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Scottish productivity lags 11% behind UK – Research from Durham University Business School

Scottish productivity lags 11% behind UK – Research from Durham University Business School

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Professor Richard Harris, Professor in Economics and Head of Department of Economics, Finance & Accounting, Durham University Business School has found that Scotland’s productivity has lagged, on average, by 11% behind the ‘rest of the UK’ since the end of the 90s (a full 22% behind the UK’s leading region.)

The findings argue that the 0.3% above trend year-on-year productivity increase proposed in May’s outlook for Scotland’s public finances would be extremely difficult to achieve, particularly through reliance on tax-incentives post-2016.

The research paper, Scottish Productivity: implications post-2016, by Prof Richard Harris and Dr John Moffat has been submitted to the journal Regional Studies for peer review.

Prof Richard Harris is a veteran Economics lecturer, researcher and adviser, with a career that has extended over three decades. He is listed in the top 8% of world economists in theRePEc (Research Papers in Economics) rankings. In addition to his academic work, he acted as an Economics consultant and advisor to high-profile organisations such as the UKTI, BIS, NI Government, Scottish Government, and recently acted as Special Advisor to the UK Parliamentary Commission on Banking Standards.

RESEARCH SUMMARY: Scottish Productivity: implications post-2016

Motivation

  • Productivity is viewed as the most important long-run driver of economic growth: Nobel-laureate Paul Krugman wrote in 1997 that ‘… productivity isn’t everything, but in the long run it is almost everything’; while Nobel-nominated William Baumol similarly stated in 1984 that ‘without exaggeration in the long run probably nothing is as important for economic welfare as the rate of productivity growth’.
  • The crucial role that productivity plays has also been recognised by the Scottish Government in making its economic case to the electorate for an independent Scotland. In presenting the outlook for Scotland’s public finances (in May 2014), the impact of increasing productivity, employment and population growth are discussed. The first, and arguably the most important scenario is that Scotland experiences an above-trend year-on-year increase in labour productivity of 0.3%, which by 2029-30 would improve Scotland’s net fiscal position by £2.4 billion a year (in 2012/13 prices). That is, by 2029-30 actual labour productivity would have undergone a ‘step-change’ and be some 4.2% higher than the level that would be attained based on current trends.
  • Thus the purpose of this paper is to consider whether Scotland has a productivity problem, by establishing the extent to which there is a productivity gap between Scotland and the rest of the UK. It then discusses what policies could be pursued to raise productivity in Scotland post-2016, operating as an independent country or in a more devolved environment.

Background analysis

  • We begin with a brief look at the data on how well Scotland does (relative to the ‘rest of the UK’) with respect to some of the underlying long-run drivers of productivity – R&D, innovation and exporting. If Scotland currently underperforms on these, this will not only confirm why a productivity gap exists, but it will also suggest that achieving a ‘step change’ in performance will be difficult in the near future.
  • Using data from the UK Government’s 2011 Community Innovation Survey, we compare Scotland and the ‘rest of the UK’.
  • The main points are:
    • Out of 12 UK regions, Scotland had the third lowest percentage of manufacturing establishments innovating (either product or process innovation), and second lowest for services.
    • For undertaking R&D, Scotland was second lowest of 12 for manufacturing but third highest for services.
    • And for exporting, Scotland had the lowest percentage of establishments involved during 2008-10 in both manufacturing and services.
    • Using data from the UK Government’s Business Enterprise R&D survey:
    • R&D intensity (spending per unit-of-sales) was less than half of that of the ‘rest of the UK’

The size of Scotland’s productivity gap

  • Based on estimates of productivity for each plant operating in manufacturing and services in Great Britain for 1997-2012, we estimate that on average Scotland has had significantly lower productivity compared to the ‘rest of the UK’ since the end of the 1990s. Overall, the ‘gap’ was around 11% across all sectors in 2012 (and 22% below the leading UK region)
  • The ‘gap’ was particularly noticeable in the service sector; indeed there is some evidence Scotland performs slightly better than the ‘rest of the UK’ in manufacturing. But given the relative size of the manufacturing and services sector, the overall outcome was a lower level of TFP in Scottish plants.

Policy options to close the gap

  • What policy instruments are likely to increase productivity in Scotland and help obtain the ‘step-change’ in productivity levels needed to boost long-run growth and thus government revenues?
  • We focus on the promotion of more investment (particularly higher inward investment from overseas), and entrepreneurship (e.g. business start-ups), especially as newer, younger plants tend to have higher productivity, as do plants belonging to foreign-owned enterprises.
  • New plants in the ‘rest of the UK’ contributed substantially to productivity growth during 1997-2012); in Scotland the contribution of new plant start-ups and the closure of existing plants both contributed negatively to productivity growth.
  • In the ‘rest of the UK’ the foreign-owned sector opened more productive plants that overall provided a significant proportion of total productivity growth; in Scotland the closure of relatively productive foreign-owned plants reduced productivity growth.
  • Scotland suffered from what has been labelled a ‘branch plant’ effect whereby the more ‘footloose’ foreign-owned sector is more likely to close productive capacity in ‘peripheral’ regions when called upon to restructure their international operations (e.g., through ‘offshoring’), even when such plants have relatively high productivity.
  • Scotland should have benefited, but the actual foreign-owned plants that were attracted were insufficiently embedded into the economy (and/or had insufficient higher value-added functions that could help to guarantee that they remained open).
  • Similarly, many of the new business start-ups (especially in services) were of insufficient quality to contribute to higher productivity.
  • Without a change in the type of new startups and FDI plants in Scotland, it is difficult to see why relying on greater tax incentives post-2016 (the policy instrument seemingly most in favour) should result in a closing of the ‘productivity gap’, let alone a ‘step-change’ in productivity growth.
  • Government-funded bodies like Scottish Development International and Scottish Enterprise need to encourage and help start-ups and inward investors with the ‘right’ characteristics that will boost productivity in the longer term.

One possible implication of an independent Scotland

  • Finally, we considered the consequences of the raising of higher ‘entry barriers’ to inward investment into Scotland for UK firms with their major operations located in the ‘rest of the UK’ – an argument favoured by the UK Treasury.
  • Some examples are of the potential new costs associated with operating in different currencies if Scotland were to not use sterling; possible (pecuniary and non-pecuniary) tariffs if Scotland had to renegotiate entry into the European Single Market; if Scotland had a lower credit rating the cost of borrowing to invest might be higher; there could be higher income taxes for Scottish workers if Scotland needed to rise extra tax revenues (either to meet any short-falls, or to achieve a more egalitarian society).
  • If such higher entry barriers result, and subsequently UK firms reduce their levels of Scottish production, the impact on Scottish productivity is likely to be significantly negative.
  • This is because when plants producing in Scotland are separated into ‘Scottish-owned’ and ‘rest of the UK-owned’, the former plants have much lower productivity, and thus if they were to become relatively more important then average Scottish productivity would decline (a ‘batting-average’ effect).

Quote from Professor Harris:

“Productivity is the most important determinant of long-run economic growth, and Scotland currently has a productivity gap. Whatever the outcome of the Scottish Independence referendum in September, this is a crucial area for policy to address. It is possible to put forward arguments on both sides at to whether this would be better handled by an independent Scottish Government; this study has nothing to say on this matter. But we do question here whether lowering corporate taxes is a panacea for closing the productivity gap, through encouraging more inward investment and/or more business start-ups. Better policy options need to be considered post-2016.”

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