British Relative Economic Decline

Re-visited

Nick Crafts

Relative Economic Decline• Does deserve to be analyzed; it can be seen in

the data even if it is also a notion constructed for political purposes

• Not a full and balanced account but a narrative focused on one key aspect, competition

• Will put Golden-Age failure in long-run perspective

• NB: the UK was overtaken in the Golden Age

Real GDP/Person

UK/USA UK/West Germany UK/France

1870 130 173 170

1913 93 135 141

1950 73 162 132

1979 70 86 88

2007 75 109 104

Relative Economic Decline• Was most apparent from the 1950s

through the 1970s

• Was associated with a period of protectionism and weak competition

• Has possibly been reversed in the recent past

Source: The Conference Board (2008)

Growth of Real GDP/Hour Worked

1950-73 1973-95 1995-2007

France 5.1 2.7 1.7Germany 5.9 2.7 1.7UK 2.9 2.4 2.2USA 3.0 1.1 2.1

Reversing Relative Economic Decline• Required improved incentive structures to

improve TFP and reduce NAIRU

• A key ingredient was increasing competition in product markets

• Regulatory and technological environment favoured UK versus the large continental-European economies

Golden-Age Britain Did Fail

• Slower growth not fully explained by less scope for catch-up

• Lots of evidence of poor productivity performance reflected in weak TFP growth

• Not just catch-up but overtaking by European peer group including both France and West Germany

Levels and Rates of Growth of Real GDP/Person 1950-1973 ($1990GK and % per year)

0

1

2

3

4

5

6

7

Switzerland

Denm

ark

UK

Sweden

Nethrlands

Belgium

Norw

ay

France

W. G

ermany

Finland

Austria

Italy

Ireland

Spain

Portugal

Greece

In the Golden Age• UK competition and (broadly-defined)

competition policy were very weak while the separation of ownership and control became more pronounced

• In all these respects comparisons with Germany unfavourable (Baldwin, 2006;Cheffins, 2008, Crafts & Mills, 2005)

• Comparisons with early and late 20th century also adverse; competition was undermined in the 1930s and strengthened from the 1970s

Competition• Depends on entry threats as well as market structure so

is influenced by trade policy and regulation

• Matters much more when shareholders are weak because it is an antidote to agency problems within the firm

• Absence generates rents from market power that can be dissipated through effort bargains that undermine productivity

• Is a key reason why gains from greater openness are much bigger than traditional welfare triangles (cf. Frankel & Romer, 1999)

Did Victorian Britain Fail?• New Economic History said NO!; subsequent

research says this is a bit too strong

• Competition in a very open economy was central to the NEH argument (McCloskey & Sandberg, 1971); if correct, implies Golden-Age UK much more susceptible to failure

• But examples skewed to tradeables; look at a sector where competition and shareholders are both weak and productivity performance is much more questionable

Late-Victorian Railways (Crafts et al., 2008)

• Cost inefficiency in late 1890s substantial; 10% for median company , cost 1% GDP

• Subsequent elimination of much of this inefficiency as profits fell to unacceptable levels suggests managerial satisficing; action taken when fall out of comfort zone

• Foreshadows much more general problem that surfaced in Golden-Age UK

Appropriate Growth PolicyAghion & Howitt (2006)

• Should base policy insights on Schumpeterian (quality-improving innovations) growth model

• As catch-up becomes advanced, need to shift from facilitating diffusion to promoting innovation

• Implies close-to-frontier countries should encourage competition/entry and expand higher education

Schumpeterian Growth Model

Y = A 1-α kα

∆A/A = μN + μO

Far-from-frontier countries need institutions and policies that raise μO but close-to-frontier countries need (different?) institutions and policies that raise μN

NB: change in technology that provides μO

may also imply need for reform

Policy experiments and endogenous growth: rise in savings; rise in R & D effort

Schumpeter relationship (high μ)

Schumpeter (low μ)

Solow (high s)

Solow steady-state relationship (low s)

x

k^

Competition and Productivity Growth

• Absence of competition allows managers to be sleepy if ineffective control/monitoring by shareholders

• Competition is strongly positive for productivity outcomes in UK firms without dominant shareholder (Nickell et al., 1997)

• Competition promotes better management practices (Bloom and van Reenen, 2007)

• Patenting performance of UK firms suggests inverted U-shaped relationship with price-cost margin which peaks at about 20% (Aghion et al., 2005)

Policy Impact on Rate of Technology Adoption

Competition Policy PositiveNegative

Industrial Policy Positive Negative

Maximizing Agency Problems

Firm Type

Maximizing FirmsCompetition Policy lowers expected profit from innovation Industrial Policy raises expected profit from innovation

Agency Problem FirmsCompetition Policy cuts rents and raises cost-reducing effort Industrial Policy pays subsidies and lowers cost-reducing effort

Traditional Criticisms of Postwar British Industry• Weak and incompetent management

• Difficult industrial relations

• Seriously inefficient use of inputs

• NB: these were all nurtured by inadequate competition in product markets interacting with the historical legacy

Competition in Golden-Age UK• Undermined by nationalization, protectionism

and largely ineffective competition policy

• Weak compared with West Germany: PCM 1.8 vs 1.1; median tariff 20% vs. 8%

• Given that UK was strongly exposed to agency-problem firms, emphasis on industrial rather than competition policy was a serious error (cf. Aghion et al., 1997)

• Implication: weak shareholders, weak competition and unreformed industrial relations undermined productivity performance

Market Power and UK Productivity Performance (Broadberry & Crafts, 1992, 1996)

• In 1930s increased market power substantially reduced productivity growth

• In early postwar years, collusion undermined productivity performance

• Both pre- and post-WWII, high CR3 associated with low levels of UK labour productivity relative to US

Restrictive Practices Act (1956)

• The one competition-policy reform during the Golden Age with teeth

• Had significant impact on productivity

• 1954-63 compared with 1964-73: productivity increase in non-colluding sectors unchanged but in formerly-colluding sectors rose by 1.8% per year (Symeonidis, 2008)

From Industrial to Competition Policy in the 1970s and 1980s

• Not through strengthening ‘competition policy’ per se

• Trade policy liberalized through EU membership and GATT rounds

• Subsidies largely withdrawn

• De-regulation

Source: Wren, 1996

UK Industrial Subsidies, 1946-90

Increased Competition and Productivity Performance• Increases in competition correlated with 1980s

productivity growth at sectoral level (Haskel, 1991)

• Compared with France and Germany, greater deregulation of product markets implied a TFP growth advantage of 0.5pp per year in the 1990s (Nicoletti and Scarpetta, 2003)

• Post-1980, restructuring and divestment replaced diversification and conglomeration that had prevailed under inadequate corporate governance (Toms & Wright, 2002)

Increased Competition:Effects via Industrial Relations• Weak competition in product markets generates rents

that can be partly appropriated by unions with bargaining power into higher wages and lower effort

• During the 1980s and 1990s, increased competition reduced union membership, union wage mark-ups and union effects on productivity (Brown et al., 2008; Metcalf, 2002)

• Multiple unionism in an industry reduced TFP growth by 0.75pp from the 1950s through the 1970s but had no effect in the 1980s (Bean and Crafts, 1996)

Source: OECD STAN database and Secretariat calculation

Mark-ups in Non-ManufacturingMark-ups are calculated for individual 2-digit ISIC sectors and aggregated over all sectors using country-specific final sales as weights

0.000.050.10

0.150.200.250.30

0.350.40

UK

Sweden

USA

Canada

Belgium

Luxembuorg

Netherlands

Germ

any

Denm

ark

France

Norw

ay

Japan

Finland

Austria

Korea

Italy

Product Market Regulation, 1978-1998 (0-10) (Conway & Nicoletti, 2006)

1978 1988 1998France 10.00 9.67 7.17

Germany 8.67 8.50 4.67

UK 8.00 6.33 2.33

USA 6.17 4.00 2.67

Regulation and the contribution of ICT-using services to aggregate productivity growth

-0.2

0.3

0.8

1.3

0 0.5 1 1.5 2 2.5 3 3.5

GBR

USAMEX

AUS

IRLSWE

CANAUT

KORNORDNKNLD

JPN DEUESP

FRA

ITABEL

FINCHE

ICT using services, 1996-2001

Product market regulation (inward-oriented), 1998

Correlation coefficient: -0.62t-statistic: -3.35

Source: Nicoletti & Scarpetta (2005)

Traditional UK Competition Policy• Case-by-case cost-benefit approach allows

efficiency defence

• Competition authorities investigate; ministers decide

• Relatively few investigations, no penalties, no redress

• Typical remedy is ‘stop it’

• 1998 and 2002 Acts are a big reform after which UK looks respectable by OECD standards

Source: Hoj (2007)

Antitrust Framework

0.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

Korea

USA

NZ

Australia

Czech R

epSlovakC

anadaH

ungaryIcelandFinlandU

KG

ermany

Denm

arkJapanTurkeySw

edenItalyPolandN

LDSw

itzerlanIrelandFranceM

exicoLuxem

bouSpainN

orway

Belgium

Austria

PortugalG

reece

Lessons for Today from the 1930s

• The ‘managed economy’ strategy made sense as damage limitation but had a significant long-term productivity cost

• Supposing that the present crisis indicates a return to state ownership and industrial policy would be a triumph for hope over experience

• There is a strong case for much stricter financial regulation but this needs to be distinguished from a claim that a return to interventionism is generally desirable