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% change on a year earlier 10 8 6 4 2 0 -2 -4 -6 Manufacturing Services -8 ’99 ’00 ’01 ’02 ’03 ’04 ’05 ’06 ’07 ’08 ’09 Source: ONS Measures of competitiveness Figure 4 shows the sterling effective exchange rate, which is a weighted index measuring the value of sterling against a basket of the currencies of the UK’s major competitors. It indicates a slow worsening of price competitiveness from 1997-2007, although inflation remained relatively low and stable. The marked fall in the value of the pound from 2007-09 has recently helped to improve price competitiveness and may allow UK companies to export more to help bring the economy out of recession. We can compare unit labour costs between the UK and other countries by using a measure known as relative unit labour costs. This is calculated using the following formula: RULCs = Index 110 105 100 95 90 85 80 75 70 Figure 3: Growth in output per hour worked in UK Relative wage costs Relative productivity x Sterling effective exchange rate The data is given in index number form. Figure 5 shows that RULCs rose between 1997 and 2007. During this period relative wage rates rose faster than relative productivity growth, revers - ing the downward trend of the 1980s and 1990s. The strength of the pound also kept RULCs high. In 2007-8, the fall in the value of the pound, declining growth in wages and faster productivity growth combined to reduce RULCs. Thus Figures 4 and 5 point up the crucial importance of how a strong pound has had a serious adverse effect on the UK’s international competitive - ness. Non-price competitiveness Prices and costs are not the only determinant of competitiveness. Nonprice aspects are also important. Nonprice competitiveness can be measured in a number of ways. One way is to Figure 4: The sterling effect exchange rate index (Jan 2005 = 100) ’97 ’98 ’99 ’00 ’01 ’02 ’03 ’04 ’05 ’06 ’07 ’08 ’09 Source: Bank of England calculate the income elasticity of demand (YED) for UK exports and imports. The YED for imports is reckoned to be between 1.6 and 2, not significantly different to that of our major competitors, while the YED for exports is lower at between 1.0 and 1.5, which is lower than that of our competitors. This means that when world incomes rise UK imports will grow quicker than exports; this is especially true of the manu - facturing sector. The reasons for this are: During an upswing firms tend to focus on the domestic market. UK businesses have insufficient productive capacity to satisfy both domestic and foreign markets. Investment has not grown enough in industries that produce tradable products: rather, investment has occurred in banking, insurance and distribution, which are less tradable. Other measures of non-price competi - tion include product charac teristics, such as quality, design and new product development, and sales characteristics such as after-sales service and market - ing. Calculating the value per ton of exports provides an empirical measure of non-price competi tiveness as inter - national competition should make the average price per ton of exports identical if goods are identical in terms of product and sales charac teristics. UK values per ton tend to be lower than that of the US and Europe, and the UK lags behind the EU average, and well behind the US and Japan in terms of the proportion of manufactured exports in the ‘up market’ unit value category. However, the widespread embodiment in the UK since the 1980s of the Japanese approach to manage ment, including initiatives such as TQM (Total Quality Management), has helped the UK improve in these areas in recent years. Why is the productivity gap persisting? Not only has the productivity gap been around for many years but also the causes of relatively poor productivity and competitiveness are the same as they have been for a number of years: A low percentage of GDP devoted to fixed capital investment spending A rise in investment increases the capital stock available for each employed worker, which should boost labour productivity. 32 M ARCH 2010
Figure 6 provides clear evidence of the fact that the UK has devoted a lower share of GDP to fixed capital investment spending than that of its major com - petitors. UK workers have a lower capital stock per head than that of the US, France and Japan. This has been an ongoing problem in the UK economy and relates to the short-termism that dominates the thinking of many UK businesses. The IMF has recently defended the UK by arguing that the quality of investment spending is more important than the quantity. The IMF claims that UK investment in equipment is comparable to that of most OECD countries. However, the UK does fall short in the area of non-residential construc tion investment, however. Since 1995, the UK has increased its rate of ICT capital spending growth significantly, and has started to close the gap on the US, Germany and France. Lack of investment in human capital The OECD suggested in 2004 that the UK compared poorly relative to its competitors on both basic literacy and vocational qualifications. Nearly a quarter of the adult population lacks basic literacy skills, more than double that of Germany, while a third of 25-34- year-olds have few or no formal qualifications beyond compulsory education. While the UK compares favourably on workers with high-level qualifications, it also has a higher percentage of workers holding the lowest level of attainment. Too many people leave education early and relatively few get an apprenticeship, skilled craft or technician qualification, according to the OECD. This is another long-standing structural weakness of the UK economy that has kept productivity levels lower than its competitors for many years. This is surely the justification behind Tony Blair’s 1997 election campaign that placed ‘Education, education, education’ at the forefront of the political agenda. The burden of regulation The number of regulations and ‘red tape’ that the Labour government has introduced since 1997 on businesses, which increases compliance costs and reduces business efficiency. Measures include the national minimum wage and other employment laws, health and safety legislation and environmental legislation. Moreover, while the govern ment has In the UK relatively few get an apprenticeship or skilled craft. Index (2005 = 100) 110 105 100 95 90 85 80 75 70 Source: OECD G7 Average USA UK Japan Italy Germany France Canada Figure 5: UK relative unit labour costs ’97 ’98 ’99 ’00 ’01 ’02 ’03 ’04 ’05 ’06 ’07 ’08 Figure 6: Investment as a share of GDP, 1994-2006, current prices 0 5 10 15 20 25 30 % Source: Department for Business, Innovation and Skills M ARCH 2010 33
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