''Survival Of The Fittest'' – The Main Driver Of Productivity Growth In UK Manufacturing

07 Jul 2003

Productivity growth in UK manufacturing is driven less by efficiency improvements within individual plants than by ''survival of the fittest'' – the Darwinian process of entry and exit, in which less productive plants contract and close while new more productive ones open and grow.

That is the central conclusion of new research by Richard Disney, Jonathan Haskel and Ylva Heden, published in July 2003 issue of the Economic Journal. They also find that productivity growth is highest in industries that face greater competition in product markets. Increasing productivity growth, especially in the competitive (traded) sector of the economy, is a central concern of economic policy. There is a general concern, for example, that UK manufacturing is ''less productive'' than manufacturing in other leading industrialised economies, and that this accounts for the disappointing jobs performance of the UK manufacturing sector.

But understanding productivity growth and, in particular, what forces drive productivity growth is not straightforward: is it a lack of capital investment (reflected in low labour productivity) or is it the poor utilisation of inputs such as capital (reflected in low total factor productivity)? This research examines both labour productivity and total factor productivity for UK manufacturing. It argues that productivity growth comes from two sources:
 Innovation and better use of existing inputs within manufacturing plants – this is called
internal restructuring.
 The process by which successful manufacturing plants grow, while less efficient plants
contract and exit – this is called external restructuring.

The study examines which of these sources – internal or external restructuring – is the most
important source of productivity growth. This is novel research in the UK context because it uses panel data on manufacturing plants that make it possible to track not only productivity growth but also the process of exit and entry. Most existing research just looks at survivors, and therefore only permits researchers to examine internal restructuring.

The results suggest that roughly half of labour productivity growth is accounted for by internal restructuring and a similar amount by external restructuring. But looking at total factor productivity (which allows for differences in capital investment across plants and over time), over 80-90% of productivity growth comes from external restructuring, and over half of that from exit and entry alone. It is the Darwinian process of ''survival of the fittest'' that is the main driver of productivity growth in manufacturing rather than internal improvements in techniques and organisation within the plant.

Some of this external restructuring is done by companies that own several plants. The evidence suggests that companies do reorganise production to increase productivity. But they tend to do it by closing less productive plants and opening new plants rather than by increasing efficiency within plants. Among small single-plant companies, there is almost no internal restructuring – almost all productivity growth comes through entry and closure.

What are the policy implications of all this?
First, there are huge flows of exits and entrants among manufacturing plants – 18-19% of the ''stock'' exit each year and are replaced by a roughly similar proportion (although typically these are smaller plants). These flows are a key driver of productivity growth. But with roughly 25,000 new plants each year entering UK manufacturing, selective policy, such as ''picking winners'' among new plants, is difficult.

Such policies, along with financial support for plants that are faced with closure, may be less effective than general measures to encourage start-up of new, innovative plants and taking a more relaxed view of failures (for example, in how bankruptcies are handled)

Second, competitive markets are a key element of productivity growth. Competition underpins the process of exit and entry, and the growth in size of the most successful plants. But it also underpins internal restructuring. This study confirms the findings of earlier published work by

Professor Stephen Nickell: that productivity growth is highest in industries that face greater competition in product markets. As Nickell puts it, when discussing his own results: ''Perhaps competition works not by forcing efficiency on individual firms but by letting many flowers bloom and ensuring only the best survive.'' The results of this study show that more competition in product markets does both these things: it forces plants to be internally efficient and it ensures that only the best survive.

''Restructuring and Productivity Growth in UK Manufacturing'' by Richard Disney, Jonathan Haskel and Ylva Heden is published in the July 2003 issue of the Economic Journal. Disney is at the University of Nottingham and the Institute for Fiscal Studies; Haskel is at Queen Mary, University of London; and Heden is at the Bank of Sweden.

Richard Disney

University of Nottingham | 0115 951 5619 | richard.disney@nottingham.ac.uk