Picture of the words Small and Medium Sized Enterprises on a notepad with some lightbulbs sat beside

SMEs and the Productivity Puzzle

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The new report published by the Business, Energy and Industrial Strategy Committee focuses on the potential of small business to make a bigger impact on UK productivity. Small businesses – SMEs – represent 99.3% of the UK economy and have, understandably, become the focus of the productivity debate. Unlocking the productivity puzzle demands better understanding of this highly heterogenous group of businesses, and in turn how low productivity might be addressed.

The wide-ranging variations in productivity of UK businesses have given rise to the now infamous long productivity tail, shown in Figure 1. The tail is complex, and while there are examples of more productive businesses of different sizes and in different sectors across the UK the evidence shows that smaller businesses tend to be less productive on average than their larger counterparts.

At the same time, research by the Centre for Cities contends that this is in fact the ‘wrong tail’, and that the cause or cure to the productivity puzzle is unlikely to reside in the long tail, and instead the emphasis should be on exporting, or tradeable businesses. While conclusions drawn from the research differ as to the cause and consequences of the long tail, focusing on small business has the potential to have a meaningful impact on the long tail, and represents an opportunity for more experimental approaches towards the productivity puzzle.

Figure 1: The UK’s productivity distribution (ONS, 2017)

From Policy to Practice

The UK is an attractive place to start a business and has a generally strong business environment. Government policy relating to aspects of business (e.g. export, finance, employment), as well as to different policy areas ranging from transport to energy, and planning to science have undoubtedly contributed to this. While the ongoing work of Productivity Insights Network aims to rethink the experimental approach of Government policy from silos to the system, the BEIS report also highlights the need to consider the support available to SMEs to help them become more productive.

Despite productivity being a political priority, there are not many small businesses that think in terms of productivity. Instead, the focus tends to be on profitability, if they have their sights set beyond their immediate survival. As the BEIS report notes, there is a need to raise the ambition of entrepreneurs to grow and scale their businesses. Another related aspect raised in the BEIS report, that was announced by the Chancellor, Philip Hammond, in the 2018 Budget committed to support leadership, business development and technology adoption for SMEs.

The BEIS report references the nature of and need for business support. However, the What Works Centre for Local Economic Growth found that of 23 evaluations on business advice that met the minimum standards 14 had a positive effect on at least one business outcome, 5 had no effect, and 4 had mixed findings. The evidence from this systematic review offers guidance on how to develop programmes and improve policy effectiveness, while also emphasising the need for clearer objectives against which to assess and evaluate success and value for money.

This is likely to become more pertinent in the preparation of Local Industrial Strategies, which aim to increase regional economic productivity. In order to redress the spatial variations in regional productivity, SME policy typically pursues locally-led approaches to improve growth and productivity. If Local Industrial Strategies are to be effective, they do need to be local in more than name – they will require the requisite autonomy and resources to design and deliver local solutions appropriate to the sectoral and firm profiles of those localities. Moreover, these solutions need to meet the challenges of the small businesses that they seek to support on their own terms if they are to improve both the businesses and ultimately the place where they are based. This means adopting strategies that are sensitive to the diverse needs of firms of different sizes and that incentivise growth across a spectrum of dimensions.

In many respects the BEIS report, and those aspects that relate most prominently to the productivity of small business as oppose to the performance, are not radical. This is for the most part reassuring. However, the next challenge in unlocking the productivity puzzle is developing and implementing effective local responses through the Local Industrial Strategies that are accepted and empowered by Central Government. Achieving this will demand the creation of new governance institutions that are accountable and able to deliver, but given the plateau in productivity more experimental and creative solutions are required if we are to meaningfully address the productivity puzzle…

Tim Vorley and Jen Nelles
productivity@sheffield.ac.uk

 

Productivity in SMEs: Management Practices or Effective Leadership?

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As the UK has started to grapple with the challenge of stagnant productivity growth over the past decade, increased attention has turned to questions of how to raise productivity in the small and medium enterprise (SME) sector. This is one important element of the work of the Productivity Insights Network. SMEs are highly diverse and, while they account for three-fifths of UK private sector employment and just over half of UK business turnover, the range includes both ‘frontier’ performers and low productivity laggards.

A recent McKinsey Global Institute report provides a very comprehensive national-level analysis, highlighting both issues of changing demand patterns and patterns of business investment and innovation, as well as ‘deep dives’ into a number of key global business sectors. But the McKinsey analysis focuses very much on the significance of the big corporates and has relatively little to say about the importance of innovation and productivity in the small business sector. This is odd given the numerical importance of SMEs and the contribution of SMEs to the economy.

Influential recent research has focused on the importance of effective management practice as a driver of productivity. A recent survey conducted by the UK Office for National Statistics, covering 25,000 UK enterprises of all sizes across manufacturing and services, computes a management practices score (normalised as an index between 0 and 1) from reported use of a range of practices in four key areas of use: continuous improvement (lean) techniques, key performance indicators, management targets and employee performance. The key finding is that an improvement in the score of 0.1 in a given business is associated with a 9.6% improvement in labour productivity. However larger firms, and foreign-owned firms are much more likely to report higher use of management practices that smaller, and family-owned ones.

I want to highlight two particular issues relating productivity improvement in SMEs, in the particular context of small (below 50 employees) rather than medium sized businesses. The first concerns the importance of successful SME leadership. The second concerns the ‘mediation chain’ through which business practice translates into better productivity.

On the first of these, my own experience is that SMEs vary enormously in their attitudes to innovation and growth, and in the leadership capacity of their owner-managers. This is something that UK policy officials and statisticians in BEIS and ONS are beginning to recognise and investigate, and is central to the recent UK Industrial Strategy. Evaluation of hands-on working with SME owner-managers suggests that productivity improvement may be as much to do with the personal skills, attributes and mind-set of the business leader. It is only through improvements in leadership skill that SMEs are able to introduce effectively those changes in management practice, as seen in the ONS analysis, that lead to better productivity. We can’t assume, in the absence of any improved ability on the part of the business owner, that ‘box ticking’ a range of good management practices alone will enhance productivity.

On the second issue, my own recent research undertaken with my colleague Dr Meng Song at Cardiff Business School suggests the following. For the smallest of SMEs, it is the need to innovate, often to take advantage of emerging international market opportunities, that leads to productivity improvement. Yet in the recent sample of UK micro-businesses analysed, only 11% of micro-businesses (under 10 employees) have brought to the market new product, service or process innovation in the last three years, and only 17% derived any sales from exporting. However, the data suggest that it is the self-imposed discipline of selling internationally that necessitates innovation and leads to improved productivity. So management and leadership advice and support that promotes innovation and encourages exporting is most likely to yield better productivity for these businesses.

Both of these issues offer pointers towards why there is such a diversity of performance across the SME sector. They also suggest that the design of appropriate support for productivity enhancement in small businesses is challenging. It needs to be targeted carefully towards business owner-managers who have both an appreciation of the market opportunities they face, and a realistic appreciation of how and why their own management and leadership practices need to adapt to address those opportunities.

Andrew Henley
henleya@cardiff.ac.uk

A Day at the ESRC Festival of Social Science

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As we set up our stall against the beautiful backdrop of Sheffield’s Winter Gardens, we weren’t sure how well passers-by would react to an offer to discuss the UK’s productivity puzzle on their Saturday morning. We needn’t have worried. As part of the ESRC’s Festival of Social Science we were challenging the general public to pick the top 3 issues they think we should be focussing on. After only a brief introduction to the productivity puzzle and our work with PIN, we were delighted with the depth of conversation that soon flowed.

First to gamely accept our challenge was Peter, a former steel worker. After posing some excellent questions of his own around how productivity can be measured when it comes to intangibles (if you’re reading, Peter, see here…) the conversation turned to the decline in the skills to make things (our work around education and skills is ably led by Dr Maria Abreu). Reflections on a decline in manufacturing skills became one of the key themes of the day. Perhaps not surprising, considering the region’s history.

Another common theme arose in variations of a question posed to us, along the lines of ‘why do you want to make people more productive? Doesn’t that just mean making people work harder?’. And is there a more important question? Indeed members of our invaluable International Advisory Board have always provided a strong steer that our work be underpinned by principles of wellbeing and a vision of inclusive productivity. However, it was a pertinent and welcome reminder to receive the same steer from the Sheffield public.

It was a pleasure to see parents engage their children in our challenge and do our work for us in breaking down the different themes that we are looking at. Many of the children who attempted our challenge were of the firm belief that “inventing things!” is our sure-fire route to success (and they might be onto something – see Professor Robert Huggins’ analysis of the innovation-productivity debate). At the other end of our participant demographic, many gravitated to the area of health and wellbeing (led by Dr Leaza McSorley). More than one opened with the rueful refrain “well, I’m getting on a bit, so…”.

By the end of the day, skills & education, work & employment (the theme led by Professor Kirsty Newsome at Sheffield), and health & wellbeing were ranked as the most important by the surprising number of individuals who took up our Saturday challenge. The real value of the exercise for us was in the rich stories that were shared in the process, bringing to life the themes of our work and strengthening our desire to find productivity insights that are accessible for all.

Phil Wallace
Impact and Knowledge Exchange Officer
Productivity Insights Network
p.wallace@sheffield.ac.uk

Returning to Work and Thriving at Work After Sickness Absence Due to Mental Health Problems

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By Professor Karina Nielsen, Principal Investigator on a Pioneer grant funded by the Productivity Insights Network

One overlooked aspect of solving the productivity puzzle is how we can support employees with mental health problems return to work to stay and thrive at work after a period of long-term sick leave.

Common mental disorders (CMDs), such as stress, anxiety and depression are costly to individual, their families, organisations and society as a whole. In 2016/2017 it is estimated that 12.5 million working days were lost due to CMDs. During this period, each individual on sick leave due to CMDs took an average of just under 24 days off.  A recent report found that the cost of mental health problems to the UK economy is £34.9 billion a year or £1,300 for every employee in the UK economy. Despite what might be expected, it is not the cost of actual sickness absence that is the highest but the loss of productivity; people being at work and unwell, also known as presenteeism, or people leaving their job as a result of poor mental health.

A lot of the current research has focused on supporting people with CMDs return to work but the figures above tell us that we also need to focus on supporting workers once they have returned. These workers often suffer from reduced work functioning and are less productive even if they are no longer so ill they need to be signed off work. Another challenge is that sometimes people return before they are ready because they are worried they might get laid off; this of course also means they struggle to be productive and thrive at work

Although there are no official figures in the UK, data from other countries show that relapse is frequent, as is turnover. Furthermore, over time workers who have been on sick leave due to CMDs also have a higher risk of being laid off due to reduced performance. We therefore need to understand what can be done to support workers with CMDs once they have returned to work after a period of sickness absence. Support includes not only helping them stay at work but also to achieve their previous performance levels and help them thrive at work.

Support for workers may come from resources outside work such as a healthy life style, support from family and friends, continued support from their GP, from local charities and community support and indirectly through the availability of affordable housing and childcare. Organisations can also do a lot to support workers with CMDs returning and thriving at work so that they can reach previous levels of productivity. Resources that organisations can offer include work adjustments, making sure that workers return to a safe environment where colleagues are not afraid to ask questions but at the same time accept that work adjustments may be needed. Line managers play a big role in making work adjustments, and adjusting these adjustments over time as the returned worker’s needs change. HR policies and practices such as flexitime and working from home policies can also help.

How we can support workers with CMDs to be productive and thrive at work is what we want to explore in the project Returning to Work and Thriving at Work after Sickness Absence. If you are interested in the project, please contact Karina Nielsen k.m.nielsen@sheffield.ac.uk

For more information, see:

http://www.hse.gov.uk/statistics/dayslost.htm

https://www.centreformentalhealth.org.uk/news/mental-health-problems-work-cost-uk-economy-ps349bn-last-year-says-centre-mental-health

The Role of Local Large Firms in the Performance of New Firm Start-Ups

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Martin Andersson

Professor of Industrial Economics
Blekinge Institute of Technology (BTH)
Karlskrona, Sweden

Policies to foster jobs, innovation and productivity typically set SMEs and start-ups centre stage. This is not surprising. On average, SMEs account for about 70 % of jobs and 50-60 % of value-added in the OECD area (OECD 2017).[1] Young firms and start-ups are also shown to create a significant fraction of new jobs and they often play an important role in driving innovation and experimentation with new technology and business models. Accordingly, SMEs and start-ups are often the main policy targets. Promoting SMEs to grow and scale-up and stimulating new entrepreneurial and innovative firms are high on the policy agenda in virtually every OECD country.

But even if SMEs and startups are a main policy target, it is important to avoid a too one-sided focus. The fact that young firms and startups are the most important in terms of e.g. direct net job creation, does not mean that other firms are unimportant. For example, the entrepreneurs that start and run these firms come from somewhere and may have gained their managerial skills, business knowledge or ideas while working in a large firm. Likewise, the local presence of established firms, such as Multinational Enterprises (MNEs), may be critical for SMEs to find people with the business experience or the knowledge of foreign markets that they need in order to expand and scale-up. Furthermore, many established large firms may be important customers for smaller firms as well as young firms. SMEs and startups do not emerge or operate in isolation but are part of an interacting system that includes large established firms. The industrial dynamics that drives innovation and productivity is in fact characterized by a significant interplay between large firms and new entrants as well as SMEs.[2]

As a case in point, we have analyzed the question of where new firms that survive and grow come from in the case of Sweden.[3] This is an issue of importance because new firms are highly heterogeneous and most firms exit shortly after they are founded or do not grow. Still, the positive effects of startups on the economy appear to be largely attributable to new firms that survive and grow.[4] Knowledge of from where such firms come helps our understanding of the relevant contextual factors in new firm formation that drive jobs and productivity. Our findings suggest that in Sweden, large established firms, in particular MNEs, are an important source of new successful firms. Furthermore, the dynamics of this process typically play out at the local level.

First, we document substantial differences in survival across types of new firms. The figure below distinguishes between five types of new firms. Spinoffs are new firms where the majority of employees come from the same parent firm. If the parent exited in the same year as the spin-off, the spin-off is classified as a pushed spin-off; otherwise it is classified as a pulled spin-off. Non-employed are new firms created by people that were unemployed prior starting their firm. Divestitures are large new firms assumed to be reorganizations of activities that previously took place at an incumbent firm. Other new firms is a residual category.

Source: Andersson and Klepper (2013).

What is clear from the figure is that pulled spinoffs systematically outperform all other types of new firms in terms of survival and that the pulled spin-offs stand out as the best performers; firms with all employees previously unemployed stand out as the worst performers; with pushed spin-offs and divestitures performing somewhat better than other new firms. Divestitures aside, spinoffs show the highest survival rates among all types of new firms.

Second, our econometric analyses further show that even after controlling for several characteristics of new firms, such as initial size, human capital, industry, we find that spinoffs still show significantly higher survival rates as well as employment growth. Another result is that spinoffs with large parents and that are MNEs also perform better, which may reflect the fact that MNEs in general have richer tangible and intangible resources that founders of spin-offs can draw upon.

In summary, our results for Sweden are highly supportive for the argument that “incumbent firms are natural training grounds for the next generation of entrepreneurs” (Klepper 2011, p. 145) and that “the breeding grounds for entrepreneurial firms are more likely to be other entrepreneurial firms” (Gompers et al. 2005, p. 612).

The data we used in these analyses also illustrate that the spinoff process is highly localized in space. The table below presents data on the fraction (in percent) of spinoffs in Sweden during the period 1993–2005 that locate in the same municipality and region as the parent firm. The original data are based on 15,103 spinoffs with two or more initial employees.

Fraction of spinoffs locating in the same municipality or region as the parent firm.

Same municipality as parent firm72%
Same region but not same municipality16%
Sum88%

As much as 72 percent of the spinoffs during the period located in the same municipality as the parent firm, and another 16 percent remained in the same labor market region although not in the same municipality. Thus, 88 percent of the spinoffs located in the same “home region” as the parent firm.

Taken together, these results suggest an important relationship between existing firms and business dynamics through entrepreneurship. Much empirical evidence speaks in favor of the argument that large resourceful firms, such as MNEs, may play a significant role in the local eco-system of entrepreneurship for example by (involuntarily) acting as “anchor-firms” that accumulate and train human capital in a region. Policies aiming to foster local productivity and job creation should recognize the indirect role that established firms play in the entrepreneurship process. A too narrow focus on SMEs alone misses much of what is crucial.

[1] https://www.oecd.org/mcm/documents/C-MIN-2017-8-EN.pdf
[2] https://link.springer.com/article/10.1007/s11187-018-0072-y
[3] https://academic.oup.com/icc/article/22/1/245/882366
[4] https://link.springer.com/article/10.1007/s00191-012-0301-5

Shovel ready, but for what?

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Whenever economic setbacks occur, from the closure of a small town manufacturing plant to an event on the scale of the Global Economic Crisis, the clarion call for more infrastructure investment to help stimulate recovery can be heard almost immediately. Business leaders inevitably announce that there is an “urgent need” for investment in whatever projects are deemed “shovel ready”, and politicians keen to have ribbons to cut are usually only too happy to oblige, budget permitting of course.

The snag is that the evidence base on the links between infrastructure investment and the economy is inconclusive, and it is far from clear how spending money on infrastructure actually improves economic performance in the real world. Whilst macroeconomic reviews claim links between the overall quantum of investment with growth at country level, finding evidence in the real economy, in real places and in real firms about the causal links that explain how such investment promotes better economic performance – by enhancing productivity for example – is usually much more difficult. Indeed, the last major independent review carried out for the UK government on the impacts of transport infrastructure on economic performance, that by the former Chief Executive of British Airways Sir Rod Eddington, set out quite unambiguously that in advanced industrialised countries with mature infrastructure systems, the potential for subsequent investment to achieve the often exaggerated claims for economic stimulus is much less than is commonly assumed.

Yet the a priori belief that infrastructure investment will lead to improvements in economic performance remains resilient. Consider the ways in which the High Speed 2 railway project is being sold to an often sceptical public; that it will ‘rebalance’ the economy between north and south. Leaving aside the rather obvious yet often wilfully ignored point that transport infrastructure is – sometimes literally – a two way street, and that economic activity can move in both directions as relative accessibility changes, the idea that any single project, however large, can make a substantive impact on an annual GDP shortfall measured in the tens of billions is fantastical. Much of the same wishful thinking can be discerned in the claims made for the criticality of high speed broadband: very high download speeds might help your choice of evening entertainment on Netflix download more quickly, but for many if not most businesses, a good enough speed to facilitate a website and/or electronic payments coupled with dependable service reliability is what is required.

Then there is the issue of whether we can measure the impacts of infrastructure investment properly in the first place. For decades, most of the value released by transport infrastructure improvements has been assumed to derive from improvements in travel times, underpinned by the assumption that travel time is completely lost to productive activity. Major schemes with substantial pricetags, and hence significant opportunity costs given the competition for scare public funds, have often been justified on the basis of some really quite small time savings, the impacts of which we don’t fully understand. For example, if a rail commuting journey is reduced from one hour to 45 minutes, how do the people that use the service every day react? Does that 15 minute saving translate into more work at the office and therefore more economic output for the economy? Does it make them more likely to be able to maintain their commute over the long term so that the labour market works more efficiently? Or do they just stay in bed 15 minutes longer in the morning? And even if they do just that, does their wellbeing improve enough as a result to make discernible differences to their health, so that they work more productively when in the office? The transformation of the travel experience by the almost universal adoption of the smart phone, so that people can either work whilst mobile or spend the time satisfying more social needs to keep in touch with others, adds a whole other dimension to the complex debate on travel time that researchers are actively exploring.

So, what should policy makers do when considering the role of infrastructure investment as part of government’s toolkit to improve the economy? The most important thing is perhaps to acknowledge openly the high level of uncertainty about the causal mechanisms linking infrastructure investment such that a range of options for action is thought through carefully. It is entirely possible for a coherent case for infrastructure investment, including the very largest schemes, to be constructed so long as proper efforts are made to understand its actual impacts in the places it occurs and on the people and firms it is supposed to support. So the next time the call for the shovels to be readied rings out, the question should be “yes, but for what purpose?”.

By Professor Iain Docherty, PIN Co-Investigator and Professor of Public Policy and Governance at the University of Glasgow

Photo credit (featured image): Jevanto Productions/Shutterstock.com

 

 

Delivering productivity the Labour way…?

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The Financing Investment report published by Labour on 20th June set out how the opposition would approach the conundrum that is the productivity puzzle in the UK. The persistence of sluggish productivity growth since the financial crisis is not going away, but is the answer in setting the Bank of England a productivity target?

Raising productivity growth is a priority of all political parties, not least because productivity is a proxy for wage-incomes and ultimately standards of living. Therefore, while a productivity growth target is admirable, it is questionable whether this should this be required of the Bank of England let alone whether it can it ever work. Moreover, in the last four decades the highly ambitious three percent annual target has never been achieved before, and is significantly above the 0.2% per year increase seen over the last decade which has left the UK c.20% below the pre-crisis productivity growth trend.

The rationale for Labour’s proposal is the perceived failure of the UK financial system that has fueled speculation in the property market at the cost of investment in other tradable technologies and sectors.  This is a well-rehearsed argument. While access to capital for growth has been highlighted as a critical issue experienced by UK firms, in the aftermath of the 2008 crisis, access to  low cost labour may also have contributed to the  propensity for firms to prioritise employment over the propensity to invest even though the costs of borrowing have been extremely low.

The Bank of England Governor, Mark Carney, has previously expressed concern over assuming responsibility for productivity in addition to the primary target of keeping inflation at 2 per cent. The elephant in the room is whether the Bank of England, regardless of the 3% goal, is actually genuinely able to influence productivity growth in this way. Using monetary policy instruments to stimulate investment is premised on the expectation that the monetary authorities can incentivize banks to lend and firms to innovate or invest in innovations to yield productivity gains. Yet, the evidence here is mixed, to say the least, and runs the risk of confusing and conflating different sets of objectives, at least in the minds of the public and politicians.

Productivity is driven by innovation and entrepreneurship and it is not in any way clear how the monetary authorities can influence these, other than maintaining stable prices and inflation expectations so that firms, investors and entrepreneurs are able to plan effectively. Moreover, assigning a productivity growth objective to the Bank of England then largely absolves the other economy ministries dealing with regulatory issues, competition policy, research and innovation, infrastructure, land use, the coordination of different investment policy arenas etc., from their own responsibilities.

On one hand the fresh thinking in these proposals is to be welcomed, while on the other hand the proposals from Labour raise many additional questions. Given the already over-centralised and top-down system of governance in the UK, the prospect that the productivity growth is managed by the central bank is somewhat ironic – even if Labour are proposing it move to Birmingham! Given the highly regional nature of the productivity puzzle in the UK, policy needs to be more sensitive to local needs and tough institutional and governance questions need to be asked.

Despite the shortcomings of successive Governments to jumpstart productivity growth, the Industrial Strategy with its emphasis on place represents a welcome focus. However, whether or not this will provide the basis to address the structural weaknesses that are manifest in the long tail of low productivity firms and the enormous interregional productivity differences remains the subject of ongoing debate.

By Professors Tim Vorley and Philip McCann

Photo credit: PeterRoe/Pixabay.com

Improving productivity by engaging small businesses

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Improving the productivity of the long tail in the UK requires the government and other stakeholders to rethink programmes that target and engage the right companies, as well as providing more holistic tailored support. Siloed support that tackles specific areas alone, such as management skills or digital adoption, is unlikely to maximise effectiveness.  A key area of research for the Productivity Insights Network is to explore the integration of different themes that underpin the productivity challenge in the UK, for instance how management practice, employee engagement, adoption of innovative ideas and place all interact.

Recent research has highlighted the long tail of “productivity laggards” in the UK.  Analysis from Andy Haldane, the Bank of England’s Chief Economist, showed that the UK business base is characterised by a small minority of productivity leaders and a long tail of laggards.  This long tail of low productivity firms has not been able to keep up with firms at the frontier and the gap has widened in recent years.

Policy-makers and business groups believe that this issue needs to be tackled in order to help address the productivity challenge in the UK.  The Industrial Strategy White Paper highlights the need to act. Moreover, Be the Business, the campaign organisation formed to tackle the UK’s longstanding productivity challenge, has recently committed to a series of actions to help businesses improve.

Bringing together the research experience of SQW with the practitioner expertise of our sister organisation, Oxford Innovation, we have identified a series of principles that must underpin the approach taken to confronting the challenge posed by the productivity laggards in our Viewpoint, Policies and Research to Solve the UK’s Productivity Puzzle.  We urge government, Be the Business and others to consider these principles in designing approaches to working with businesses to improve their productivity.  In brief the principles are as follows:

Target companies in the long tail of productivity laggards that have potential to improve. Recent business support programmes have tended to target companies that have asked for help and been identified as having high growth potential. But these programmes exclude many ‘long tail’ laggards with potential to improve, since generally these companies neither know they have such potential nor see themselves as needing help in realising it.

Holistically strengthen all the factors affecting their productivity. Our work shows us that a range of interrelated factors affect productivity improvements in individual SMEs, notably their leadership and management strengths, workforce skills and motivation, capacity to innovate, strategic use of digital technologies and access to finance. These factors are closely interrelated. For maximum effect, therefore, support for individual SMEs needs to address these factors holistically, taking their interrelationships into account.

Engage target companies using the right channels and incentives. Haldane comments that while many business leaders recognise low productivity as a general problem, they don’t see it as their problem to fix. That makes attracting SMEs to come forward for support and make the most of it a challenge. Our work indicates SME leaders respond best to offers of practical, tangible support that come through their familiar networks, rather than official channels. They also need a lot of consistent external help in trying to improve their productivity to get significant and lasting results.

Programmes that adopt these principles will improve the chances of success. They should also build in evaluation so that they can learn fast. For instance, engaging the target companies will be a key challenge. Programmes could experiment with different engagement mechanisms and messages and see which ones work best with different companies.

We also highlight, in our Viewpoint, the need to consider whether national and local policies could complement each other more.  To take innovation policy as a case in point, it is important to distinguish between different forms of innovation, such as new-to-market or new-to-firm innovation, and between innovation at the technology frontier and the diffusion of innovation within the frontier.  This distinction matters for policy, because the balance between the frontier/new-to-market innovation and diffusion/new-to-firm innovation affects the distribution of benefits from innovation across the business base.

Whilst innovating at the frontier is important, potentially more important to improving the productivity of laggards is the diffusion through new-to-firm innovations that help ensure that more companies are adopting new practices or imitating higher value products and services.  Current policy, however, focuses on the cutting edge and new-to-market innovations, partly on the assumption that these will be diffused through supply chains or through knowledge networks.  A key question is what types of interventions could help innovations diffuse faster.  Part of the answer may lie in regional programmes.  ERC research has found that regional innovation support is important for process and organisational innovation; whereas national innovation support is important for product or service innovation.  So, striking a balance between national and regional/local support for innovation may be important in supporting diffusion of innovation, which in turn could help the long tail of productivity laggards.

 

By Jonathan Cook, Director at SQW and Co-Investigator of the Productivity Insights Network

Absorptive Capacity and Productivity

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This blog is based on: Harris, R. and J. Yan (2017) Absorptive Capacity: Definition, Measurement and Importance.

Professor Richard Harris is a Co-Investigator of the Productivity Insights Network

Government industrial policy often sets out to encourage firms with high levels of productivity to locate in geographic areas (or in industrial sectors) that are underperforming – for example, to aid rebalancing and to strengthen the resilience of such areas or sectors, as well as to provide new jobs. Examples include encouraging inward investment of foreign-owned multinational firms and facilitating the creation or strengthening of ‘clusters’ of co-located firms around a core of higher productivity firms (see the UK Government’s White Paper, 2017[1]).

Firms exhibiting higher productivity (such as multinationals) tend to spend more on R&D, and thus introduce new innovative products wanted by consumers, or new production processes which are more flexible and cost efficient. And they are more likely themselves to export into highly competitive markets (and thus need to be capable of doing so). The dynamic capabilities such firms have can potentially ‘spill over’ to other less productive firms if the latter are capable of assimilating into their business this new knowledge from the external environment in which they operate.  Engaging in cooperating or partnering with, and sharing information that is available from, suppliers, customers, competitors, or other specialised sources, is evidence that firms are involved in internalising new, external knowledge spilling over from more productive firms. Similarly, firms that introduce new business practices for organising procedures (e.g., business improvement methods) and/or new methods of organising work practices and/or new methods of organising external relationships and/or implementation of changes to marketing concepts or strategies, are also demonstrating their capability of being able to internalise new knowledge, methods and practices. Overall, the ability of firms to engage in such activities denotes their ‘absorptive capacity’; like the ability of an individual to learn, absorptive capacity (AC) is not just about firms being able to potentially benefit from spillovers but rather using knowledge from the external environment to improve their productivity. If a firm has a limited ability to learn, then new strategies or technology that spills over, and that can potentially help firms become more productive, are likely to have only limited impact. More generally, having too many firms with lower AC is also likely to be a major reason for lower productivity in general, as it is shown in Harris and Yan (2017) that the higher is absorptive capacity, the greater the likelihood that a firm will do R&D, innovate and export – with all three activities, key underlying drivers of a firm’s (and thus nation’s) long-run productivity.

Harris and Yan (op. cit.) have used nationally representative data for Britain (based on the governments’ Community Innovation Surveys for 2004-2014) to calculate the level of absorptive capacity for each firm; from this it is possible to look at which firms have higher levels of AC. Figure 1 summarises the results; it shows the cumulative distribution (i.e., from the lowest to the highest values) of absorptive capacity separately for firms with a range of different characteristics. Establishments located in the Greater South East of England (which covers the administrative regions of the South East, Eastern England, London and the South West) generally have higher absorptive capacity throughout (their distribution lies to the right of the distributions of other areas); followed by capital cities (London plus Cardiff and Edinburgh); and then other areas (excluding Leicester and Nottingham, which have the lowest levels of absorptive capacity).  The second panel shows that multinational firms are must better as well, especially establishments that belong to UK multinationals, followed by US-owned firms. Establishments employing graduates have significantly better absorptive capacity levels, as well as those that are relatively larger, innovators (product and/or process), those engaged in R&D, and to a lesser extent exporters.  Establishments involved in the chemicals, engineering and aircraft sectors perform the best, followed by other manufacturing, and other services (excluding retail, hotels and real estate). When taking account of other factors that determine a firm’s AC (such as its size, age and organisational status), the differences shown in Figure 1 remain statistically significant (i.e., they are not ‘explained away’ by other underlying firm level characteristics).

The main results obtained by Harris and Yan have important lessons for policymakers, especially in terms of whether encouraging more multinationals to locate in (underperforming areas of) the UK, and pursuing a ‘clusters’ policy, will improve productivity levels. Firms with high levels of AC do have higher productivity, but the majority of less productive firms (the ‘tail’ of underperforming businesses) are more likely to benefit from their presence only if they have sufficient capacity to absorb potential spillovers from co-location.

Figure 1: (Weighted) Absorptive capacity indices by various firm characteristics, Great Britain, 2004-2014

Source: Harris and Yan, 2017 (Table 1)

[1] https://www.gov.uk/government/publications/industrial-strategy-building-a-britain-fit-for-the-future.

Thoughts from our Advisory Board Chair, Lord Jim O’Neill

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I am delighted to Chair the International Advisory Board of the ESRC-funded Productivity Insights Network led by the University of Sheffield. This programme of research and engagement is an important initiative in changing the tone of the productivity debate. Raising productivity is arguably the central economic challenge in the UK, but to achieve this we need to better understand the drivers and inhibitors of productivity.

There are many different factors that influence productivity, ranging from skills, infrastructure, technology, migration, trade, and international investment as well as the regulatory and institutional environment. Each of these factors interact with each other in different ways to influence productivity growth. Over the next three years the Productivity Insights Network will unpack these factors, how they interact and play out spatially across the UK.

The complexity of the productivity puzzle is complicated further by the question of measuring productivity, especially in some knowledge-intensive sectors where information and communications technologies dominate. Yet, exactly how all of these factors and influences interact to drive productivity is not well understood. While we are able to measure productivity growth with a reasonably high degree of accuracy, we are still unsure about many of the mechanisms underpinning this growth.

Over recent years the role played by cities and regions in fostering productivity growth has also become a major focus of research and policy-thinking. International evidence suggests that the performance of countries depends crucially on the productivity growth of the country’s cities. Countries demonstrating productivity growth have typically seen strong growth in their core cities.

In the UK many of our great cities had been underperforming economically for decades, and only recently have some of these cities started to display an economic turnaround. Many of our great urban areas are very close to each other geographically, but this is not the case in terms of their connectivity, coordination and cooperation. These shortcomings have contributed to the underperformance of the UK economy, and overcoming these failures was central to the policy-agenda I led while I was at HM Treasury.

There have been some major institutional changes associated with the City-Region agenda which I spearheaded, all of which are aimed at helping cities to drive productivity growth. Achieving better local governance and decision-making capabilities is critical, both within and between our cities. There is a clear link between the devolution agenda and the productivity agenda, of which both portfolios were part of my ministerial brief.

The Productivity Insights Network puts these questions squarely on the table to advance insights on the productivity debate from a social science perspective. The UK still faces some of the largest interregional productivity variations in the industrialised world, with local area productivity differences akin to those across the whole of the Eurozone. The place-based framework adopted by the Productivity Insights Network provides a lens through which the productivity puzzle can be examined, interpreted and addressed.

Alongside the academic expertise the Productivity Insights Network is committed to engaging with government, the private sector, and civil society to diffuse evidence and insights about productivity. Serving as more than a focal point for advancing, connecting, integrating and synthesising ideas, there is a commitment to ensuring the research makes a difference by developing actionable insights with a view to raise productivity.

These are challenging times, and the Productivity Insights Network is an exciting initiative aimed at providing answers to some of our greatest societal challenges. I wish the network every success and I look forward to being part of these fascinating discussions over the coming years.