the Regional Venture Capital Funds, which are being established
in England as public/private partnerships and administered through
the Small Business Service (SBS). The Government expects in this
way to make up to £235 million available for small scale
The success of this initiative will depend not only on whether
the SBS can deliver the private sector finance to match public
funds available, but also the extent to which SMEs can be persuaded
to accept this type of funding.
21. We will be returning to the problems
businesses experience in accessing venture capital during our
inquiry into the UK biotechnology industry this Summer.
22. The long-standing
shortfall in capital investment in the manufacturing sector is
the main obstacle to improving productivity in the sector. Changes
in attitude are required from all parties if this obstacle is
to be overcome. Financial institutions need to recognise that
manufacturing investment may require a longer term view than other
types of investment. Banks in particular should review their lending
policies with respect to small firms. And SMEs should be more
flexible in their approach to securing investment, and more open
to investment using venture capital. The Government has a central
role in encouraging such a profound change in culture. In the
shorter term, it should consider the extension of its policy to
provide more encouragement to investment. We heard a number of
calls for tax credits to boost manufacturing investment. We recognise
the difficulty of ensuring that such support is properly directed,
really encourages productive investment and provides value for
money for taxpayers. Nevertheless, we think that the Government
should consider introducing some form of tax credit for volume-based
investment. It will be necessary, however, to ensure that such
an incentive does not subsidise investment that would have been
undertaken in any event.
23. It is a matter of record that there is
a significant gap between UK industry and its major EU competitors
in terms of the skills base within the workforce.
Nearly all of the witnesses to this inquiry identified the skills
shortage within industry as another major obstacle to improving
productivity. We found general agreement that the UK workforce
falls behind France and Germany in terms of basic literacy and
numeracy, and data provided by the DTI showed that the UK has
a lower proportion of workers with intermediate skills.
24. The CBI/TUC Productivity Report to the
Treasury found that one in five adults of working age have low
levels of literacy and numeracy and that 32% of the UK workforce
do not have Level 2 (GCSE) qualifications. Low skilled employees
were found to receive less training from their employers than
their more highly skilled colleagues. Shortages of skilled employees
have hampered growth in manufacturing industry, both locally and
nationally, during economic upturns, as well as limiting the potential
for switching to high tech industries.
25. The Government
has recognised the need to address the lack of basic skills among
school leavers and has announced plans to encourage training for
technical and vocational careers, through reform of the school
curriculum. The new Local Learning and Skills Councils are intended
to work with the Small Business Service, local authorities and
other educational service providers to produce post-16 training
programmes at a local level. However, a witness from the British
Chambers of Commerce expressed doubts as to the degree of flexibility
that these Councils would have in practice to respond to the needs
of their local industries, given that a very large percentage
of their funding was reserved to certain centrally-determined
types of training.
It is essential that Local Learning and Skills Councils
respond effectively to the views of manufacturing businesses
to address the skills need of the sector in their area. The Government
should review the proportion of funds available to meet specific
26. Given that OECD and other studies have
shown a positive link between investment in employee training
and productivity, we were surprised that many UK firms do not
make employee training a higher priority. We were advised that,
although the best and most productive companies recognised the
benefits of providing training and personal development programmes
to their employees, too many regarded it as excessively expensive
or too difficult to improve the skills base of their workforce.
This was a particular problem for SMEs, which often could not
afford to lose key workers for significant periods of time from
27. It is obvious that an efficient and productive
organisation matches the skills and qualifications of its staff
to their roles within the organisation. In a survey of global
productivity, however, Proudfoot Consulting found that among the
countries surveyed, UK companies had a particular problem with
inappropriately qualified employees in their structure.
28. Several witnesses argued for some form
of Government incentive to help employers provide training for
basic and intermediate level skills. The Government has responded
by announcing in its Budget Statement financial incentives for
employers to make provision for staff training, coupled with an
entitlement for lower-skilled workers to training in basic skills.
29. Improving skills is essential for the
future development of manufacturing; yet many employers, particularly
SMEs, either do not recognise the need or find it difficult to
invest in training for their staff. We welcome the Government's
action to give an incentive to employers to provide training for
their workforce. We will monitor the effectiveness of the implementation
of the Government's policy as it affects the manufacturing sector.
At the same time, while recognising the particular difficulties
faced by SMEs, we urge employers to play a more active role in
encouraging skills development among their workforce. Having a
more highly skilled and flexible workforce will be beneficial
for all companies in the long term.
30. The Government's
Modern Apprenticeship (MA) Scheme is another welcome initiative
which should help address the technical skills deficit in the
manufacturing sector. According to the DTI, as at 23 December
2001, 16,800 people were engaged on Engineering Manufacturing
Advanced and 4,900 on Foundation MAs.
We were perturbed, however, to learn that the industry felt
that there was a shortfall of perhaps 10,000 engineering-based
Given the importance to the sector of providing an adequate supply
of suitably trained new entrants, the Government must take all
the steps necessary to ensure that the supply of engineering modern
apprenticeships meets demand in the future.
31. In addition to their reluctance or inability
to provide employee training British companies are often loath
to adopt new technologies and management strategies which can
improve productivity and competitiveness. For example, lean manufacturing
systems use a range of management tools to improve productivity
by streamlining design and production processes and functions,
reducing waste and maximising the efficiency of production and
delivery systems. The EEF Productivity Survey has shown that firms
which employ lean manufacturing techniques in their business get
a significant return in terms of improved company performance.
Yet adoption of these techniques by UK companies is very patchy.
Only one third of firms in the UK have adopted lean manufacturing
across their whole organisation while 40% have not undertaken
any lean manufacturing at all.
32. Compared with their US counterparts,
UK manufacturers have also been relatively slow to embrace new
workplace initiatives such as output monitoring, performance appraisal,
and a range of other techniques to improve communications with
employees. Research has shown that the introduction of such initiatives
had a significant effect on productivity growth in US manufacturing
in the 1990s, and UK companies employing similar techniques have,
in the main, found them to be successful in increasing profitability
Yet, again, a large number of UK companies have been reluctant
to embrace them. According to the EEF and others, the most common
barrier to adoption of these improvements seems to be opposition
to change from management as well as employees. There appears
to be a general lack of understanding of the benefits of adopting
these practices which reinforces a conservative attitude to change
among some managers.
33. We were told
by a number of witnesses that a few hours spent by key personnel
in thinking about how processes can be improved can result in
very substantial increases in productivity. We urge more companies
to invest the comparatively small amount of time, both from management
and workforce, to at least examine the potential of well-known
techniques. The identification and dissemination of best practice
can help to overcome the reluctance of firms to embrace new techniques
and thereby make major contributions to the improvement of productivity.
We endorse the activities of the sector-specific Forum programmes,
such as "Accelerate" and PICME, and the CBI's Fit for
the Future Campaign, both of which are Government/Industry joint
initiatives and which provide valuable sources of advice, particularly,
but not exclusively, to SMEs. Support for such activities should
be demand-led. The Government has already committed £20 million
but should be prepared to provide extra resources should it be
34. The quality of management in UK manufacturing
has also been identified as a barrier to improving productivity.
A Proudfoot Consulting survey found that inadequate management
and insufficient supervision was a major contributor to loss of
productivity, indicating that managers were not fulfilling their
roles or being allocated enough time to supervise their staff
National Skills Task Force found that UK managers compared poorly
with their international counterparts in terms of their adaptability
and entrepreneurial and technical skills.
The CBI pointed out that, while the proportion of graduate level
employees in UK and German manufacturing industries was roughly
the same, the CBI/TUC Productivity Report identified concerns
that qualified engineers and scientists may lack managerial skills.
35. Low quality management may derive at
least partially from a poor image of manufacturing as a career.
The EEF Productivity Survey showed that nearly 25% of manufacturing
companies have difficulties in recruitment and retention of suitable
staff, and that these difficulties were undermining company performance.
Salary levels and skills shortages were the factors most commonly
identified by firms struggling to attract or retain staff, but
nearly 20% of firms so affected also identified as a factor poor
perception of the manufacturing sector as an employer. This was
supported by anecdotal evidence from other witnesses, such as
36. Poor perception of manufacturing is not
something that can be changed overnight. Part of the answer lies
in Government leadership, and a clear commitment to manufacturing
as an important, valuable and not least in terms of R&D
potential exciting and innovative sector would help. In
this context, we welcome the apparent change of heart on the part
of Government to recognise the importance of manufacturing industry
to the UK. Parallel changes in the way that, for example, the
financial institutions regarded investment in manufacturing would
help improve the sector's prestige.
However, although changes in perception would help manufacturing
industry to recruit and retain higher quality managers, on their
own they will not provide the managerial skills which the industry
needs now in order to avoid falling further behind in the productivity
league. Companies need to invest in developing the skills of
the key managers involved in production to take advantage of best
practice in areas such as lean manufacturing.
Effect of exchange rates
37. 60% of UK manufacturing exports are sold
on European markets. The relative strength of sterling compared
with European currencies since 1997 has had a significant impact
on the cost competitiveness of UK manufacturers, who have found
it difficult to compete effectively in EU markets. UK-based manufacturers
selling to domestic markets have also faced increased competition
from relatively cheap imports, and the comparative weakness of
the Euro may have affected the competitive position of UK firms
exporting to markets such as the USA.
38. Such exchange rate instability has been
experienced before, notably in the 1980s. In that period, industry's
response included an increase in manufacturing productivity which
has not been replicated this time. This must be a major cause
for concern. One major difference lies in the nature of industry's
reaction over the two periods. In the 1980s, many major manufacturers
increased competitiveness by reducing their workforces and bearing
down on external cost. We have been told that this time around,
many companies have been more reluctant to lose their skilled
workforce and have chosen to retain market share by accepting
minimal or even loss-making margins, as an attempt to ensure that
they are properly-skilled and in a position to respond positively
to any upturn in demand. However, firms can sustain a strategy
of accepting minimal profit margins for only a limited period
without seriously affecting their cash flow and compromising their
ability to invest for their future development.
39. For example, Toyota (UK), despite having
one of the most productive car manufacturing plants in the EU,
identified the strength of sterling against the Euro as the biggest
contributory factor in their losses each year since 1998. Exchange
rate instability also reduces certainty and hinders forward business
planning. Uncertainty over the prospects for the UK's entry into
the single European currency, too, has also discouraged forward
planning and investment.
This is particularly true of the engineering sector, where companies
need to plan investments several years ahead of production. However,
we found that, although the majority of the organisations we consulted
were in favour of UK adoption of the Euro under the right terms,
this view was by no means unanimous.
The Government's policy on the process of securing entry is clear,
but its effect is not to provide industry with the degree of certainty
40. There is no doubt that the strength of
sterling has adversely affected the competitiveness of UK manufacturing
in the short term. This will impact upon productivity in the longer
term, because many UK firms have chosen to squeeze margins in
order to remain competitive, rather than make efficiency savings.
The current situation therefore differs from previous periods
of exchange rate volatility, which saw industry react by improving
Innovation and Research
and Development (R&D)
41. We found general agreement that the future
success of UK manufacturing lies in the production of high-value-added
goods, rather than the production of bulk commodities for which
production costs here will almost always be higher than in Asia,
for example. Innovation and the application of new technology
are central to profitable growth in the value-added end of manufacturing
and a successful R&D programme is essential to new product
development, more efficient production methods and hence improved
42. In this area as well as others, the UK
lags behind its international competitors. The DTI's R&D scoreboard
shows that average UK R&D intensity, or spend as a proportion
of sales, is half the international average (2.1%, compared with
4.2%). It cannot
be coincidental that the UK manufacturing sector lies in the bottom
half of the EU league which compares the share of manufacturing
turnover from new or improved products.
Not all sectors fare so badly. For example, R&D intensity
in the pharmaceutical sector, one of the UK's most successful
sectors on international markets, is substantially higher than
the international average (14.8% compared with 12.8%).
43. The DTI provides direct support for R&D
in the form of sector-based research and technology programmes.
It offers a range of schemes to raise awareness among firms of
technical developments and to encourage industry to develop and
take up new technology. The latter, though welcome, were seen
by some witnesses as being difficult to access by smaller firms,
who told us that take-up of the assistance on offer tends to be
restricted to larger companies which already have a well-developed
R&D programme. Smaller firms do not appear to have the resources
to tap into such support systems, and investment in research and
technology remains low compared with their international competitors.
44. Against this background, the introduction
last year by the Government of an R&D tax credit for small
firms, with the option for companies not in profit to take a cash
payment of £24 for every £100 spent on R&D, was
a welcome step; as was the provision of a volume-based tax credit
for larger companies which was announced in the 2002 Budget. We
hope that these measures will provide sufficient incentive to
UK manufacturing to take steps to reduce the R&D investment
gap between it and its competitors. In particular, we are concerned
that the tax credits should not simply subsidise research by large
companies that would have been done anyway. We agree with the
recommendation of the Treasury Committee that the effectiveness
of the incentives should be closely monitored and reported to
45. We will explore further the link between
R&D investment and the exploitation of new technology and
high value-added manufacturing during the course of our inquiry
into the UK biotechnology industry.
We will also look at the effect of Government incentives such
as grants, tax and share options to encourage R&D take-up
in that industry.
The regulatory burden
46. Many witnesses identified the imposition
of new regulations as a significant burden on business in the
UK. The DTI's Small Business Service Omnibus Survey identified
'regulation' as one of the most important concerns among SMEs.
Concerns were expressed to us not only about the compliance costs
associated with new regulation, but the impact of new legislation
originating in Europe and the manner in which it is implemented
and enforced in this country. These are familiar themes, to which
successive governments have been sensitive. Over the years we
have seen many initiatives designed to cut down on red tape and
bureaucracy, but the perception remains that UK business remains
over-regulated, particularly in comparison to some of its EU competitors.
47. Much of the evidence received on this
point was anecdotal, however. The BCC does try to quantify the
costs of new regulations to business as a whole, using data from
the Government's own regulatory impact assessments, and has estimated
that over the period 1997-2002 this may have amounted to £15
billion, with recurrent costs running at an average of about £2.7
billion per annum.
Unfortunately in this case, the BCC has been unable to narrow
the focus of its survey to cover the manufacturing sector alone.
48. The general perception of an over-regulated
industry does not seem supported by hard evidence. The DTI has
pointed out that the UK has the lowest product market regulation
of any OECD country,
and the UK labour market is less heavily regulated than many other
EU countries. Neither
is there compelling evidence that the UK transposes and implements
EU legislation more vigorously than other EU Member States. Indeed,
the European Commission's Internal Market Scoreboard, which summarises
the efforts of EU Member States to transpose EU legislation, puts
the UK at no more than mid-table.
49. Government, business and the unions,
however, recognise that, while the objectives and implementation
of individual regulations may be acknowledged and accepted, the
cumulative regulatory burden on business is considerable. The
financial and management resources required to ensure compliance
can be onerous, and impact disproportionately on SMEs. The Government
has sought to address this, in some cases reducing the regulatory
requirement for small businesses, and occasionally exempting them
altogether. We endorse
this approach and recommend that consideration of the scope for
further relaxation of the administrative burden imposed by regulatory
demands on smaller businesses, or their exemption, be adopted
as a routine element of the process of regulatory assessment.
16 Ev 182, Table 1 Back
Ev 183, Table 3 Back
EEF Catching up with Uncle Sam, ISBN 1-903461-20-0 Back
HM Treasury Productivity Report, November 2000 Back
For example, Ev 34 (EEF), Ev 85-7 (CBI), Ev 106 and 107-8 (TUC)
Ev 106, paragraph 17 Back
TUC memorandum: original source The UK Productivity Challenge:
CBI/TUC Submission to the Productivity Initiative, TUC and
CBI, (2001). Back
Ev 181, paragraph 11 Back
Q 177 (CBI) Back
Q 163 (Industrial Society) Back
Q 177 (CBI), Q 256 (EAMA) Back
Q 261 Back
Competition Commission Report: The supply of banking services
by clearing banks to small and medium sized enterprises, Cm
5319 (2002) Back
Q 262 (EAMA) Back
Ev 187, paragraph 39
O'Mahoney, M., and de Boer, W.: NIESR Review No. 179, January
DTI Competitiveness Indicators, February 2001 Back
Q 146 (Mr J Peel) Back
Ev 146 Back
Not printed Back
Ev 206 Back
Q 89 (EEF) Back
Ev 35, paragraph 16 Back
EEF - Catching up with Uncle Sam, ISBN 1-903461-20-1 Back
Not printed Back
Ev 183-4, paragraph 20: original source Johnson, S. and Winterton,
J., Skills Task force Research Paper 3 (1999); and Bosworth, D.,
Skills Task Force Research Paper 18 (1999). Back
Ev 88, paragraph 5.10: original source "The UK Productivity
Challenge: CBI/TUC Submission to the Productivity Initiative"
TUC and CBI (2001). Back
Ev 146, paragraph 6.1.1 Back
See paragraphs 19 to 22. Back
Ev 216 Back
Qq 70 and 71 (EEF) Back
Qq 78 (EEF), 186-7 (CBI) Back
DTI R&D scoreboard, 2001 Back
DTI R&D Scoreboard Back
Second report of the Treasury Committee, Session 2001-02, 2002
Budget (HC 780), paragraph 21 Back
See the terms of reference set out in our Press Notice No.18
Ev 207 Back
Ev 68 Back
OECD Economic Outlook (1999) Back
Economist Intelligence Unit (2000), as cited in Ev 207 Back
The European Commission's Internal Market Scoreboard can be found
at www.europa.eu.int/comm/internal_market/en/update/score/index.htm Back
Ev 207-10 Back