Britain's brilliant career in the services sector proves a myth

Employment growth can't explain away the productivity gap. Since 1979 we have had one of the slowest job creation rates in Europe

Britain is better placed than most to take advantage of a euro, according to the Chancellor in his speech to the House of Commons this week. Because British firms are so competitive, argued Ken Clarke, they will be able to leap in fast and enjoy the benefits of a truly single market brimming with euros.

It seems Mr Clarke believes British firms are ahead of the game, at least compared with their European counterparts. Thanks to downsizing, to an early and energetic shift out of manufacturing and into services, and to the flexible labour market, British companies are supposedly well equipped to meet the challenges of expanding markets. Lean, mean, sharp and sophisticated, so the story goes, British companies have been toughened and enlivened by the Thatcher revolution.

Squaring up to them, according to the story, are clumsy, flabby European monstrosities, complacent after decades cosseted in a cosy, corporatist pre-Thatcherite world. Where British companies can supposedly deploy their workers in the most efficient and creative way (thanks to that flexible labour market), French and German companies are - we are told - held back by archaic labour market legislation.

But something in this tale just doesn't add up. If British firms were really so efficient, and so uniquely able to deploy labour in the best possible way, UK productivity should be high and rising. Output per worker should be higher in Britain than in Germany or France - at least in the service sector where we supposedly excel.

The truth is very different. New research suggests that Britain's employees are less efficiently employed than our counterparts in the US, France and Germany. Not just in manufacturing (where we have long known of our weaknesses) but in the service sector too, British productivity levels lag behind those of our three biggest competitors.

To discover that we are less efficient in service provision as well as manufacturing may come as something of a shock. The myth of the UK services miracle has become well ensconced. Some pundits even postulated in the Eighties that we could become the service centre for Europe, leaving manufacturing to our continental colleagues.

Service sector success was supposed to be our salvation, allowing us to shrug our shoulders at our poor manufacturing record. The service sector now accounts for substantially more output, more employment, and particularly more employment growth, than manufacturing in every Western country.

In Britain, 40 per cent of jobs are in so-called market services - private sector services including everything from banking to hotels, but excluding public services and personal services like hairdressing. Only 17.5 per cent of jobs are still in manufacturing. The same story holds true for output: 37 per cent of our GDP is produced by our market services, compared to only 18 per cent by manufacturing industry.

Were we to be ahead of the game in the wealth-producing, employment-rich service sector, it would be indeed promising for economic growth in future. Sadly it seems we have the same comparative weaknesses and inefficiencies in services as we do in manufacturing. So much for being competitive in Europe.

In a new pamphlet* from the National Institute of Economic and Social Research (NIESR), Mary O'Mahony, Nicholas Oulton and Jennet Vass have examined productivity in market services in Britain, France, Germany and the US. They found that in market services as a whole, US productivity was 38 per cent higher than in the UK (in other words for every pounds 1 value added by a UK worker, the US employee adds pounds 1.38 in the same period). France's service sector productivity is 36 per cent higher, and Germany's 34 per cent higher.

Even more surprising, they found that the gap between British and French or German performance was bigger in the service sector than in manufacturing. So our bankers, hoteliers and retailers are at more of a disadvantage compared to their European counterparts than UK car manufacturers.

Keen to find something we might be good at, the economists split the service sector down even further. But in every sector the results were broadly the same. US retailers were 44 per cent more productive than British retail workers. In hotels and catering, and in communications, our employees are more productive than the Germans, but the French and the Americans still beat us hands down. Even in banking and finance - the one thing we are supposed to excel in thanks to the City - our workers are less productive.

O'Mahony et al concede that if you break industries down even further there may be specific things we are very good at. For example, the Brits may indeed be the most productive foreign exchange dealers in the world. But in the research these NIESR economists have carried out, we emerge as extremely successful (compared to France and the US at least) in only one area: selling insurance.

The big question is: why are we so unproductive? From one point of view, low productivity need not be a bad thing at all. It could mean that more people are employed.

More people providing the same level of services and sharing the proceeds between themselves could be better for society than having a few people working hard and paid well while everyone else draws the dole. For example, Japan has a sector, which is heavily overstaffed, but which is tolerated because it keeps a lot of people in work.

There is some limited evidence to suggest that productivity growth was lower in Britain compared to Germany because we expanded service sector employment faster than they did. As market services grew in both countries between 1979 and 1989, service sector employment grew faster in Britain, while service sector productivity grew faster in Germany.

Even so, employment growth can't explain away the productivity gap. Our job creation record is too miserable for that. Since 1979, we have had one of the slowest job creation rates in Europe. Moreover no one in this downsizing, hire-and-fire culture, could plausibly believe that the British service sector is deliberately overstaffed for social purposes. The Japanese example is not being replicated here.

So we shall have to look elsewhere for explanations of the persistent productivity gap. The British failure to invest properly, particularly in skills but also in infrastructure, emerges as a strong suspect. The same criticisms that have been made of our manufacturing record - inadequate investment, poor education and skills, bad management - for so long, appear to be relevant for our service sector too.

So Mr Clarke should sound a little less optimistic about Britain's ability to make the most of any economic opportunities a single currency zone might deliver. British companies in both manufacturing and services may be doing well relative to their European counterparts simply because we have emerged from recession rather earlier than France or Germany. But the underlying efficiency of British business - and the skills, infrastructure and climate for investment on which our companies depend - still leave much to be desired.

*`Productivity in Market Services: International Comparisons', Mary O'Mahony, Nicholas Oulton and Jennet Vass, discussion paper No 105. National Institute of Economic and Social Research, 2 Dean Trench St, London SW1P 3HE