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Solving the UK's productivity puzzle: is a higher public science budget alone sufficient?

The UK’s lagging productivity has been a significant, long-term economic challenge that the government has attempted to tackle since the 1960s. Although hourly productivity recently recently increased as the fastest rate in six years, productivity is still 16% lower than the pre-2008 trend. This is damaging to the economy as it translates into a lack of competitiveness against other countries, resulting in fewer exports and ultimately a balance of payment deficit. A recent estimate finds that if the UK raised its productivity by one percentage point every year, then it would add approximately £240 billion to the the economy within a decade, illustrating the degree of urgency of this problem.

(Source: The Guardian)

One important determinant of productivity is the improvement of physical capital, such as the quality and efficiency of machinery and infrastructure; this in turns depends critically on the progress of scientific innovation. In the digital age, encouraging scientific innovation is increasingly important in improving productivity growth. A research by the British government found that 51% of productivity growth between 2000 and 2008 was due to innovation, and that the firms who consistently invested in R&D were 13% more productive that those who did not. Given the apparent importance of R&D, there are increasing calls for the UK government to raise the public science budget as a means increasing productivity. Although raising the public science budget can help boost flagging productivity, it is insufficient on its own. Rather, pursuing other complementary reforms have the potential to maximise the benefits of raising public science budget on productivity.

How a higher public science budget can help boost productivity

Essentially, through a higher public science budget, more capital will be allocated into R&D, allowing the development of new physical capital and improvements in the efficiency of production methods. Increasing the science budget could take the form of higher tax credits for research centres, which reduces the overall cost of capital and therefore encourage research centres and start-ups to devote more capital towards capital expenditure. These tax credits could also attract new firms from abroad to start their business in the UK and encourage more private investment, allowing firms to improve the quality of their capital goods. An example of this is when Rolls-Royce adopted methods developed by Sheffield University in 2001, which reduced the time it took to produce turbine discs in jet engines by 50%. It could also help improve scientific, network and communication infrastructure; the 2016 budget has devoted £614 million to World-Class Laboratories, which renews existing scientific infrastructure. These schemes benefit productivity as it improves the efficiency of the existing stock of capital and infrastructure, thus allowing firms to maximise the number of goods they produce at cheaper prices.

Jo Johnson (Science Minister) announcing major UK-India Newton Fund research investments at the UK-India TECH Summit (Source: Newton Fund)

Another way in which an increase in the public science budget could benefit productivity is through improving the quality of labour, for example by granting monetary incentives to talented entrepreneurs, scientists and researchers. Currently, there are schemes such the Global Challenges Research Fund and Newton Fund which aims to encourage the cooperation between UK and foreign researchers; however, these schemes aim to address pressing global issues through worldwide scientific cooperation. Another way to improve the quality of labour is by sponsoring scientific festivals, such as the two-day Science and Engineering Festival in the US; and to create ‘hubs’ such as Silicon Valley. These conferences and close networks allow for the diffusion and exchange of ideas, allowing for the advancement of technologies, and thus boosting productivity.

Alternatively, productivity improvements need not require persistent fiscal injection in the science budget, but rather one-off injections that could incur long lasting benefits on productivity through a crowding-in effect. Research shows that these short term injections, which act as an initial ‘big push’, could attract up to 30% more investments from the private sector, and that for every £1 spent by the government on R&D, private sector R&D productivity rises by 20p per year. Accordingly, investment from the private sector could improve both the physical and human capital, allowing for a self-sustaining period of productivity growth. Moreover, positive externalities could arise through the continued advance of technology, which will diffuse across the economy. For example, the combination of mass data and the development of Artificial Intelligence (AI) has allowed such technologies to be adopted , meaning that we will see the incorporation of AI in the financial and service industries so as to automate business processes and reduce operational costs, thus boosting productivity.

But is it enough on its own?

However, raising the public science budget alone will be insufficient in boosting UK productivity growth. Although countries who spend more on R&D, such as Germany, tend to have higher levels of productivity, this does not imply that spending more on public science will lead to higher productivity. For instance, Japan spent 3.6% of GDP on R&D in 2014, considerably higher than the UK; yet its productivity is actually lower than that of the UK. This implies that raising the public science budget may not guarantee productivity improvement, and therefore cannot on its own boost productivity.

One drawback of increasing the public science budget to boost productivity is that it might lead firms to rely on continuous monetary support from the government. As one cannot predict and control the immediate investment decisions of private investors, a continuous fiscal injection is necessary until the private sector recognizes the benefits of pursuing private investment in scientific research. This is not compatible with the UK government’s policy of austerity following the 2008 financial crash, and relies heavily on the government’s commitment. With the negotiations of Brexit in store, as well as the NHS and pension funding crisis, it is unlikely that the government will be willing to increase the magnitude of the public science budget due to other priorities.

Another challenge is how efficient raising the public science budget is in boosting productivity. Not only will there be a time-lag, as the impacts on productivity may not be recognised immediately, since breakthroughs in research can take years on end; but it also has a low elasticity of output: every 10% increase in R&D only results in a less than 1% increase in output.

There is also the issue of the opportunity cost. Not only could the amount spent on raising the public science budget be allocated to other areas such as healthcare and social protection (as mentioned above), the spending could go into improving the structure of university courses or working alongside local businesses to establish better apprenticeship programmes.

Complementary reforms

By making education more applicable for industries, young workers will be equipped with more relevant technical skills, which could be put in place during work and produce more efficiently. In the long run, this will raise labour productivity.

Germany's Dual Vocational Training System (Source: German Culture)

One successful case study of technical education worth referencing is the German Dual Vocational Training System (TVET): after completing 18 years of compulsory schooling, students can sign onto two to three year training contracts with firms such as BMW, whilst also receiving an education from a vocational school. Trainees start off by doing more unskilled work in their first year; however, by the third year, more than 50% of their work are skilled tasks. Not only do students gain technical skills, but firms also benefit directly from enhanced productivity. Almost 16% of 16-29 year olds in Germany participate in such schemes, due to its prestige as students receive credentials at the end of the contract. In comparison, less than 3% of British students partake in them, perhaps because apprenticeship schemes are still less well-regarded in British society when compared to a university degree. The fact that Germany’s youth unemployment rate is half of that of the UK also shows the effectiveness of apprenticeship schemes in lowering youth unemployment and boosting productivity, giving reason for why the UK government should subsidise such courses.

Another complementary reform that should be taken to boost productivity is to improve the existing UK infrastructure. Britain’s infrastructure was ranked 9th in the world in 2016, which is behind that of the Japan (5th); London has been ranked as the 5th most congested city in the world, while Britain’s perceived quality of road infrastructure is at 5.2 points, sitting in the middle of the other G7 countries. As network infrastructure such as public transport and roads yield direct benefits on productivity through more speedy transfer of goods and factor resources, enhancing infrastructure could enhance productivity and efficiency. Additionally, governmental investments into full-fibre connections and 5G, for example, will not only increase productivity, but will also benefit both businesses and consumers due to its non-excludable nature; thus creating positive externalities. With the rise of e-commerce and the digitalisation of many industries, this method of improving productivity is becoming even more critical than before.

If the government were to raise the public science budget, it should also consider how well the UK is at conducting and applying R&D. The UK is relatively good at innovation (ranking 13th for innovation), and has a strong creative industry in cities like London. However , it is relatively weak at commercialising their research; this is evident from the lower number of patents filed in the UK compared to Germany. Therefore, from a comparative advantage perspective, it might be more appropriate to spend the budget in a way that encourages firms in the service and production sector to adopt the existing technological advancements, considering that they account for 80% and 13%of economic output consecutively. These improvements in physical capital will boost productivity in the sectors of the economy that the UK performs best in, thus maximising output whilst utilising to their comparative advantage.

(Source: Market Business News)

While better technological adoption by businesses has the potential to boost productivity, it is also important to enhance the competitiveness of industries, which is often associated with productivity improvement. In the UK, one of the main reasons for the low productivity is the existence of ‘zombie’ firms — businesses whose survival are only possible due to government supports. These businesses are often on the verge of bankruptcy, generate little or no revenue, and do not wish to become more innovative and productive. Worse still, they tend to hold capital in place, preventing funds from flowing to businesses which are more productive and which have potential to grow, such as innovative start-ups. In fact, an aggregate estimate by the OECD found that a 3.5% rise in the share of zombie firms is associated with a 1.2% decline in the level of labour productivity across industries, which clearly demonstrates how the presence of these firms would lower aggregate productivity. Therefore, productivity improvement could be achieved simply by removing entry barriers into markets and cutting bureaucracy, such as extending the existing ‘Cutting Red Tape Programme’ in the UK. This would allow the increase in public science budgets to yield an even higher benefit than before.

In the context of Brexit, Britain is likely to lose benefits from the existing custom unions; therefore, solving the ‘UK productivity puzzle’ to effectively compete against other countries has become more important than before. Although there is a convincing case for increasing the public science budget to increase productivity, this is likely to be insufficient in raising the overall productivity level. Instead, complementary reforms in other areas must be put in place to enhance the marginal benefits from increased public science budget, namely the development of technical education systems, improvements on existing infrastructure to help enhance productive efficiency, as well as the removal of entry barriers to encourage competition between firms. By doing so, Britain could ensure that it does not become the ‘sick man of Europe’ once again in the 21st century.

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