UK Competitiveness Tcm8-13559

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DTIECONOMICSPAPERNO.3

UKCompetitiveness:movingtothenextstage

BYPROFESSORMICHAELEPORTERANDCHRISTIANHMKETELS

INSTITUTEOFSTRATEGYANDCOMPETITIVENESS,HARVARDBUSINESSSCHOOL

MAY2003

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ECONOMIC&SOCIALRESEARCHCOUNCIL

TheDTIdrivesourambitionofTheESRCistheUKslargestfundingprosperityforallbyworkingtocreateagencyforresearchandpostgraduate

thebestenvironmentforbusinesstrainingrelatingtosocialandeconomicsuccessintheUK.Wehelppeopleissues.Itprovidesindependent,high-andcompaniesbecomemorequality,relevantresearchtobusiness,productivebypromotingenterprise,thepublicsectorandGovernment.innovationandcreativity.TheESRCinvestsmorethan76millioneveryyearinsocialscienceWechampionUKbusinessathomeandatanytimeissupportingsom

eandabroad.Weinvestheavilyin2,000researchersinacademicworld-classscienceandtechnology.institutionsandresearchpolicyWeprotecttherightsofworkinginstitutes.Italsofundspostgraduatepeopleandconsumers.Andwetrainingwithinthesocialsciencestostandupforfairandopenmarketsnurturetheresearchersoftomorrow.

intheUK,Europeandtheworld.Moreathttp://www.esrc.ac.uk

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DTIECONOMICSPAPERNO.3

UKCompetitiveness:movingtothenextstage


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BYPROFESSORMICHAELEPORTERANDCHRISTIANHMKETELS

INSTITUTEOFSTRATEGYANDCOMPETITIVENESS,HARVARDBUSINESSSCHOOL

MAY2003

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Foreword

ThepersistenceoftheproductivitygapwithourmaincompetitorsisakeyissueinUKeconomicpolicy-making.Inordertounderstandthisproblembetter,theDTIandtheESRCaskedProfessorMichaelPorter,oftheInstituteofStrategyandCompetitivenessatHarvardBusinessSchool,toinvestigatethecurrentstateofUKcompetitiveness.

ProfessorPorterpointstotheUKsrecentsuccessinraisingprosperity.HedemonstratestheUKsstrengthsintermsofscienceandengineering,itssupportivemarketframework,anditsimprovedmacroeconomicenvironment.However,hehighlightscontinuedweaknessesintermsofskills,clustersofinterconnectedcompaniesandinnovation.

ThemostvaluablemessageisthattheUKneedsanewconceptionofcompetitiveness.Inthepast,theUKhasbeenverysuccessfulinimplementingkeymarket-basedre

forms:deregulation,privatisationandcompetition.Buttheseaspectsofindustrialpolicyarenowrunningintodiminishingreturns.

ProfessorPorterarguesthattheUKnowneedsanapproachfocussedonimprovingskills,stimulatinginnovationandfosteringenterprise.Itisonlybybuildingsuchcapacity,thatwewillbeabletomovetothenextstageofimprovingcompetitivenessandachievesustainedhigherlevelsofprosperity.

Inadditiontohispolicyrecommendations,ProfessorPorterhassetoutanambitiousresearchagendafortheUK.BoththeDTIandESRCarecommittedtoimprovingthestateofknowledgeabouttheUKeconomyinordertoprovidearobustevidencebaseforfuturepolicydevelopment.MuchofthisworkwillbecarriedoutthroughAIM,themanagementresearchinitiativesupportedbytheESRCandledbyProfessorAnneHuff.


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OtherinvestmentsbytheESRCwillalsomakeasignificantcontribution.

WehopeProfessorPorter sanalysiswillstimulatedebateandformpartofawiderdialogueinvolvingtheDTI,ESRCandallwithaninterestintheeconomicperformanceoftheUK.

VickyPryceFrancesCairncrossChiefEconomistandChair,EconomicandDirector-GeneralEconomics,SocialResearchCouncilDTI

UKCOMPETITIVENESS:MOVINGTOTHENEXTSTAGE1

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DTIEconomicsPapers

ThereviewsoftheDTIinAutumn2001placedanalysisattheheartofpolicy-mak

ing.AspartofthisprocesstheDepartmenthasdecidedtomakeitsanalysisandevidencebasemorepubliclyavailablethroughthepublicationofaseriesofDTIEconomicsPapersthatwillsetoutthethinkingunderpinningpolicydevelopment.Previoustitlesinclude:

Bundling,TyingandPortfolioEffects,ProfessorBarryNalebuff(YaleUniversity),February2003

AComparativeStudyoftheBritishandItalianClothingandTextileIndustries,

NicholasOwen(DTI),AlanCanonJones(LondonCollegeofFashion),April2003

TheviewsexpressedwithinDTIEconomicsPapersarethoseoftheauthorsandshouldnotbetreatedasGovernmentpolicy.WewelcomefeedbackontheissuesraisedbytheDTIEconomicsPapers,[email protected]

2UKCOMPETITIVENESS:MOVINGTOTHENEXTSTAGE

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Contents

1Introduction4

a)ProjectBackground4b)KeyFindings5


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2OverallPerformanceoftheUKEconomy7

a)Prosperity7b)Productivity9c)Internationalisation,InnovationandProductivityGrowth13

3CompetitivenessandtheUKBusinessEnvironment:SummaryoftheEvidence18

a)Macroeconomic,Political,Social,andLegalContext18b)MicroeconomicBusinessEnvironment19c)Clusters27d)Roles,Institutions,andProcesses30e)InfluencesofDifferentGeographicalLevels32

4CompetitivenessandUKCompanyBehaviour:TheRoleofManagement34

a)UKCompanyPerformance34b)UKCompanyOperationsandStrategy:CompetitiveAssessment35c)UnderstandingUKCompanyBehaviour38

5ImplicationsforPolicyandFutureResearch

42

a)UKCompetitivenessattheTransitiontoaNewStage43b)TheUKCompetitivenessAgenda200345c)ImplicationsforUKCompetitivenessResearch47

ReferencesandDataSources49

AppendixA:UKSubclusterExportsbyValue,2000

54

AppendixB:ConvergenceorDivergenceAmongRegions-SelectedCountries55


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1Introduction

a)ProjectBackground

InOctober2002,theEconomicandSocialResearchCouncil(ESRC)appointedProfessorMichaelPorterandhisteamtoconductabrief,three-monthreviewoftheexistingevidenceonUKcompetitiveness.TheeffortwasfundedjointlybytheESRCandtheDepartmentofTradeandIndustry(DTI).TheLondonSchoolofEconomicsandPoliticalScience(LSE)graciouslyservedastheUK-basedacademicsponsoroftheproject.

Theobjectiveofthisreviewistosynthesise,interpret,anddrawimplicationsfromtheavailableevidenceonthecompetitivenessoftheUnitedKingdom,applyingthePortercompetitivenessframeworkanddrawingonthelearningfromdozensofnationalcompetitivenessprojectsoverthelastdecade.TheESRCaskedthatspecialattentionbepaidtotheroleofmanagementinUKcompetitiveness.

Thereviewisbasedprimarilyonexisting,andsometimesconflicting,researchbyothers.WehavealsoanalysedexistingdetaileddatafromtheGlobalCompetitivenessReport(GCR)thathasnotbeenpreviouslypublished,butwehavenotcreatedanynewprimarydata.OurfindingsbuildontheexistingresearchonUKcompetitivenessandconfirmmanyofitsfindings.Weaimtoprovideanintegrativeframeworkthatcanaidscholarsanddecisionmakersinthepublicandprivatesectorstosetprioritiesandidentify

missingpiecesintheUKcompetitivenessagenda.

TheintegrativeframeworkprovidedbythePortermicroeconomicapproachtocompetitivenessgoesbeyondagrowthaccountingdecompositionofeconomicperformancetoidentifytheprobablecausesunderlyingUKeconomicperformance.ItalsooffersaholisticwayofassessingtheirinterrelationshipsandthechangingconstraintsonUKproductivityandprosperitygrowthovertime.WehopethatthisframeworkwillenableamoreinformedpolicydebateintheUKonhowtomanagethetransitiontothenextstageofcompetitiveness.

ThisreviewisdecidedlynotacomprehensivestudyofUKcompetitivenessbutisintendedtoprovidehigh-levelguidancetopolicymakersonbroadpriorities,andtoassistindefiningapriorityresearchagendafortheESRC.Inparticular,thisreviewwillbemadeavailabletotheESRCinitiativeonmanagementheadedbyProfessorAnneHuff.

ApreliminaryversionofthisreportwasdeliveredbyProfessorMichaelE.Porte


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rinapubliclectureattheLSEonJanuary22nd2003.Thisreportalsodrawsupondiscussions


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Intoduction

duringandafterthelectureandthecommentsmadeinaclosedpolicyworkshopwithparticipantsinvitedbyDTI.

b)KeyFindings

PessimismandthelackofanoverallstrategicperspectivecharacterisemuchofthecurrentpublicdiscussionaboutUKcompetitiveness.AttentionisfocusedontheprosperityandproductivitygapthatremainswiththeUnitedStatesandprimaryEuropeanrivalsGermanyandFrance.ThisperformancegappersistsdespitetheUKsfarreachingeconomicpolicyreformsofthelasttwodecades.Asearchforexplanati

onshassofarnotreachedaclearconsensus.

LookingattheUKsfuturecompetitiveness,concernsdominateaswell.ArecentsurveyofUKbusinessleadersreportedasignificantlymorenegativeviewonthefutureversuscurrentUKcompetitiveness.1ChangingprioritiesinUKeconomicpolicyareperceivedto

threatentheachievementsofthepasttwodecades,e.g.lowlevelsofregulationandtaxation.Also,othercountriesareseenashavingmatchedmanyofthereformst

hatgavetheUKacompetitiveedgeinthepast.

Ourfindingsagreeonmanyofthespecifics,butaredifferentinoveralltone.TheUKhasinfactachievedaremarkablesuccessinhaltingtheeconomysprotracteddownwardeconomictrajectoryofthepre-1980period.Onmanyindicatorsofeconomicperformance,theUKhaskeptpacewith,ifnotoutpaced,competinglocations,especiallyinEurope.2Thissuccessintermsofeconomicperformanceisdirectlylinkedtothefar-

reachingeconomicpolicyreformsbysuccessiveUKgovernmentsthathavefundamentallychangedthemacroeconomicand,moreimportantly,themicroeconomiccontextforcompetition.

However,theUKcurrentlyfacesatransitiontoanewphaseofeconomicdevelopment.Theoldapproachtoeconomicdevelopmentisreachingthelimitsofitseffectiveness,andgovernment,companies,andotherinstitutionsneedtorethinktheirpolicyp


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riorities.Thisrethinkingisnotasignofthepaststrategysfailure;itisanecessarypartofgraduatingtothenewstage.Apublicconsensusonthedirectionofthetransitionandonthenextstageofthecountryscompetitivenesswouldhelptomanagetheuncertaintiesofthisprocess.TheabsenceofsuchaconsensusatatimewhentheoldpolicyapproachisrunningitscourseexplainsmuchofthepuzzlementandevenpessimisminthecurrentUKdebate.

WefindthatthecompetitivenessagendafacingUKleadersingovernmentandbusinessreflectsthechallengesofmovingfromalocationcompetingonrelativelylowcostsofdoingbusinesstoalocationcompetingonuniquevalueandinnovation.Thistransitionrequiresinvestmentsindifferentelementsofthebusinessenvironment,upgradingofcompanystrategies,andthecreationorstrengtheningofnewtypesofinstitutions.

Astomanagement,wefindthattheroleofmanagementcannotbeseparatedfromt

heUKCOMPETITIVENESS:MOVINGTOTHENEXTSTAGE5

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Introduction

overallcompetitivenessissuesfacingthecountry.Managementanditsdecisionsarebothaninputandaresultofthebusinessenvironment.ThusUKmanagementperformanceinmanywayseitherreflectsweaknessesinthebusinessenvironment

orinvolvesdecisionsthatareconsistentwiththecurrentbusinessenvironmenteventhoughtheydonotimprovecompetitiveness.Managementpractices,then,arenotatthecoreoftheUKcompetitivenesschallenge;however,thereisalwaysroomforimprovement.AspartoftheoverallefforttoupgradeUKcompetitivenessthereisaclearroleformanagement.EffortstoupgrademanagementwillnothoweverbesufficienttoachieveasustainedimprovementinUKcompetitiveness.

References

1CBI(2002)

2EuropeanCommission(2002)


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2


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OverallPerformanceoftheUKEconomy

Competitivenessremainsaconceptthatisnotwellunderstood,despitewidespreadacceptanceofitsimportance.3Tounderstandcompetitiveness,thestartingpointmust

bethesourcesofanationsprosperity.Anationsstandardoflivingisdeterminedbytheproductivityofitseconomy,whichismeasuredbythevalueofgoodsandservicesproducedperunitofthenationshuman,capitalandnaturalresources.Productivitydependsbothonthevalueofanationsproductsandservices,measuredbythepricestheycancommandinopenmarkets,andtheefficiencywithwhichtheycanbeproduced.Truecompetitivenessthen,ismeasuredbyproductivity.Productivityallowsanationtosupporthighwages,astrongcurrencyandattractivereturnstocapital,andwiththemahighstandardofliving.

TheUKeconomyhasperformedwellonthemostimportanteconomicmetricsinthe

lasttwodecades,andtheawarenessofcompetitivenessissueshasincreasedmarkedly.Prosperityhasimprovedinabsolutetermsandhasalsoincreasedrelativetomanyotheradvancedeconomies.Prosperitygainsrelativetootherlocationsbenefitedfromasignificantincreaseintheleveloflabourforceutilisationintheeconomy(hoursworkedperemployee,employmentrate,andlabourforceparticipationrate).Labourproductivitygrowthhasbeengood,butnotsignificantlyabovethelevelinothereconomies.Otherintermediatemeasuresofcompetitiveness,suchastheUKsworldexportmarketsha

reandFDIattraction,havebeenstable.

Despitetheseimprovements,thelevelsofproductivityandprosperityintheUKstilllagmanyotheradvancedeconomies.Withlabourforceutilisationalreadyatahighlevel,onlyfurthercatch-upinlabourproductivitywillbeabletoreducethegap.Labourproductivitycanincreasethroughhigherskilllabourinputs,highercapitalintensity,andhighertotalfactorproductivity(technology).InallthreeareastheUKcurrentlylags

behindimportantcompetitorssuchastheUnitedStates,FranceandGermany.Itwillneedtoclosethesegapstofinallyachieveprosperitycatch-up.Thiswillrequiresustainedimprovementsinthemicroeconomicbusinessenvironment.

a)Prosperity

Inthelastfiveyears,theUKwasoneofthefewadvancedeconomiesthatcameclose


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tomatchingtheeconomicperformanceachievedbytheUnitedStates.TheUKsgrowthrateofGDPpercapitaoutpacedotherEuropeancountrieslikeGermany,France,Italy,andSweden,andlaggedonlysomewhatbehindAustralia,theUnitedStates,andtheNetherlands.OnlyIreland,Finland,andanumberofEuropeanandAsianmiddle-incomecountriesoutpaceditsignificantly(Figure1).

Figure1:ComparativeEconomicPerformance-SelectedAdvancedEconomies

100UnitedStates

0

01Ireland=S(92%,+6.6%)USwitzerlandCanada,100JapanAustralia2

,75GermanyFranceNetherlandsaSwedentHongKongFinlandipaCItalyUKrTaiwaneSingaporepP

DNewZealandSpainG

KoreaSlovenia50-2.0%-1.5%-1.0%-0.5%0.0%0.5%1.0%1.5%2.0%

CAGRofGDPperCapitaRelativetothe


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US,1995-2001

Source:WorldDevelopmentIndicators2002

TheUKscurrenteconomicperformancepresentsasignificantchangefromthepre-1980period.4Inthedecadesbefore1980,theUKlostgroundagainstallmajorcompeting

economies.From1961to1970theannualgrowthrateofGDPperworking-agepersonfortheUKregisteredat2.6%,significantlybelowmostotheradvancedeconomiesincludingGermany(4.2%),France(4.4%),Italy(5.2%),Spain(6.6%),andJapan(8.2%).5

Inthe1970s,growthratesdroppedgloballyduetooilpriceshocks.TheUKsannualgrowthrate,thenat1.6%,remainedbehindmostothereconomies.The1980sbroughtfirststabilisationandlateranincreaseofprosperitygrowthratesasthefirstwaveofmarketopeningreformssetin.Amacroeconomiccrisisintheearly1990sbroughtprosperitygrowthtoahalt.Macroeconomicstabilisationandfurthermicro-econo

micreformsledtoareboundofprosperitygrowthinthesecondhalfofthe1990s.

Despiteitscomparativelyhighgrowthrateinthelastfiveyears,thelevelofGDPpercapitaintheUKstillfallsbehindmostotheradvancedeconomies.InpurchasingpowertermsthegaptotheUnitedStatesiscloseto40%,Switzerland20%,Japan11%,Germany6%,andFranceandSweden3%.TheUKprosperitylevelisonparwithItaly,andoutpacescountrieslikeSingapore,NewZealand,andSpain.


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TheUKhas,accordingto1996data,ahighlevelofpovertyrelativetootherEuropeancountriesatsimilarlevelsofprosperity.6Theexistenceofsuchpocketsofpoverty

indicatesanuntappedpotentialforproductivitygrowthaswellasasocialchallenge.Itis

alsoasignalforremainingweaknessesinthebusinessenvironment,suchaslackoftraining,discrimination,alowleveloflocalgovernmentresponsibility,andtheseparationofsocialandeconomicpolicies.Theeffortsofthelastfewyearstoaddressthisproblemmayhavealreadyledtoanimprovementinthesituation,butnoconsistentdataonthisiscurrentlyavailable.


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b)Productivity

TheUKsGDPperheadcanbedecomposedintotwofactors:itsleveloflabourforceutilisation(hoursworkedperemployee,employmentrate,andlabourforceparticipationrate)anditslabourproductivity.

TheUKcurrentlyhasoneofthehighestlevelsoflabourforceutilisationintheOECDbehindonlyJapanandtheUnitedStatesbutaheadoftheContinentalEuropeancountries(Figure2).TheUKhasalowerunemploymentratethanmanypeercountries,andworkinghoursperemployeeintheUKagainfallbetweenUSandContinentalEuropeanlevels.Whiletheliterature7tendstoviewlabourproductivityasthesole

measureofeconomicperformance,integratingalargershareofthepotentialworkforceintheeconomyisanimportanteconomicandsocialachievement,andtheUKdeservescreditforitssuccessinthisarea.

Figure2:LabourForceUtilisationandProductivity

001120=KU,110Japan00GreeceUnitedStates

02-AustraliaUK610099Canada1,n90SwedenoDenmarki

taFinlandsIrelandNorwayilit80GermanyUeSpain


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NetherlandscrFranceo70ItalyFrBelgiumuob60aL60708090100110120130

LabourProductivity,1999,UK=100

Note:LabourForceUtilisationmeasuredashoursworkedperworkingagepopulation;LabourProductivitymeasuredasoutputperhourworked.Source:OECD(2001),IMF(2003)


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ThegrowthinlabourforceutilisationintheUKhasbeenstrongerthaninContinentalEurope,andisthedecisivefactorthatallowedtheUKtocatchupintermsofprosperity.8

Itisalwayspossibletoraiselabourproductivitybysheddingemployment,butt

hisneitherincreasestrueprosperitynoralocationscompetitiveness.9ManyContinental

Europeancountrieshavegonedowntheroadofmakinglowerproductivityemploymentunattractiveandhavesufferedhighunemployment;theUKhasinsteadincreasedincentivesforwork.TheUKdidsignificantlyreduceunemployment,anddidnotresorttocuttingtheaverageemployeesworkingweek.

UKlabourproductivitygrowthhasbeencomparabletootheradvancedeconomies-a

markedimprovementtothepre-1980swhereUKproductivitygrowthpersistentlylaggedcountrieslikeFranceandGermany.UKlabourproductivitygrowthinthelastthreedecadeshasfluctuatedbutaveragesaround2%annually(Figure3).10Intheearly1980s,

theinitialwaveofreformsledtofastproductivitygrowthbutalsoledtoariseinunemployment.Withtheeconomypickinguplaterinthedecade,labourforceutil


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isationsoaredwhilelabourproductivitygrowthmoderated.Themacroeconomiccrisisintheearly1990scostmanyjobs,butlabourproductivitygrowthremainedstable.Recently,bothlabourproductivitygrowthandlabourforceutilisationhavecontributedtostrongprosperitygrowth,butlabourproductivityisbecomingthedominantfactor.

Figure3:DecompositionofUKProsperityGrowthoverTime

4%LabourProductivityGrowthLabourForceUtilisationGrowthGDPpercapita

seta3%Rhtwo

rG2%egarev1%Adn

uopm0%oC

-1%70-8080-8585-9090-9595-9898-01

Source:USBureauofLabourStatistics(2002),authorscalculations

WhilefasterUKlabourproductivitygrowthrateshavehaltedtheerosionofrelativeproductivity,theyhavenotledtoasubstantialconvergence.AccordingtotheOECD,theUKlabourproductivitygapversustheNetherlandsperhourworkedisat25%,versustheUnitedStatesat15%,versusFranceat11%,andGermanyat8%.Thisdatareferstoalleconomicactivity;OMahony/deBoer(2002)reportevenhighergapsforthemarket


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sectorexcludinggovernmentandnon-governmentalservices.


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Thisproductivitygapcannotbeexplainedbydifferencesinthecompositionoftheeconomies(Figure4).Theoverallgapisdrivenbyproductivitygapsacrossallindustries.11WithUKlabourforceutilisationalreadyhigherthaninmanycompeting

countriesexcepttheUS,furtherimprovementsinUKprosperitywillhavetocomefromreducingthislabourproductivitygap.

Figure4:RelativeOutputperHourWorkedbySector,1999(UK=100)

UKAheadUKLevelUKBehind

Financial&BusinessServicesUS

ManufacturingFrance

Non-MarketServicesGermany

Distribution

Transport&Communication

PersonalServices

Construction

Utilities

Mining

Agriculture

050100150200

Note:SortedbyshareinUKoutput.Source:OMahony/deBoer(2002)

DecomposingUKProductivityApplyingthetechniquesofgrowthaccounting,theUKlabourproductivitygapversusotheradvancedeconomiescanbefurtherdecomposedintotheeffectsofthreecomponents:capitalintensity,labourforceskills,andtotalfactorproductivity(orthecomponentofproductivitythatcannotbeexplainedbythequalityorquantityof


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factorinputs).Eachofthesecomponentsisnotcausalperse,butcanbeseenasanintermediateindicatorofmanyothermicroeconomicattributesofaneconomy.Nevertheless,theexerciseofdecomposingprovideshelpfulcluesaboutwheretolookforthesourcesofcompetitivenessdifferences.

OMahony/deBoer(2002)providesadetailedanalysisoftheUKversustheUnitedStates,Germany,andFranceonthesemeasures.TheyfindthattheUKlagsGermanyandFrancemainlyoncapitalintensityandtoalesserdegreeonlabourforceskills(Figure5).TheUKlagstheUSmainlyontotalfactorproductivityand,toalesserdegree,oncapitalintensity.TheIMF(2003)presentsaslightlydifferentview,findingthattotalfactorproductivitydifferencesarethemaindriveroftheUKproductivitygapversusallpeercountries.However,theauthorsalsoacknowledgethattotalfactorproductivityisoftenconnectedtocapitalinvestment.


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Figure5:DecomposingtheUKLabourProductivityGap

150TotalFactorProductivityLabourForceSkillsCapitalIntensityUKLevel

140

130

leve120lKUf110o%

100

90

80

UKGermanyFranceU.S.

Note:Thedataappliestothemarketsector(excludingthepublicsector)in199


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9Source:OMahony/deBoer(2002)

TheUKhasalowercapitalstockperworkerandperhourworkedthantheotherthreecountries,laggingFranceby60%,Germanyby32%,andtheUnitedStatesby25%intermsofcapitalstockperhourworked.12Figuresonthecapital/outputratioaremorefavourableandputtheUnitedKingdominthemiddleoftheOECDcountries,13but

normalisingbyoutputfavoursrelativelylessproductivecountriesliketheUK,yieldingapotentiallybiasedindicationofcapitalintensity.14TheUKsrateofcapitalinvestmentin

thelastdecadehasincreasedstrongly,anditscapitalstockgrowthratesareonparwithFrancebutlagGermanyandtheUnitedStates.However,capitalinvestmentratesarenothighenoughtoclosethecapitalintensitygap.

LowercapitalintensityintheUKhasbeenraisedrepeatedlyasasourceofits

labourproductivitygap.Thegrowthaccountinganalysissupportsthisview,butimportantquestionsremain:Whatspecifictypesofcapitalinvestmentarelaggingrelativetootherlocations,andwhyareUKcompaniesmakingthedecisiontooperatewithlowercapitalstocks?Ouranalysisbelowwillexaminetheavailableevidenceonthesequestions.

Onskills,theUKlagstheUSintheshareofhighskillemployeesinthelabourforceandalsohasaslightlyhighershareoflowskillemployees.TheUKhasasignifican

tlylowershareofintermediateskillemployeesthanGermanyandFrance,whiletheshareofhighskillemployeesisroughlyequal.TheUKslabourforceskillproblemappearstobemainlyaproblemofthecurrentstockofemployees;intermsofinflowsfromrecentgraduatestheUKdoesnotlagitsEuropeancompetitorsortheUnitedStates.

LowerlevelsofskillsintheUKlabourforcehavealsobeenraisedintheliteratureforsometimeasasourceoftheUKproductivitygap.Onceagain,thegrowthaccounting

analysissupportsthisview.Butitalsohighlightsthepatternofskilldistributionacrosscountries.WewilldiscusstheimplicationsoftheUKskillmixinourfurtheranalysis.


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OverallPerformance


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oftheUKEconomy

Intotalfactorproductivity(TFP),thepartoflabourproductivitythatcannotbedirectlyattributedtofactorinputs,theUKfallsinthelowermiddlegroupofadvancedeconomies.TheUKlagstheUS,thegloballeader,byroughly50%,Franceby10%,andiscomparabletoGermany;basedonOECDdataforthe1995-1998period.15Thedataonthegrowthof

TFPissomewhatconflicting:theUSBureauofLabourStatisticsreportsUKTFPgrowthtobehighintheearlyphaseofmicroeconomicreformsinthe1980s,butfallingbacktoalevelsimilartootheradvancedeconomiesmorerecently.16TheIMFinsteadreportsUK

TFPtobelowerthaninpeercountriesexcepttheUnitedStatesnotonlythroughoutthe1970sbutalsothe1980s,andincreasinginthefirsthalfofthe1990s.Asdoothersources,theIMFreportsfallingUKTFPgrowthtowardstheendofthe1990s.17

LowerlevelsofTFPindicateinefficienciesunrelatedtothelevelandqualityoffactorinputsandreflectlowlevelsofinnovation,broadlydefined,andlesseffectiveuseoftechnology.DeficitsinTFPareespeciallyproblematicforanadvancedeconomyliketheUK,becauseTFPbecomesincreasinglyimportantforlabourproductivityasaneconomyseekshigherlevelsofprosperity.WewillexaminevariousmeasuresofinnovationandprobableexplanationsforUKinnovationperformanceinourfurtheranalysis.

c)Internationalisation,InnovationandProductivityGrowth

Productivitygrowthisunderpinnedbytrade,foreigninvestment,andinnovativeactivity.HereweexaminethesethreeareasasadditionalindicationsofthetrajectoryoftheUKeconomy.Ingeneral,wefindthattheUKsexportpositionisstable;thatitsattractivenessforforeigndirectinvestmentishighbutdecreasing;andthatitsinnovationperformanceisweak.

ExportsInternationaltradeisadirectwaytoratchetuptheproductivityofthedomesticeconomy

byconcentratingonthoseactivitiesinwhichthecountryhasarelativeproductivityadvantage.Theabilitytotradedomesticforforeigngoodsandservicesisequivalenttohavingaccesstoamoreefficienttechnology.Internationalexportsarealsoaneffectivemeasureofcompaniesabilitytocompetesuccessfullyonworldmarkets.Stableandgrowingexportsharesthatarenotengineeredthroughdevaluationsfosterrising


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productivity.

TheUKsshareofexportsandimportsinGDPindicatessignificantopennesstointernationaltradeandisinlinewiththesizeofitseconomy.18TheUKsexport

performancehasbeenstrongoverthelastdecade(Figure6).Itsshareofworldexportsinbothgoodsandserviceshasstayedrelativelystableatabout5.2%19.TheUKowesits

stableperformancemainlytoitsincreasingstrengthsinserviceexports,whichhaveoffsettheslowlydecliningpositioningoodsexports.ExportsremainedstrongastheUKsrealexchangerateappreciatedsignificantlyaftermid-1996.20Onlyafewother

advancedeconomiessuchasCanadaandtheNetherlandshavemaintainedtheirworldexportshares,whilemanyothersincludingtheUnitedStates,Japan,Germany,France,andItalyhaveexperiencedslowerexportgrowththancountriessuchasChinaandKorea.


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Figure6:UKWorldExportMarketSharesoverTime

9UKGoodsUKServicesUKTotal

8

%7nie6rahs5tr

op4xedlr3oW


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2

1

019911992199319941995199619971998199920012002

Source:WTO(2002),authorscalculations

ForeignDirectInvestment(FDI)Inwardforeigninvestmentimprovesthebusinessenvironmentbyelevatingthelevelofdomesticcompetition,andraisingthelevelofbuyersophisticationthroughtheprocurementstandardsandchoicesofforeignmultinationals.Anditalsoprovidesaneconomywithaninflowofnewtechnologies,operationalpractices,andotherknowledgedevelopedelsewhere.Foreigninvestorshavecapabilitiesotherwisenotavailableinthedomesticeconomy;thatisthereasontheycancompeteinalocationtheyotherwiseknowlesswell.21Thesesuperiorcapabilitiesarereflectedinthehigherproductivityof

foreign-ownedcompaniesrelativetotheaveragedomesticcompany,typicalinallleadingeconomies.22

Outwardforeigninvestmentenablesaneconomytogrowareasoftheeconomywithhighrelativeproductivity,henceraisingproductivitygrowth.OutwardFDIalsoamplifiesthecompetitivepositionofUK-basedfirmsallowingthemtotapintolowcostresourcesforactivitiesnotrequiringUK-levelskills.Also,outwardforeigninvestmentsallowcompaniestodeepentheirpositionsinforeignmarketsthroughprovidinglocals

erviceandproductcustomisation.Highervalueactivitiesstillremaininthehomecountry,andexperiencesuggeststhattheimprovementsincompetitivepositionabroadcanactuallyexpandhomecountryjobsatthesametimeassomeactivitiesaremovedabroad.Finally,outwardFDImaysometimesbeanecessitytopreservetheveryvitalityofthehomecountryorganisation.

TheUKisaneconomywithstronginwardandoutwardinvestmentflows,withnetoutwardFDIbalances.Theroleofforeign-ownedcompaniesinUKmanufacturingis

comparabletoFranceandsignificantlyhigherthaninGermanyortheUnitedStates.23


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WithafewexceptionstheUKoutperformsotheradvancedandemergingeconomiesintermsofFDIinflowsaswellasinstocksofFDIrelativetoGDP(Figure7).24Intheyears

1998-2000theUKsshareofworldinwardFDIstoodat7.8%,exceedingitsshareofworldGDPby80%,downfromanevenlargermargin.

Figure7:ComparativeInwardForeignDirectInvestment

004502-840Netherlands99NewZealand135egBrazil

ar30evAustraliaAP,25UKDG20fChinaSwedenoSpain(18%,89%)

%15sFranceGermanyas10FinlandkUnitedStatescItalyo5tSIJapanD0F

0102030405060

FDIInflowsas%ofGrossFixedCapitalFormation,Average1998-2000

Note:GermaninflowsinthisperiodarebiasedupwardbytheacquisitionofMannesmanin2000Source:WorldInvestmentReport(2002)


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TheUKalsooutperformsmostcountriesintermsofoutwardFDI.UKcompanieshaveasignificantinvestmentstockabroad;thevalueoftheirforeigninvestmentsstoodat$942bnin2001,about14%ofallcountriesforeigninvestmentcombined.25Theyalso

continuetoinvestheavilyoutsidetheUK:in2000,UKcompanyinvestmentsoutsidetheUKexceededtheirinvestmentsintheUKforthefirsttime.

InnovationThecreationandcommercialisationofnewknowledgeisafinal,andcrucialsourceofdynamicimprovementsinproductivity.Foradvancedeconomies,innovationisamatterofpushingtheworldfrontierofknowledge.Fordevelopingcountriestechnologyassimilationisthecentralchallenge.

WhiletheUKhasdonewellintradeandFDI,itsinnovationperformanceintherecentpasthasbeendisappointing.Whileothers,notablytheNordiccountries,Singapore,SouthKorea,Taiwan,andIsrael,significantlyincreasedinnovationasmeasured

byU.S.patenting,theUKhasgrowninnovationoutputonlyslowlyfromarelativelylowbase(Figure8).ThedataonUSpatenting-chosenasagoodindicatorbecausemosteconomicallyimportantinnovationsarelikelytobepatentedintheworldslargestmarket-isconfirmedbydataonEuropeanpatenting.26


-----------------------Page20-----------------------


Figure8:InternationalPatentingOutput

1040002,no350UnitedStatesi

talup300opno


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i250lJapanlTaiwanimSwitzerland1r200Swedene=10,000pGermanypatentssFinlandt150Israelngrantedinet2001aCanadap.100NLDenmarkSU.UKSouthKoreaSingapore

l50FranceNorwayauAustraliaNewZealandnItalynA0

0%10%20%30%40%

CompoundannualgrowthrateofUS-registeredpatents,1990-2001

Source:USPatentandTrademarkOffice(2002),authorsanalysis

ThequalityofUKpatentsmeasuredbycitationscompareswellwithotherEuropeancountries,butisstillonlyaverageinaglobalperspective.27Othersourcesoncompanyinnovationoftenuselessrobustdata,28buttendtoputtheUKneartheaverageofthe

advancedeconomies.UKmanufacturingcompaniesarereportedtospendlessoftheirturnoveroninnovationthantheirEuropeanpeers,whiletheoppositeistrueforUK

servicecompanies.

Overall,theUKhasastrongsciencebase,butlagsinpatentingandcommercialisation.29

Also,theUKsstrengthinthelifesciencesmaskslowerperformanceinotherareasofscienceandtechnology.CurrentlevelsofUKinnovationareinsufficienttodriveUKproductivitygrowthandclosetheUKproductivitygapversuskeycompetitors.


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-----------------------Page21-----------------------


References11OMahoney/deBoer(2002)20IMF(2002)

3Porter(2002a)12RecentworkbytheIMF(2003)21Giventhislogic,itshouldbenorelatesthisgapinoverallcapitalsurprisethatmultinational4ForotherdiscussionsofrecentintensitytolowerinvestmentscompaniesareeverywhereUKeconomicperformanceseeinnon-residentialconstruction.moreproductivethantheirlocalNickell(2002),Nickell/VanUKinvestmentsinmachinery,competitiors.See,forexample,

Reenen(2002),andhowever,arecomparabletoAshworth(2001),Card/Freeman(2002).ForaotherOECDcountries.Griffith/Simpson(2000).morelong-termperspectiveseeMaddison(2001).13IMF(2003)22Pain(2000)

5IMF(2003)14Oughton(1997)23OECD(2001)

6OECD(2002),Nickell(2002a)15TheIMF(2003)reports24UNCTAD(2002)somewhatdifferentgapsforthe7ForexampleIMF(2003)and25UNCTAD(2002)averageofthe1996-2000EuropeanCommission(2002).periodwiththeUKlaggingthe26EuropeanCommission(2001)8Card/Freeman(2002),OECDUnitedStatesby33%,France27NationalScienceFoundation(2002a),IMF(2003)by25%,andGermanyby12%.

(2000)citedinPorter/VanOpstel9Thesameistrueforreducing16USBureauofLabourStatistics(2001)workingtimeandthus(2002)28Nickell/VanReenen(2002)increasingtheintensityofwork17IMF(2003)discussthequalityofthe


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intheremaininghours.EuropeanInnovationSurvey18DTI(2002)10BureauofLabourStatistics29Nickell/VanReenen(2002)(2002),IMF(2003)19WTO(2002)


-----------------------Page22-----------------------

3CompetitivenessandtheUKBusinessEnvironment:SummaryoftheEvidence

Highandincreasinglevelsofproductivityandinnovationaremanifestationsofcompetitiveness.Theircausesareembeddedinthecontextprovidedbyanationorregionforcompetition.Contextcanbedividedintotwoareas:(1)themacroeconomic,

political,legal,andsocialcontext,and(2)themicroeconomicfoundationsofcompetition.Thesetwobroadareasaredifferent,butmutuallyreinforcing.

a)Macroeconomic,Political,Social,andLegalContext

Soundmacroeconomicpoliciesandstablepolitical,legal,andsocialinstitutionscreatethepotentialforimprovingnationalprosperity(Figure9).Appropriatepoliciesintheseareasareincreasinglywellunderstood,andbeingpursuedinanincreasingnumberofcountries.

Figure9:DeterminantsofProductivityandProductivityGrowth

Macroeconomic,Political,Legal,andSocialContextforDevelopment

MicroeconomicFoundationsofDevelopment

SophisticationofCompanyQualityoftheMicroeconomicOperationsandStrategyBusinessEnvironment


-----------------------Page23-----------------------

CompetitivenessandtheUKBusinessEnvironment:SummaryoftheEvidence

However,competitivenessultimatelydependsonfirmsandthewaytheycompete.Hence,asoundmacroeconomic,political,legal,andsocialcontextisnecessaryforachievingcompetitiveness,butnotsufficient.30


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TheUKspoliticalandlegalsystemisstableandnotabarriertoeconomicdevelopment.TheUKhasinrecentyearsachievedahigherlevelofmacroeconomicstabilitythaninanyotherperiodafter1945.Before1980,deterioratingpublicfinances,ahighlevelofinflation,andanerosionofthevalueofthepoundhamperedtheeconomy.Intheearlyphaseofthepost-1980reformsthefocuswasonreducingthesizeofgovernmentandstabilisingpublicfinances.Monetarypolicy,however,remainedvolatileandgrowtherratic.Inthelastdecade,however,fiscalandmonetarypolicyhavebecomemuchmorestable,especiallyaftertheindependenceoftheBankofEngland.ThereremainsuncertaintyaboutEconomicMonetaryUnion(EMU)membership,butthisuncertaintyisinitselfunlikelytobeanimportantfactoraffectingtheUKscompetitiveness.

Progressonsocialissueshasbeenmoremixed,andtheUKstillfacessignificanteconomicdisparitiesacrossregionsandpopulationgroups.Sofar,povertyhasbeenseenasmoreasocialthananeconomicproblem,butthedemographicshiftcould

inthefutureincreasetheeconomiccostsofthesesocialproblems.

b)MicroeconomicBusinessEnvironment

Wealthisactuallycreatedatthemicroeconomiclevelintheabilityoffirmstocreatevaluablegoodsandservicesusingefficientmethods.Onlyinthiswaycananationsupporthighwagesandtheattractivereturnstocapitalnecessarytosupportsustainedinvestment.Themicroeconomicfoundationsofproductivityrestontwointerrelated

areas:thesophisticationwithwhichdomesticcompaniesorforeignsubsidiariesoperatinginthecountrycompete,andthequalityofthemicroeconomicbusinessenvironment.

Increasingproductivitythroughmoresophisticatedwaysofcompetingdependsonparallelchangesinthemicroeconomicbusinessenvironment.Thebusinessenvironmentcanbeunderstoodintermsoffourinterrelatedareas:thequalityoffactor(input)conditions,thecontextforfirmstrategyandrivalry,thequalityoflocaldemandconditions,andthepresenceofrelatedandsupportingindustries.Becauseoftheir

graphicalrepresentationthefourareashavecollectivelybeenreferredtoasthediamond(Figure10).31


-----------------------Page24-----------------------



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Figure10:ProductivityandtheBusinessEnvironment

ContextforFirmStrategyandRivalry

Thecontextshapingtheextentofcorporateinvestment,thetypesofstrategiesemployed,andtheintensityoflocalrivalry

Factor(Input)Conditions

Theefficiency,quality,andDemandspecialisationofunderlyinginputsthatfirmsdrawininConditionscompetinghumanresourcesThesophisticationofhomecapitalresources

demandandthepressurephysicalinfrastructurefromlocalbuyerstoupgradeadministrativeinfrastructureproductsandservicesscientificandtechnologicalinfrastructurenaturalresources

RelatedandSupportingIndustries

Theavailabilityandqualityof

localsuppliersandrelatedindustries,andthestateofdevelopmentofclusters

TheUKbusinessenvironmenthasbeenfundamentallyupgradedinthelasttwodecades.32Thishasbeentheresultofsignificantchangesinpolicystartinginthelate1970s,33whichhavemadetheUKamuchmoreattractiveplacetodobusinessandhave

enabledcompanieslocatedtheretoachievemuchhigherlevelsofproductivity.

Overall,theUKhasbeensuccessfulinreducingunproductiverolesanddistortio

nsofgovernmentinthecompetitiveprocess(Figure11).IntheGlobalCompetitivenessReport(GCR),34theUKperformsespeciallywellinmeasuresofcompetitivevitalityandmarket

incentives;italsoperformswellondemandconditionsandcapitalmarkets.



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-----------------------Page25-----------------------


TheUKhasbeenlesssuccessfulinareasthatrequirelong-terminvestmentsinassetsorinstitutionsbythepublicorprivatesector.35Itsmostsignificantweaknessesaccordingto

theGCRareinphysicalinfrastructureandhumanresources.

Figure11:TheUKBusinessEnvironment-Overview

CompetitiveAdvantagesCompetitiveDisadvantages

HighlyopentointernationaltradeWeakanddeterioratingphysicalandinvestmentinfrastructure

VerylowregulatorybarrierstoSkilldeficitsinthelabourforcecompetitionatthenationalleveldespitefavourabl

einternationalSophisticatedcapitalmarkets,rankingsoneducationalespeciallyequitymarketsachievement

Constrainedaccesstodebtcapital

LowlevelsofR&Dinvestmentandcommercialisationinfrastructuredespitestrongsc

iencebase

Largeregionaldifferencesinthequalityofthebusinessenvironment

Limitedpresence/effectivenessofInstitutionsForCollaboration

i)Factor(Input)Conditions

InfrastructurePhysicalinfrastructureemerges,accordingto2002GlobalCompetitivenessReport(GCR)Surveydata,astheUKsmostimportantweakness.Thequalityofrailwaysranksparticularlylow,buttheportinfrastructureandeventhetelecommunicationinfrastructureregisterasrelativedisadvantages.InallthreeareastheUKsrankinghasdroppedby5or


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moreplacesrelativetoothercountriesthroughoutthelastfiveyears.36These

weaknessesreflectthelowerrateofpublicinvestmentintheUKcomparedtootheradvancedeconomiesoverthelasttwodecades.Theymayalsobeaffectedbythepost-privatisationregulatoryframeworkinwhich,forexample,railroadcompanieshaveoperated.UKpublicinvestmentrelativetoGDPhasbeenroughly50%belowtheUnitedStates,France,andGermany,althoughthegapwithGermanyhasdecreasedinthelastdecade.37

SkillsLabourforceskillscontinuetobeanareaofcompetitivedisadvantagefortheUK,althoughthepictureismixed.Intermsofeducation,intheGCRtheUKreceiveslowmarksonthequalityofitsschoolsandspecificallyonthequalityofitsmathsand

UKCOMPETITIVENESS:MOVINGTOTH

ENEXTSTAGE21-----------------------Page26-----------------------


scienceeducation.ThisisconsistentwiththecomparativelylowspendingoneducationintheUK;onaperstudentbasistheUKranks15thamongallOECDcountriesonthismeasure.However,UKstudentshaveperformedwellintherecentPISAstudyoneducationalperformanceacrosscountrieswheretheUKranksbetween4and6ondifferenteducationalareas.38

Intermsofgenerallabourforceskills,theUKstillfallsbehindcompetingeconomies,especiallybecauseofahighshareofthepopulationwithlowlevelsofeducationalattainment.39UKcompaniesreportsignificantskillshortagesthatareconsistentwiththesedeficits.40

Intermsofadvancedskills,theUKrankswellintheGCRonmanagementeducation,anareainwhichthecountryattractsmanyforeignstudents.TheUKreceiveslowGCR

marksontheavailabilityofscientistsandengineers.TheUKhas,however,registeredahigherincreaseinthenumberofresearchersperemployeesintheworkforcethanmostotheradvancedeconomies,althoughitstillisatalowlevel.41

FinancialmarketsTheCityofLondonisoneofthemostcompetitivefinancialservicesclustersintheworld.TheUKranks1intheGCRonthesophisticationofitsfinancialmarkets.


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Itsequitymarketsinparticularareratedhighly,althoughthereisanecdotalevidenceofcompaniesgoingprivatetoavoidthemarketsshort-termscrutiny.42VenturecapitalavailabilityisthehighestinEuropebehindtheNetherlands,43althoughsomeobserversareconcerned

abouttherelativelygreaterfocusonlaterstageinvestments.Whileequityfinancingiscompetitive,ittendstobemoreexpensivethandebtfinancing.Therearesignsthattheenvironmentfordebtfinancingisnotascompetitive:InvestmentsofUKcompaniesreactmorestronglytocash-flowchanges,indicatingconstrainedaccesstoexternalfinancing.44Thiswouldbeparticularlyharmfultothegrowthprospectsofsmalland

mediumsizedcompanies.

Science&TechnologyTheUKhasintherecentpastinvestedlesspublicsectormoneyintoR&Dthanmost

otheradvancedeconomies.Andoverthelastdecade,theUKspositiononpublicR&DspendingrelativetoGDPhasworsened(Figure12).45Recentpolicychangeshavestarted

toaddressthis,andthegovernmentbudgetsforthenextfewyearsregisterasignificantrampingupofpublicsectorR&Dspending.Itwilltakeawhile,however,untiltheaccumulatedeffectofyearsofunderinvestmentin,forexample,theuniversityinfrastructure,willhavebeenovercome.46


-----------------------Page27-----------------------


Figure12:PublicSectorSpendingonR&D

1.2%P,DG

f1.0%oSwedenFinlandeeNetherlandsrlabhalSi0.8%FranceAustraliaa


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svNorwayaagtGermanyJapannsUKCanadaie0.6%dtanlerUSItalypoS90.4%SpainD9&91Rc0.2%ilbuP0%-0.3%-0.2%-0.1%0%0.1%0.2%0.3%0.4%

0.5%0.6%ChangeinPublicSectorR&DSpendingasShareofGDP,1989-1999orlatestavailable

Note:Includesspendingbygovernmentandinstitutionsofhighereducation.Source:OECD(2002)


-----------------------Page28-----------------------


U.S.patentingbyUK-basedentities,areliableindicatorofworld-classinnovationoutput,ischaracterisedbyastrongrepresentationofinternationalcompanies(Figure13).ThisfindingisconsistentwiththeviewthattheUKisarelativelycostefficientlocationforforeigncompaniestoconductresearch.

Figure13:Top25UKpatentinginstitutionsintheUS

OrganisationU.S.PatentsIssuedfrom1997to20011ASTRAZENECALIMITED(PREVIOUSLYZENECA)3982BRITISHTELECOMMUNICATION,PLC335


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3IBMCORP.2804U.S.PHILIPSCORPORATION2575SMITHKLINEBEECHAMPLC2446EASTMANKODAKCOMPANY2067LUCASINDUSTRIESPUBLICLTD.COMPANY2048MINISTRYOFDEFENCE1839ROLLS-ROYCEPLC17410MERCKSHARP&DOHMELIMITED16711IMPERIALCHEMICALINDUSTRIESPLC16012NORTHERNTELECOMLIMITED15413PROCTER+GAMBLECOMPANY15414NORTELNETWORKSCORPORATION135

15THEBOCGROUPPLC13116SHARPKABUSHIKIKAISHA(SHARPCORPORATION)11717PFIZERINC.11518BRITISHTECHNOLOGYGROUPLIMITED10919BPCHEMICALSLIMITED10320HEWLETT-PACKARDCOMPANY10321NOKIAMOBILEPHONESLTD.

9222SONYCORPORATION9123NCRCORPORATION8924BRITISHNUCLEARFUELSPLC8825GLAXOGROUPLIMITED83

Note:Shadingindicatesgovernmentagencies,universities,andresearchinstitutionsSource:USPatentandTrademarkOffice(2002),authorsanalysis

UKpatentingintheU.S.isalsocharacterisedbyalowrepresentationofuniversitiesandotherpublicinstitutions;adangersigninmoderntechnologydevelopmentandcommercialisationprocesses.Incomparison,France,acountrywitharoughlyequallevelofoverallU.S.patenting,registersasignificantlylargerroleforuniversitiesandresearchinstitutionsinpatenting.ThisisconsistentwithUKuniversitiesbeinglessactivein


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commercialisationeffortsthantheirpeersinotheradvancedeconomies.


-----------------------Page29-----------------------


ii)ContextforFirmStrategyandRivalry47

MarketopennessTheUKtraditionallyisanopeneconomywithlowbarrierstoforeigntradeandinvestment,especiallytowardsneighbouringEuropeancountries.AsamemberoftheEuropeanUnion,itfallsunderthegeneralrulesofthecommonmarketandthecommontradepolicy.48AccordingtotheGCR,theUKhasanoveralllowleveloftariffsbutsome

remainingnon-tariffbarrierstotrade.

Domestically,thereformsofthelasttwodecadeshavelefttheUKwithverylow

administrativecostsfornewbusinessformationrelativetoothercountries.However,whiletherateofnewbusinessformationishigh,UKstart-upshaveasignificantlylowerlikelihoodtosurvivetheinitialyearsthantheirpeersinotherEuropeancountriesandthe

49UnitedStates.

GovernmentregulationsTheUKhasthelowestlevelofproductandlabourmarketregulationsintheOECD.The

levelofdistortivegovernmentsubsidiesintheUKislow,andthesubsidiespaidtendtobehorizontalratherthanindustryspecific.50WhiletheUKoutperformsmanyother

Europeancountriesonthelevelofdistortivegovernmentsubsidies,itranksonly12intheglobalcomparisonoftheGCR.Specificlocalregulations,suchaszoninglaws,arealsomentionedasbarrierstomoreinvestmentandproductivity.51Thereisalsosome

concerninthebusinesscommunityaboutanincreasinglevelofEuropeanUnion-dr

ivenregulationthattheUKwillbesubjectto.

IncentivesTheUKhasagenerallycompetitivesystemofbusinesstaxationwithincentivesforR&Dinvestmentsandinvestmentsineconomicallydistressedareas.Theoverallleveloftaxationisslightlylowerthaninmanyotheradvancedeconomies;thisrelativeadvantage


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oftheUKhas,however,decreasedinrecentyears.52AccordingtotheGCRsurveydata,

theUKhasverystrongintellectualpropertyrightsprotection,providingagoodenvironmentforinnovationandtechnologytransfer.

CompetitionRelativelylowlevelsofcompetitiveintensityinsomepartsoftheUKeconomyarerepeatedlymentionedintheliterature.Theexamplesoftentendtobeinthenon-tradedsectoroftheeconomy.Reasonsmentionedincludetheeffectsofpastprivatisationthatarearguedtohavebeendriventooheavilybyfiscalconsiderations.ThecompetitionpolicyintheUKwashistoricallyperceivedtobemorelenientthaninotherOECDcountries.53Recentpolicychangeshavemarkedlyimprovedthepolicycontextbutwilltakeconsiderabletimetobefullyreflectedincompaniescompetitivebehaviour.54

UKCOMPETITIVENESS:MOVINGTOTHEN

EXTSTAGE25-----------------------Page30-----------------------


Whilethereisnoconclusivedata,thereisevidencethatUKpricelevelsinmanysectorsarehigherthaninotherEuropeancountriesand,insomesectors,aboveUSlevelsaswell.55ThelowerUKrankingonGDPpercapitameasuredbypurchasingpowerparity

versusbycurrentexchangerateisconsistentwiththisview(Figure14).However,thedataisnotconclusive:thedivergencebetweenpurchasingpowerparityandexchangeratecouldbeexplainedbyotherfactorsunrelatedtothelevelofcompetitionintheUK.

Figure14:TheEffectofPurchasingPoweronNationalProsperity

RankCountryby2001Countryby2001GDPperCapitaGDPperCapita

(FX)(PPP)1USUS2NorwayIreland3SwitzerlandNorway4JapanSwitzerland5DenmarkIceland6IcelandDenmark7IrelandCanada8NetherlandsNetherlands9UKAustria


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10SwedenBelgium11FinlandAustralia12AustriaJapan13GermanyGermany14BelgiumItaly15CanadaFinland16FranceSweden17ItalyUK18AustraliaFrance19SpainSpain20NewZealandNewZealand

Source:OECD(2002)

iii)DemandConditions

Theimportanceofadvancedandsophisticateddomesticdemandgrowsasadvancedeconomiesprogress.Sophisticatedlocalcustomerseducatelocalcompaniesaboutfutureneedsandpressurethemtoproducesuperiorgoodsandservices.Homedemandisinfluencednotonlybyconsumersandcorporatecustomersbutalsobythestringencyoflocalregulatorystandardsinareassuchasenergy,safety,andenvironmentalimpacts.

GiventhepriorityfortheUKtoovercomecurrentweaknessesininnovation,demandconditionsareanincreasinglyimportantinfluenceonthecountryscompetitiveness.

DemandsophisticationTheUKrankshighonoverallbuyersophisticationintheGCR.Specificexamplesare


-----------------------Page31-----------------------


relatedtoindividualclusterssuchasoil&gas,financialservices,media,andothers,butthereislittleharddataavailable.

StandardsandregulationsTheregulatorycontextintheUKprovidesaverageincentivesforcompaniestoaddresssophisticatedconsumerneeds.Onenvironmentalregulations,forexample,theUKperformslesswellthanScandinavia,Germany,orFrance,butstilloutperformsthe

averageoftheadvancedeconomies.56

GovernmentprocurementTheUKrankslowonthesophisticationofgovernmentprocurementintheGCR.Thereislittleotherharddataavailableonthissubject.

c)Clusters

Clustersconstituteonefacetofthediamond,buttheyarebestseenasamanife


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stationoftheinteractionofallthediamondselements.57Clustersaregeographicallyproximate

groupsofinterconnectedcompanies,suppliers,serviceproviders,andassociatedinstitutionsinaparticularfield,linkedbycommonalitiesandcomplementarities.ClusterssuchasITinSiliconValleyorhighperformancecarsinSouthernGermanycanbeconcentratedinaparticularregionwithinalargernation,andsometimesinasingletown.Otherclustersarenationalandsometimesstretchacrossbordersintoadjacentcountries,suchasSouthernGermanyandGerman-speakingSwitzerland.Proximitymustbesufficienttoallowefficientinteractionandflowofgoods,services,ideas,andskillsacrossthecluster.

Clustersaffectcompetitivenessinthreebroadways:First,clustersincreasethelevelofproductivityatwhichconstituentfirmscanoperate.Firmscan,forexample,operatewith

lowerlevelsofstockduetothelocalpresenceofsuppliers.Andtheycanreducedowntimeincasesoftechnicalfailuresintheproductionprocessduetothequickaccesstolocalserviceprovidersthatcansolvesuchproblemsquickly.Second,clustersincreasethecapacityforinnovationandproductivitygrowth.IntheBostonLifeSciencesCluster(Figure15),forexample,thepresenceofworld-classresearchuniversities,teachinghospitals,competingbiotechcompanies,andclusterinstitutionsthatfacilitateinteractionamongallthesefosterthedisseminationofknowledgeandprovidea

fertilegroundfornewideas:Bostonhasbetween1996and2000generatedthehighestnumberoflifesciencepatentsofalleconomicareasintheUnitedStates.Third,clustersstimulateandenablenewbusinessformationthatfurthersupportsinnovationandexpandsthecluster.InBoston,theavailabilityofhighlyexperiencedresearchersandlaboratorytechnicians,theaccesstospecializedVentureCapitalprovidersandlawyers,andthemanyoptionsforemploymentinotherclustercompaniesincaseoffailureallreducethecostsandrisksofstartinganewlifesciencescompany.


-----------------------Page32-----------------------


Figure15:TheBostonLifeScienceCluster


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SurgicalInstrumentsHealthandHealthcareandSuppliesBeautyProductsProviders11,409847145,587

MedicalEquipment6,506SpecialisedServicesDentalInstrumentsBanking,Accounting,LegalandSupplies180BiologicalPharmaceuticalProductsProductsDiagnostic1,0725,249Specialised

Substances

RiskCapital1,885VCFirms,AngelNetworks

OpthalmicGoods2,390ResearchPatentOwnersOrganisationsandLessorsContainers21,8811,046

1,430

AmongtheNationalEducationalLeaders(1-5)ClusterInstitutionsInstitutionsforCollaborationCompetitive(6-20)HarvardUniversity,

MassMedic,MIT,TuftsUniversity,PositionEstablished(21-40)MassBioBostonUniversityLessDeveloped(41+)

Note:Employmentnumbersfor2000giveninsideboxeswhenavailable


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Source:ClusterMappingProject,InstituteforStrategyandCompetitiveness,HavardBusinessSchool

Itisrarethatthereisonlyasingleclusterintheworldinagivenfield.Inmostcasesthereareseveralclustersindifferentlocationswithdifferentlevelsofsophisticationandspecialisation.Clustersinonelocationofteninvolveforeigndirectinvestmentbyfirmsbasedinotherclusters.

Onlyasmallnumberofclusterstendtobetrueinnovationcenters.Othersmaytendtospecialiseinproducingproductsaimedatparticularmarketsegments,orbemanufacturingcenters.Stillotherclusterscanberegionalassemblyandservicecenters.Firmsbasedinthemostadvancedclustersoftenseedorenhanceclustersinotherlocationsastheydispersesomeactivitiestoreducerisk,accesscheaperinputs,orseektobetterserveparticularregionalmarkets.Thechallengeforaneconomyistomovefirstfromisolatedfirmstoanarrayofclusters,andthentoupgradethesophisticationof

clusterstomoreadvancedactivities.Nationaleconomiestendtospecialiseinparticularclusters,whichaccountforadisproportionateshareoftheiroutputandexports.Exportdataisaparticularusefulwaytoidentifybroadclustersacrossawidesetofcountries,becausestrongexportpositions


-----------------------Page33-----------------------


inspecificclustersindicateabaseofinternationallycompetitivecompaniesorsubsidiariesintheseareas.

Overall,theUKdoesnotrankhighonmeasuresofclusterdevelopment.Ithasstrongpositionsinservices,forexamplefinancialservicesandmedia,butthereislittlesystematicdataontheseclustersavailable.Outsideofservices,theUKhasclusterswith

strongexportpositionsindefence,productsforpersonaluse,healthcare,andtelecommunications(Figure16).Otherclusterswithsignificantpresenceincludeentertainment,semiconductorsandcomputers,transportation,andofficeproducts.58Onamoregranularlevel,theUKhasclusterswithsignificantpotentialinbiotechnology59andmotorsports,forexample.60

Figure16:UKsExportPerformancebyBroadSector


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UK saveragechangeinworldaveragegoodsexportshare:-0.5%12%

Defense(10.9%,-4.4%)10%PersonalServicesHealthCareTelecommunications00028%,eraEntertainmenthSemiconductors/St6%ComputersOffice

rTransportationoUK saveragepxgoodsexportEHouseholddshare:4.88%l4%PowerrPetroleum/

oWChemicalsMultipleBusinessMaterials/MetalsFood/Beverages

2%Textiles/Apparel=$15billionForestProductsexportvolumein20000%

-3%-2%-1%0%+1%+2%

ChangeinUK sWorldExportShare,1995-2000

Source:UNCTAD,WTO,authorsanalysis

TheUKgovernmenthasundertakenanefforttomaptheregionalstructureofclusters


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withinthecountry.61Thiseffortanalyseddetaileddataonthelocationofeconomic

activityacrosstheUK,butsufferedfromad-hocclusterdefinitions.Theanalysisfailedtomakethecrucialdistinctionbetweenlocalandtradedindustries.AccordingtoU.S.data,localindustriesdistributedequallyacrossgeographiesaccountforabouttwothirdsofemployment,buthavelowerproductivityandlowerratesofinnovation.Tradedindustriesarefarmoreconcentratedgeographicallyandservemarketsoutsidetheirlocation.Theyaccountforonlyonethirdofemploymentbuthavemuchhigherproductivity,innovation,andwages.62Whilethereareanumberofinitiativesforcluster


-----------------------Page34-----------------------


activationthroughouttheUK,ofteninitiatedbytheRegionalDevelopmentAgencies(RDAs),thedataprovidedbytheexistingclustermappingeffortseemstohavehadonlylimitedpracticalvalue.

d)Roles,Institutions,andProcesses

Competitivenessincreasinglyreliesonacountrysappropriatestructureofroles,institutionsandprocessestoenable,organise,anddriveeffortstoimprovebusinessenvironmentsandclusters.Inthepast,government,oftenatthenationallevel,

wasinchargeofimprovingcompetitivenessthroughpolicydecisionsandincentives.Firmscompetedinthemarketplaceandtooktheirenvironmentasgiven.Inmoderncompetition,however,improvingcompetitivenessbecomesacollaborativeprocessinvolvingmultiplelevelsofgovernment,companies,educationalinstitutions,andinstitutionsforcollaboration(IFC).Atthemicroeconomiclevelalargenumberoffactorsimpactoncompetitivenessandhenceonlyabroadcoalitioncanhopetoimproveanationsfoundationsofcompetitiveness.

Governmentcontinuestoplayanimportantrolebecauseitaffectsmanyaspectsofthebusinessenvironment.Governmentshapesfactorconditions,forexample,throughitstrainingandinfrastructurepoliciesandsimilarpolicyinfluencesarepresentinallelementsofthediamond.Therearedistinctrolesforgovernmentinimprovingthebusinessenvironmentatthenational,state,andlocallevelaswellasamongneighbouringcountries.Governmentatalllevelsalsohasacentralroleinconv


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eningandsupportingcompetitivenessefforts,eventhoughtheseeffortswilltendtobeledbytheprivatesectororotherinstitutions.Withoutgovernmentinvolvement,initiativeslacklegitimacyandtheyfailtoaddressthosecompetitivenessissuesgovernmentpolicycandirectlyaffect.

Companiesplayanincreasinglyimportantroleforthecompetitivenessoftheirlocations.Competitiveadvantageresidesnotonlywithinthefirm,butisalsoshapedbytheexternalcontextfirmsoperatein.Individualcompaniescanimprovetheirexternalcontextbyindividualactionssuchasestablishingschools,attractingsuppliers,ordefiningstandardsthatnotonlybenefitthemselvesbutalsoimprovetheoverallenvironmentforcompetition.Companiescanalsotakecollectivestepstoenhancetheabilityofindividualcompaniestoimproveoperatingpracticesandstrategies,suchasqualitycertificationprogramsandmanufacturingassistancecenters.

Universitiesandothereducationalandresearchinstitutionshavealsobecomeincreasinglyimportantfactorsfornationalandregionalcompetitiveness.Traditionally,theyhavebeenimportantinimprovingtheskillbaseoftheeconomy.Butashiftinthewayresearchanddevelopment(R&D)isorganisedisnowalsostrengtheningtheirroleincommercialR&D.Inthepast,universitiesdidbasicscience,whilecompaniesworkedseparatelyonapplicationsforcommercialuse.Today,theseboundarieshaveblurred,andsuccessfulR&Dofteninvolvescooperationthroughouttheinnovationprocess.


-----------------------Page35-----------------------


Awidevarietyofotherorganisationsalsohaveasignificanteffectoncompetitiveness.Theseentities,whichwerefertoasinstitutionsforcollaboration(IFCs)63,areneither

firms,governmententities,noruniversities.Theyinclude,forexample,chambersofcommerce,industryassociations,professionalassociations,tradeunions,technologytransferorganisations,qualitycenters,thinktanks,universityalumniassociations,andothers.IFCsperformimportantrolesasintermediariesthatorganiseandperformcollectiveactionandenablemoreeffectivecollaborationbetweenpartsofacluster.


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TheAustralianWinecluster,asuccessstorywithaworldexportmarketsharemorethandoublingwithinthelastfiveyears,64providesavividexampleofthekeyrolesuch

institutionscanplayinimprovingcompetitiveness(Figure17).

Figure17:InstitutionsforCollaborationintheAustralianWineCluster

WinemakersFederationCooperativeCentreofAustraliaforViticulture

Establishedin1990Establishedin1991

Focus:PublicpolicyrepresentationFocus:Coordinationofresearchofcompaniesinthewineclusterandeducationpolicyinviticulture

Funding:MembercompaniesFunding:otherclusterorganisations

AustralianWineGrapeandWineExportCouncilR&DCorporation

Establishedin1992Establishedin1991asstatutoryFocus:Wineexportpromotionbody

throughinternationalofficesinFocus:FundingofresearchandLondonandSanFranciscodevelopmentactivi

ties

Funding:Government;clusterFunding:Government;statutoryorganisationslevy

WineIndustryWineIndustryNationalInformationServiceEducationandTrainingCouncil

Establishedin1998Establishedin1995

Focus:Informationcollection,Focus:Coordination,integration,organisation,anddisseminationandstandardmaintenanceforFunding:Clusterorganisationsvocationaltrainingandeducation

Funding:Government;otherclusterorganisati


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ons

Source:UNCTAD,WTO,authorsanalysis

IntheUK,thereisanecdotalevidencethatthesecriticalinstitutionsarelessnumerousandlesseffectivethanincompetinglocations.65Thegovernmentefforttocreatea

networkofindustryforums,forexample,isbelievedtohavehadsomesuccessinthe


-----------------------Page36-----------------------


automotivecluster,butlittleimpactelsewhere.However,thereisnosystematicevidenceontheseefforts.

e)InfluencesofDifferentGeographicalLevels

Inthepast,analysisofcompetitivenesshasfocusedonthenationandnational-levelpolicies.Increasinglyitisbecomingclearthatthisperspectiveistoolimited:competitivenessisaffectedbyassetsandpoliciesatmanydifferentgeographiclevels.Theserangefromcross-national,e.g.theBalticRimortheEuropeanUnion,tonational,toregional,tolocal.Indeed,themostsignificantspilloversandinteractionstakeplaceattheregionalandlocallevel.Aclearindicationoftheimportanceofregionalbusiness

environmentsisthesharpperformancedifferenceacrossregionswithingivencountries,eventhoughtheyareallexposedtothesamenationallevelpolicies.

AcrossUKregions,asinmanyothercountries,therearestrongdifferencesinregionaleconomicprosperitythatareconsistentwithdifferencesinthequalityofregionalbusinessenvironments.66IncountriessuchastheUnitedStatesthereisconvergenceofprosperityacrossregions.IntheUK,thereisdivergenceofregionalprosperity.67Therich

aregettingricherandthepooraregettingpoorer.InFranceandGermanythereisnosignificantrelationshipbetweenregionalprosperityandprosperitygrowth,ornochangeindispersionofperformance.WhileGDPpercapitadifferencesinUKregionsappeartobemorepersistentthaninotherEuropeancountries,unemploymentratesintheUKaremoresimilaracrossregions.68ThisisconsistentwithflexiblelabourmarketsintheUK.


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Labourmobilityandwageflexibilityareeffective,andregionaldifferencesinincomereflectthequalityoftheregionalbusinessenvironments.

Strongregionsandregionalinstitutions-frommayorstoelectedregionalandstateleveladministrationswithsignificantdecisionrights-haveproventobeanincreasinglyimportantfactorforcompetitivenessinmanyothercountries.Theirimportancehasgoneup,becausetherehasbeenconvergenceonthepoliciescontrolledatthenationallevel,suchasmacroeconomicpolicy,taxation,andoverallgovernmentregulation.Theremainingdifferencesinregionalbusinessenvironmentsaffectedbythedecisionsofregionalinstitutionshavebecomemoreimportant.IntheUnitedStates,forexample,thereisclearevidencethatmuchoftherelevantprogressinimprovingthemicroeconomicfoundationsofcompetitivenessoccursontheregionallevel.69

IntheUKonlyabout25%ofpublicsectorexpenditureiscontrolledbyregionalandlocalgovernments,belowmostotherOECDcountriesincludingGermany(35%)andthe

UnitedStates(42%),butaboveFrance(18%).70TheUKscentralisedorganisational

structureforgovernmenthasrepercussionsforcompetitiveness:Publicspendingisinevitablylesswelladaptedtoregionalandlocalopportunitiesandneeds.Andprivatesectorleadersarelesswillingtoengageinlocalandregionalefforts,ifimportantdecisionsaffectingthequalityoftheirbusinessenvironmentaremadeinthecapital.

TheRegionalDevelopmentAgencies(RDAs),71establishedbyorderoftheRegional

DevelopmentAgenciesActof1998,hascreatednewinstitutionstoaddressregional


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competitivenessintheUK.TheRDAsareaninnovativeapproachtostrengthenregi

onalpolicyintheUK,butitwilltakemoretimetoevaluateiftheycanovercometheinherentchallengestheyfaceinthegivenstructureofUKgovernment.72

References46JMConsulting(2001)hometomorethan70030Porter(2002)47Forgeneralinformationonmotorsport-relatedcompanies.


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31Porter(1998)recentpolicychangesseeHM61DTI(2001)32ForagoodoverviewonpolicyTreasury(2001a)62Porter(2003),Porter/Councilon

initiativesandoutcomesseeDTI48TheresearchrevieweddidnotCompetitiveness/MonitorGroup(2002)andOECD(2002)distinguishmorebetween(2001).33Beath(2002)arguesinsteadthatopennesstoEUmembersinthe63Porter/Emmons(2003)commonmarketandopennesstherehasbeenremarkable64Porter/Slvell(2003)tocountriesoutsidetheEU.consistencyinmuchofthe65See,forexample,thediscussionmicroeconomicpolicies.49Bartelsmannetal.(2003)oftheBusinessLink-schemein

34Porter(2002a)50EuropeanCommission(2001)Oughton(1997)

35Thepharmaceuticalsectorand51McKinsey(1998)

66HMTreasury(2001b)itsabilitytodrawontheUK52Bond/Chennells(2000)67Seetheresultsofastatisticalsciencebaseisanotable53Nickell(2002)analysisinappendixBexamples.54OECD(2002a)68Soltwedel(1999)quotedinIMF36GlobalCompetitivenessReport55EuropeanCommission(2001)(2000).(2002),unpublisheddata.56Porter/Esty(2001)

69Porter/Councilon37OECD(2002a),IMF(2003).ItisCompetitiveness/MonitorGroupunclearifthehigherlevelof57Porter(1998),Porter(2000)(2001),Porter(2001d)privatizationintheUKis58InappendixAwehaveincluded70OECD(2002a)importantinexplainingthisamoredetailedrankingofdifference.subclustersbyexport71Formoreinformationonthe38OECD(2000)performance.RDAsseewww.dti.gov.uk/rda.

Otherregionaleffortshavebeen39OECD(2002a)59ThereisasignificantliteratureonundertakenwithEUsupportintheUKbiotechnologycluster.40Hogarth/Wilson(2001)theInnovatingRegionsinEuropeSeeDTI(1999)forthe41OECD(2001)governmentperspective.See(IRE)network.Thiseffortis


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promising,butlacksaconsistent42Nickell/VanReenen(2002)alsoEuropeanCommissionintellectualframework.43EuropeanCommission(2002)(2001)andOECD(2002b)72Cockerill(2002)44Ashworthetal.(2001)60MotorsportValleyinOxfordshireisclaimedtobe45OECD(2001)


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4CompetitivenessandUKCompanyBehaviour:TheRoleofManagement

Theproductivityofacountryisultimatelysetbytheproductivityofitscompanies,both

domesticfirmsandthesubsidiariesofforeigncompaniesoperatingthere.However,thesophisticationofcompaniesisinextricablyintertwinedwiththequalityofthenationalbusinessenvironment.Moresophisticatedcompanystrategiesrequiremorehighlyskilledpeople,betterinformation,improvedinfrastructure,morecapablesuppliers,moreadvancedresearchinstitutions,andstrongercompetitivepressure,amongotherthings.

Companiesinanationmustupgradetheiroperatingpracticesandstrategiesifsuccessful

economicdevelopmentistooccur.Thecompetitiveadvantagesofanationscompaniesmustshiftfromcomparativeadvantages(low-costlabourornaturalresources)tocompetitiveadvantagesarisingfromuniqueproductsandprocesses.Companiesmustmovefromtappingforeigndistributionchannelstobuildingtheirownchannels.

a)UKCompanyPerformance

TheUKishometoasignificantnumberoflarge,internationallysuccessfulcompanies.WithinEurope,theUKhasanequalorhighernumberofcompaniesintheFortune

100relativetoGDPthandoGermanyorFrance.Amongmultinationalcompanies(MNCs)withthelargestforeignassets(classifiedastransnationalcompaniesbyUNCTAD)theUKishometo14companies,behindonlytheUnitedStatesandJapanandaheadofGermany,France,Italy,andtheNetherlands.73Inadatasetof10,000largecompanies

fromCanada,Germany,Japan,theUnitedStates,andtheUnitedKingdom,UK


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companiesreportedthehighestreturnonequityinthe1997-2001period.74

ProductivitylevelsofUKmultinationalsareroughlyinlinewithGermanandFrenchmultinationals,butlagUSmultinationals.75ProductivityofdomesticUKcompaniesis

lowerthanthatoftheMNCsoperatinginthatcountry,asinothercountries.ThedifferenceinrelativeUKproductivityacrossindustriesisconsistentwiththeircompetitivenessasrevealedintheirexportpositions:strengthsinservices(retail,banking)andselectedmanufacturing(oil&gas,pharmaceuticals,foodprocessing)and


-----------------------Page39-----------------------

CompetitivenessandUKBusinessCompanyBehaviour:TheRoleofManagement

weaknessesinmanyothermanufacturingindustries.76Thehypothesisofalongta

ilofunderperformingfirms,i.e.thepresenceofahighershareofcompanieswithverylowperformanceintheUKrelativetoothercountries,findsnosupportincurrentresearch.77

b)UKCompanyOperationsandStrategy:CompetitiveAssessment

UKcompaniesexcelingeneratinghighreturnsfromexistingassetsthroughefficient,wellestablishedbusinessprocesses,especiallyincustomerrelationshipandsupply

chainmanagement(Figure18).Theyarelesswellpositionedtoinnovate,createnewassets,andcompeteonuniquemarketpositions.

Figure18:UKCompanyOperationsandStrategy-Overview

CompetitiveAdvantagesCompetitiveDisadvantages

SophisticatedmarketingandLowcapitalstockbrandingLowinvestmentsininnovation

StrengthsinsupplychainCompetelessonuniquevaluemanagement,distribution,and(versuscost)thanadvancednationretailingpeers

HighlevelofprofessionalversusSomeindicationsoflowuptakeoffamilymanagementanduseofmodernmanagementtechniques


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incentivecompensationSomeindicationsthatHighlevelofinternationalisationmanufacturingislaggingthe

overalleconomy

Source:GlobalCompetitivenessReport(2002),McKinsey(2002),EEF(2002),COI(2000),WIR(2002)

CapitalStockUKcompaniesareoperatingwithlowerlevelsofcapitalintensitythantheircompetitiorsinEuropeandtheUnitedStates(Figure19).Businessinvestmenthasincreasedtothelevelofotheradvancedeconomiesoverthepastdecade,butthathasnotbeenenoughtoclosethegapintermsofcapitalintensity.78RecentanalysisbytheOECDsuggests

thatthelowerinvestmentintheUKoverthelastdecadehasbeenmainlyrelatedtoinvestmentsinbuildingsandstructures.Thereisnolagininvestmentsinmachi

nery79.TheOECDreportspeculatesthatthisresultsisduetoalargerexistingbuildingstockintheUKrelativetoothercountries,buttheevidenceonlowercapitalinvestmentbyUKmultinationalsindependentoflocationcastsdoubtonthishypothesis.


-----------------------Page40-----------------------


Figure19:LevelandChangeofCapitalStock,SelectedCountries

180%

Germany,deItalyk160%rNetherlands

o%FranceBelgiumw0Norway0r1uo=140%hKDenmarkrUe


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p,Japan0FinlandIrelandk0UnitedStatesc0120%o2-IcelandtSwedenS69l9Spainat1CanadaUKip100%aAustraliaCNewZealand80%-1.5%-1.0%-0.5%0.0%0.5%1.0%1.5%2.0%2.5%3.0%3.5%GrowthRateofCapitalStockperhourworked,1996-2000

Source:IMF(2003)InnovationUKcompaniesinvestsignificantlylessinR&Dthantheircompetitors(Figure20).80For

mostsectorsintheUKthisgapisunderstatedduetothestrongpositionoftheR&Dintensivepharmaceuticalsector.IntheUKthissectoraloneaccountsfor23%ofallmanufacturingR&Dbycompanies,aheadofallotherOECDcountriesincludingFrance(9%),theUnitedStates(7%),andGermany(5%).81TheR&Dgapisincreasing;th

eUK

wasoneofthefewadvancedeconomiesinwhichbusinessspendingonR&DhasfallenrelativetoGDPinthe1990s.Interestingly,theshareofforeign-ownedcompaniesresearchintotalprivatesectorR&Dexpenditureshasincreasedfrom16.4%in1989to31.2%in1999.Atthesametime,thereareindicationsthatUKcompanieshaveperformedanincreasingamountoftheirR&Dabroad.82

CompanypositioningThereissomeevidencethatUKcompaniesarecompetinglessonuniquevaluethan

theiradvancedeconomypeers.TheUKhas,forexample,alowerexportshareinindustriesthatarehighlyquality-sensitive;italsohasbeenincreasingitsexportshareinsuchindustrieslessthanmanyotherEuropeancountries.83

However,thisevidenceisnotveryconclusive,anddifferencesacrossindustriesarelikelytobesignificant.OneofthepossibleexplanationsfortherecentappreciationoftheUK


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realexchangerate,forexample,istheimprovementintheunitvalueofUKexportsrelativetoothercountries.84Thiswouldindicatethat,atleastforthecompaniesthatare

successfulinexporting,competingonvalueisincreasinglybecomingthenorm.


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ManagementUKcompaniesrelyonprofessionalmanagersversusmanagementbyfamilymembersofcompanyowners.ModerncompensationtechniquessuchasincentivecompensationforcompanyexecutivesareusedmorewidelythaninmostothercountrieswiththeexceptionoftheUnitedStates.However,thereissomeevidence,especiallyfromthemanufacturingsector,thatUKcompaniesadoptmodernmanagementtechniquessuchastotalqualitymanagement(TQM)laterandlessoftenthantheircompetitors.85

Theyalsoseemtoachievelowerreturnsfromimplementingthem.However,thereisconflictingevidencefromotherstudiesthatfindUKcompaniestobeaverageintheuseofmanagementtechniques.86

TheUKhasalowershareofmanagerswithadvancedformaleducationversuspeercountries.However,thiscouldbeastatisticalartefactduetotheveryhighnumberofemployeesclassifiedasmanagersintheUK.ThesupplyofthemostskilledmanagersintheUKislikelytobecompetitive.UKmanagementschoolsgethighratingsanda

ttractmanystrongforeignstudents.TheUKalsoisatleastasattractivealocationforexpatriatemanagersasanyotherEuropeancountry.ProblemswithmanagerialskillsintheUKseemlikelytobeconcentratedatthelowerandmiddlemanagementlevel,reflectingtheoverallskilldeficitintheUKlabourforce.87However,thereisnoconclusivecomparativedataavailabletomeasuresuchdifferences.88

ManufacturingTherearesomeindicationsthattheUKmanufacturingsectorisperformingbelowthe

restoftheeconomy.89LabourproductivityinUKmanufacturingrelativetotheUnited

Figure20:CompanySpendingonR&D

P,3DGf


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oSwedene2.5raelhbJapanFinlandSalsi2aavgaUnitedStatesntisGermanyde1.5ntealpSrNetherlandsFranceoD91UK&9R9Canada

y1NorwayAustralian0.5ItalyaSpainpNewZealandmoC0-4%-2%0%2%4%6%8%10%12%14%AnnualGrowthinCompanyR&DSpendingasShareofGDP,

1989-1999orlatestavailable

Source:OECD(2002)


-----------------------Page42-----------------------


Statesunderperformstheoveralleconomy.90However,thesameistrueforFranceand,

tosomeextent,forGermany.91LabourproductivitygrowthinUKmanufacturingwas

lowerthanintheoveralleconomyandbelowmanufacturinglabourproductivitygrowthintheUnitedStates,France,andGermanyafter1995.ThiswasincontrasttotheprioryearswhenUKmanufacturinggrowthwassignificantlystrongerthaninpeercountries.92


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Intotalfactorproductivity,theUKmanufacturingsectorlagsothercountriesandalsotheUKeconomyaverageproductivityinlevelandrecentgrowthrate.93

ThelowerUKproductivityinmanufacturingrelativetotheUnitedStatesis,accordingtosomeobservers,relatedtothepresenceofeconomiesofscaleandsmallerhomemarketsize.94Dataontheaveragesizeofmanufacturingcompaniesdoesindicatethat

UKcompaniesindeedaresmallerthantheirUSpeers.However,thedataalsoshowsthatUKcompaniesarelargerthancompaniesfromotherEuropeancountriesthatstillachievehighermanufacturingproductivity.95ThelowproductivityperformanceofUK

manufacturinginrecentyearsisconsistentwithlowerspendingoncapitalinvestmentandR&Drelativetocompetitorsfromotherlocations.96

c)UnderstandingUKCompanyBehaviour

Managementchoicesareafunctionofthefollowingmainfactors:management

capabilities,companycapabilities,andthecompanysbusinessenvironment.Thesefactorsinturnaremutuallydependentovertime.Thereisnosimplerelationshipbetweenanyonefactorandmanagementchoicestodrivecompanycompetitivenessandultimatelycountryperformance.

FortheUK,therearethreeareasthatareperceivedtoresultincompetitivedisadvantagesforUKcompanies:insufficientinvestmentincapitalassetsandinnovation,positioningonlowinputcostratherthanhighvalue,andlaggingadoptionofmodernmanagementtechniques(Figure21).Together,theseareascouldexplainthepersistent

productivitygapandthelowlevelofinnovationoftheUKeconomyrelativetotheUnitedStatesandtheleadingContinentalEuropeaneconomies.


-----------------------Page43-----------------------


Figure21:CompetitiveCompanyWeaknessesintheUK-PotentialExplanations

CompetitiveDisadvantagesPossibleDrivers

LowrateofinvestmentincapitalManagementweaknessassetsandinnovationHistoryofmacroeconomicandpolicyvolatilityFinancialmarket


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failureLowpublicinvestmentLimitedlinkagesbetweenprivateandpublicresearch

CompetinglessonuniquevalueManagementweaknessthanadvancedpeersNationalcompetitivenessbasedonrelativelylowcostsandaccesstoEuropeanmarketLowpublicinvestment

IndicationsofloweruseofmodernManagementweaknessmanagementtechniquesLowlevelofcompanyinvestmentsincomplementar

yassetsandtechnologyFeweffectiveinstitutionstodisseminatepracticalknowledge

ExplanationsforlowinvestmentsincapitalandinnovationThereisclearevidencethatUKcompaniesonaverageoperatewithasmallercapitalstockandinvestlessinR&DthantheirpeersinEuropeandtheUnitedStates.Theliteratureproposesanumberofpossibleexplanations.Thefirstpossibleexplan

ationismanagementfailuretoreacttoeconomicopportunities.However,intermsofcapitalassetsthelowerinvestmentrateintheUKisconsistentwiththeUKslowcapitalproductivity(therealanomalyisFrancewhichhasahighcapitalstockdespitethesamecapitalproductivityastheUK).97TherearealsoindicationsthatUKcompaniesearnedalowerreturnfrominvestmentsininformationtechnologythantheirUSpeers.98What

explainsthelowercapitalproductivitydespitethelowcapitalstockintheUK

isnotaddressedintheliterature.Managementfailureisagainapossibleexplanation,butitisfarfrombeingtheonlyone.

ThesecondpossibleexplanationistheUKshistoryofrelativelyhighmacroeconomicvolatility.99Thereisclearevidenceshowingthathighermacroeconomicvolatility


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depressesinvestmentrates.However,pastmacroeconomicvolatilityintheUKwashigherthaninContinentalEurope,butlowerthanintheUnitedStates.Moreimportantly,theUKhasenjoyedanumberofyearsofincreasedstability,andithasputinstitutionalstructuresinplace,suchastheindependenceoftheBankofEngland,thatcreatemorestablemacroeconomicexpectations.Ifmacroeconomicvolatilityisindeedthedriveroflowerinvestmentrates,thiswouldindicateasignificanttimelaginmanagementadjustingtothenewcontextintheUKeconomy.


-----------------------Page44-----------------------


ThethirdpossibleexplanationistheUKsequitybasedfinancialmarketstructurethat,itisargued,favoursshort-termmanagementoutlook.100Thereisclearevidencetha

tthevalueoffinancialassetscanbemis-pricedforextendedperiodsoftime.101Thereis,

however,nosystematicevidencethattiesthistomanagementbehaviour.Theanecdotalevidenceonfirmsgoingprivatetoenablemorelong-termstrategiesindicatesthatthismightbethecase,butitalsoindicatesthatcompanieshaveachoiceandthatthereisnodeterminism.Theevidencefrommoregeneralstudiesontherelationshipbetweenfinancialsystemsandeconomicperformanceindicatesamorecomplexrelationshipwith

relativeadvantagesanddisadvantagesfortheAnglo-SaxonversusContinentalEuropeansystembutnoobvioussuperiorityofanyonemodel.

ThefourthpossibleexplanationforthelowlevelofinvestmentincapitalstockandinnovationistheUKslowlevelofcomplementarypubliccapitalassetsandlabourforceskills.102ThereisclearevidencethattheUKhasweaknessesinthegeneral

infrastructure,suchasthetransportationnetworks,inpublicsectorR&Dspending,andintheoverallskillbaseofitslabourforce.Generaleconomicresearchindicat

esthatthesefactorswilldrivedowntheprofitabilityofinvestmentsincapitalassetsandR&D.ThereisnospecificdataonthequantitativeeffectofthesefactorsintheUK.103

Thefifthexplanation,relatedtothelowerlevelofR&Dinvestments,istheinstitutionalstructureandlaggingfinancingoftheuniversityandpublicresearchsector.Privatesector


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researchisincreasinglyrelatedtopublicsectorresearch.104LowuniversityR&Dspending

andlowlevelsofuniversityinteractionswithcompaniesarefactorsthatdirectlyeffectcompaniesincentivestoinvestinR&D.TherelativelylowleveloffinancingforUKuniversitiesaswellasuniversitieslowlevelsofpatentingareindicationsthatsuchdeficitsexists,atleastoutsideofthelifesciences.105

ExplanationsforcompanypositioningonefficiencyandlowcostsThereissomeevidencethat,onaverage,UKcompaniescompetelessonuniquevalueandinnovationthantheirpeersfromotheradvancedcountries.106However,current

researchprovidesnosystematicexplanationofwhythatmightbethecase.Onecandidateismanagementfailure,especiallyintheareaofstrategyandinnovation.107UK

managersmighteitherfailtounderstandtheopportunitiesofcompetinginpremiumsegments,ormightindeedbebetteratlowcostprocesses,products,andservice

s.ThealternativecandidatetoexplainUKcompanypositioning,however,isagainthebusinessenvironment.Theweaknessesintheinfrastructure,scienceandtechnologysystem,andlabourforceskillsmakeitharderforcompaniestocompeteoninnovationanduniquevalue.Incontrast,historicallytherelativelylowcostsoflabourandothercostsofdoingbusinesscomparedtopeercountriesmadeitattractivetocompeteonefficiencyandlowercost.

ExplanationsforslowadoptionofmodernmanagementpracticesThereisevidencefromthemanufacturingsectorthatUKcompaniesarelessactiveinadoptingmodernmanagementpractices.GiventhesuccessofUKretailersattributedtoleadingsupply-chainmanagementsystems,itisunclearastohowbroadlythis


-----------------------Page45-----------------------

CompetitivenessandUKBusinessCompanyBehaviour:

TheRoleofManagement

observationholds.AcceptingthenotionthatUKcompaniesfallbehindtheirpeersinmodernmanagementpractices,managementfailureinthesenseofresistancetochangeorinadequatetraininginsuchpracticesarepossiblecandidatesforexplanation.

However,anothercandidatetoexplainloweradoptionofmodernmanagementtechniquesisthelowerlevelofprivateandpublicinvestmentincapitalassets


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andR&D.Manyofthenewtechniquesneed,itisargued,modernmachineryandskilledemployeestoreachtheirfullpotential.Ifthosearemissing,itmightexplainwhymanagersdecidenottomigratetothesenewtechniques.Theultimatecause,then,wouldbethefactorsthatdrivelowinvestment.Tacklingthoseproblemswouldthenleadmanagerstoadoptthenewmanagementtechniques.

ThethirdcandidatefortheslowadoptionofmodernmanagementpracticesistheinsufficientpresenceofinstitutionsforcollaborationintheUKeconomy.Theseinstitutions,suchasclusterorganisationoruniversity-linkednetworkinginstitutions,oftenplayaparticularlyimportantroleinthediffusionofnewmanagementbestpractice.Someofthesetechniquesarehardtocommunicateinanabstractform,andarebestlearnedindirectinteractionwithotherprofessionalsinthesameclusterorindustry.

Whilealloftheseindividualexplanationshavesomecredibility,thereisnosystematic

evidenceevaluatingtheirrelativeimportanceinexplainingthefacetsofcompanybehaviourthatunderlietheUKproductivityandinnovationgaprelativetoitspeers.

Referencesimpressions,becausethestrong(2001),OMahoney/deBoer73UNCTAD(2002).UKcompaniesspendingonthelifesciences(2002)comeprimarilyfromtheoil&masksdeficitsinotherareas.93OMahoney/deBoer(2002)

gasandthefood&beverages81PICTF(2001)

94EEF(2001)sector,whileforexample82Pain(2000)95Bartelsmannetat.(2003)Germancompaniestendtobefrommanufacturingsectors.83Aiginger(2001)96DTI(2001c)

74Conversely,Oughton(1997)84IMF(2003)97McKinsey(1998)

notesthathistoricallythe85EEF(2001),McKinsey(2002)98Nickell(2002a)profitabilityofUKcompanies86Nickell/VanReenen(2002),

99Ashworthetal.(2001),OughtonwaslowerthanbycompaniesinOECD(1999)(1997)otheradvancedeconomies.Itis87SeealsoDepartmentfor100Nickell/VanReenen(2002),unclearifthisdataisconflictingEducationandSkills(2001)Oughton(1997)withtheevidencementionedinthemaintext,orifachangein88TheCouncilforExcellencein101Myners-Report(2001)


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LeadershipandManagementtheprofitabilitypatternshas102Nickell(2002)occurred.(2002)providesinterestingdataontheUKsituation.103SeeFord/Poret(1991)forsome75Griffith/Simpson(2000)andComparativedataonotherearlierempiricalworkonthisongoingresearchworkatcountries,however,isgeneralissue.CERIBA(CenterforResearchunfortunatelynotavailable.104OECD(2002b)intoBusinessActivity)89McKinsey(2002),EEF(2001)105Inthelifesciences,theUKhas76DTI(2002)90Pilat(1996),OMahoney/Deasignificantposition,andinthe77Haskel(2002),unpublishedBoer(2002)university-basedclustersaround78Ashworthetal.(2001)OxfordandCambridge91Germanyhashigherlabour79OECD(2003)productivityifmeasuredbyGDP

significantuniversity-companyinteractiondoestakeplace.80Oughton(1997)arguesthatperhourworked.106Aiginger(2000)eventheseaggregatenumbers92BureauofLabourStatisticscreateatoopositive(2002),EuropeanCommission107TUC(2002)


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5ImplicationsforPolicyandFutureResearch

Thesefindings,takentogether,allowustoseetheoverallcompetitivenessoftheUKanditsstageofeconomicdevelopment.Successfuleconomicdevelopmentisaprocessofsuccessiveupgrading,inwhichanationsbusinessenvironmentevolvestosupportandencourageincreasinglysophisticatedandproductivewaysofcompetingbyfir

msbasedthere.Thisprocesstakesalongtime,stretchingfarbeyondtheadministrationofanyindividualgo

Documents

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