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Economics is the study of how to share out scarce resources. But it is also about how to make those resources less scarce by creating a bigger economic pie to share. The key to economic growth is increased productivity - producing more goods or services relative to the amount of money and work going in. Economists study how firms and countries can become more productive.

In the long run, wage growth follows productivity growth, so the only way to obtain sustainable improvements in living standards is to increase output per hour worked.

Such productivity improvements are what happened on a widespread scale in the Industrial Revolution - first in 18th century England, then around the world. After millennia of extremely slow economic change, steady productivity growth enabled the population to grow without the Malthusian cycle of feast followed by famine. Moreover, this led to an unprecedented rise in living standards.

How to increase productivity has been a critical question for the Centre for Economic Performance (CEP) since its launch 30 years ago. CEP's predecessor was the Centre for Labour Economics, set up by Richard Layard. When Layard won funding for a broad-ranging research programme at CEP, the name change from "labour" to "performance" was not just re-branding. It signalled that a significant dish on the CEP research menu would be productivity - thinking about policies that increase the size of the economic pie, not just how that pie is distributed between businesses and workers, or between high- and low-paid employees.

Despite being the first industrial nation, the UK has long suffered from a productivity gap with its peers, notably France, Germany and the United States. In the early years of CEP, this deficit was documented in detail by Stephen Nickell. More importantly, he set about analysing the causes of low productivity. A key advance in the 1990s was the use of much better micro-data. Longitudinal data on firms, where companies could be tracked, often over decades, was developed at CEP and combined with detailed surveys of labour, product and financial markets. Nickell's seminal 1996 paper published in the Journal of Political Economy pointed to how stronger product market competition was the key to raising productivity.

Supporting technological innovation

This raised the question of why competitive intensity is so effective in boosting productivity. In the late 1990s economist John Van Reenen and colleagues at University College London showed that technological innovation was one major factor. Firms facing more competition from new entrants, domestically or internationally, responded by generating new products and processes. Later CEP work looking at the impact of China on European firms showed that the blast of competition from East Asia cost jobs but boosted ingenuity.

Photo: metal building. Source: Black metal empty building photo by Ant Rozetsky on Unsplash
Firms facing competition respond by creating new products and processes. Photo by Ant Rozetsky on Unsplash.

Policymakers took notice. Competition policy was toughened up in several pieces of legislation such as the Enterprise Act 2002, which introduced jail sentences for collusive practices that undermine competition. CEP was cited in the discussions leading up to the creation and strengthening of new competition bodies such as the Competition Commission and its successor, the Competition and Markets Authority.

Technology could also be shaped by taxation. Stephen Redding, Rachel Griffith and Van Reenen were involved in theoretically and empirically analysing whether using tax credits to subsidise research and development (R&D) spending helped to stimulate innovation. At that time, there were no tax credits in the UK, but looking internationally their work established that well-designed tax incentives had a positive effect on R&D and productivity growth. Therefore, such incentives could help reverse the decline in R&D intensity that the UK had experienced since the early 1980s. Their policy simulations suggested good potential payoffs in the UK context.

Policymakers again took notice, introducing the UK's first R&D tax credit in 2000, which helped to halt the R&D decline. This illustrates the way in which research can move from theory to econometric analysis to policy: and in turn spurs evaluation and new research ideas.

How the world manages

From the early days, CEP economists worked with psychologists and organisational scholars to look at how management influences firm performance. Small but in-depth studies were launched. CEP believed that management really mattered and that competitive pressure helped to drive improved productivity.

Van Reenen became CEP director in 2003 and together with Nicholas Bloom, then a research fellow, developed a rigorous methodology for measuring management practices across firms, industries and countries. After pilots, the first major wave of the World Management Survey was launched in 2004 in four countries. This has now grown to 25,000 interviews in 34 countries.

There is a 'long-tail' of poorly-managed firms.

A key result was the incredible variation of managerial quality within and between countries. A surprisingly large number of firms appear to have really awful practices, collecting no information on their activities, having no serious goal-setting and failing to recognise talent and hard work in the firm through promotion or rewards. How could such firms even exist in a market economy? Yet economists and policymakers now accept the problem of the "long-tail" of poorly-managed firms.

CEP research revealed a tight correlation between productivity and management, and showed that this relationship was mainly causal, as demonstrated by randomised controlled trials. Furthermore, management could explain much of the differences in productivity between firms and between countries. About half of the productivity gap between the United States and the UK, for example, was related to weaker management practices in the latter.

As Nickell had hypothesised, competition was a key driver of improved management, both through selecting out the poorly-managed firms and pushing the survivors to improve. Competition seemed to matter not only in the private sector but also, and more controversially, in the public sector. CEP research showed that the mid-2000s New Labour reforms, which increased competition between English hospitals, raised managerial quality and clinical quality, reducing avoidable deaths. Work in the United States, where problems of market power are rampant, confirmed this finding.

The work has also uncovered many other drivers of improved management. Skills - of workers as well as managers - turned out to be an important factor. Anna Valero and Andy Feng showed that this correlation appeared to be causal - a more highly-skilled workforce led to better management. They did this by using the location of universities as a "natural experiment" finding that firms further from universities (and thus drawing from a less-skilled workforce) tend to employ less-educated workers and were worse managed. It is well known that the UK does well at elite education, but fails to foster intermediate skills - ie training and education for people who do not go to university. Other important influences on management include openness to trade and foreign investment, governance (a sure way to ruin a firm is to give it to your eldest son!), regulation and information.

Government policy has responded to this research. The creation of agencies such as BeTheBusiness and large investments in management training programs such as "Help to Grow" were partially based on this work.

Growth policy

CEP research on the importance of technological innovation and management practices for productivity has changed the way people think about it. This research has helped to inform policymaking in the UK and overseas. An example of this is the first LSE Growth Commission chaired by Tim Besley and Van Reenen. This analysis focused on the structural short-termism of the private and public sectors that has led to systemic under-investment, above all in skills, innovation and infrastructure.

Many of the suggestions have been taken up by policymakers, such as the establishment of a new institutional architecture - the National Infrastructure Commission and the new Infrastructure Bank. Unfortunately, many have not. The premature abolition of the Industrial Strategy is a prime example of continuing problems in the UK.

CEPs productivity work led to a spin-off in 2020: the Programme on Innovation and Diffusion (POID). This focuses on ways to harness technology to raise productivity growth through business and public policy.

By John Van Reenen