1 Jonathan Haskel HMT meeting, March 12 th, 2010 Reports on work funded by NESTA and FP7 Productivity and growth session Options for improving medium to long-run growth © Imperial College Business School 1

2 Some big questions Will growth return after the crisis? Can the UK economy prosper with a smaller financial sector? © Imperial College Business School

3 Understanding growth  (y-l) =  1  (k TAN -l)+  2  (k INTAN -l)+  (l QUALITY -l) + TFPG Hence focus on: Tangible capital deepening: cost of capital, tax, stability Intangible capital deepening = R&D, and non-R&D Labour force quality: education, training etc. TFPG: spillovers from R&D, non-R&D, universities, foreigners

4 Will long run growth resume at previous levels? Possible scenarios Cost of capital higher Tighter bank regulation, more risk averse banks, increased taxes and base rates Size of financial services sector lower Less demand Lower employment Public investment falls Easy to cut Infrastructure gets worse Tangible infrastructure: transport, buildings, telecoms network Intangible/knowledge infrastructure: schools, universities Policy mistakes Unemployment literature: post adverse shocks in 70s and 80s: rise in employment taxes, replacement ratios, subsidies stopping market sorting Implies Capital deepening slows down during adjustment to lower K/L ratio Labour quality deepening slows down Spillovers from tangible and intangible infrastructure less: TFPG slows down Economy-wide TFPG slows as financial services smaller (via averaging effect) Lower productivity growth as sorting effects fall

5 Contribution of capital deepening, labour quality and TFP to growth: NESTA innovation index 1.Major contributors to labour productivity growth, TFPG (39%) 2.Intangibles (22%) 3.Tangibles: computers (18%) 4.Tangibles: other (14%) 5.Labour quality (6%) 2.Question: what happened to these contributions in previous recessions?

6 What happened to tangibles/intangibles in earlier recessions? Output per hour fell: Output per hour slowed: Familiar: tangible investment fell Additional question raised by intangible research: What was the impact on intangible investment? We have decent time series for Tangible investment (computers, other) Intangible investment Software (own account, purchased) R&D Advertising

7 Investment, £bn CP 90s recession – big drop in tang, but intang inv remains flat, Likewise in 2000s slowdown So does intangibles “cushion” effects for growth? No, its K deep and contrib that matters for growth

8 Growth in Capital deepening: Δln(K/L), S/w and comp are different, and part distorted by Y2K and s/ware bundling K deep for othtan and intang are similar, in early 90s, after changes in inv feed through to K stock Why is this different to Investment: depreciation is different

9 Contributions of comp, othtan and intang i.e. share* Δln(K/L) Cont of tang (esp othtan) are much more volatile, and turned – ve shortly after 90s recession. Intang fell, but remained +ve

10 Policy: some speculative and provocative remarks Redoubles emphasis on capital deepening, but both tangible and intangible Key margins: tax, regime certainty Much intangible investment we think is new business models. Basic presumption should be: regulation lowers productivity since stops experimentation. Industrial support Job flows and reallocation are huge. Spotting winning firms/industries requires massive information. Support for weak companies lowers productivity growth (cuts off reallocation). Regional assistance? Support for good companies is deadweight; example patent box. V expensive, £1.5bn, no effect on innovation. Labour quality Over long run, early education, huge externalities. Ring fence this. Liberate universities from central planning Many government low level training schemes have zero rate of return. Scarring? Public sector infrastructure Cuts to university research to fund patent box will massively lower growth

11 More on the impact of public sector R&D on TFPG

12 Very large increase in research council spend © Imperial College Business School Source: BIS data. Official data on publicaly supported R&D is broken down into funding for research councils, HEFC research-designated spend, civil R&D and defence R&D

13 MARKET SECTOR TFP GROWTH AND RESEARCH COUNCIL SPENDING

14 MARKET SECTOR TFP GROWTH AND NON-RESEARCH COUNCIL SPENDING