McKinsey finds UK lags on productivity

News Analysis: Over-regulation and too little competitive pressure are to blame, says the consultancy. Only a free market will help close the gap

EVERYONE - the Government, academics, the private sector - agrees UK productivity is not up to scratch. Just how far Britain lags behind its competitors is painfully apparent from the study released today by McKinsey, the management consultancy.

McKinsey says Britain languishes bottom of the G7 - the world's seven richest countries - in terms of output per head. In particular UK output, or gross domestic product (GDP) per capita, trails that of west Germany by 15 per cent and the US by 30 per cent.

Focus on what McKinsey calls the "market sector" - that is, strip out government services, health and education - and matters look even worse. UK GDP per capita in the market sector trails that in west Germany by 20 per cent and the US by 40 per cent.

Alternative measures of productivity paint no better a picture. According to the McKinsey measure of total factor productivity - which essentially analyses how good Britain is at turning capital and labour inputs into output - the UK lags west Germany by 14 per cent and the US by 26 per cent.

In the car sector, UK labour productivity is 50 per cent lower than Japan's. In hotels, UK output per hour trails the US by 50 per cent and France by 40 per cent. Even the UK's deregulated telecoms sector fails to lift the gloom: UK total factor productivity in telecoms is about 60 per cent that of the US, reports McKinsey, primarily because of lower usage.

Closing the UK productivity gap is seen as essential by the politicians, and indeed by many leading commentators. Workers at Rover's Longbridge plant know only too well the consequences of poor productivity levels. Unless productivity at Longbridge improves, the plant looks set to close.

The Chancellor's pre-Budget statement, due next Tuesday, is expected to have an entire section devoted to productivity. Peter Mandelson, the Trade and Industry Secretary, has also been beating the productivity drum, and measures to boost UK competitiveness will be discussed in a forthcoming White Paper.

But, although everyone recognises that "something must be done", there is rather less agreement about what that should be.

Standard arguments about the causes of and solutions to the productivity issue essentially fall into three camps.

First, the UK has a relatively low skills base. "The skills and training aspect is a very important part of the explanation," said Nigel Pain, an expert in productivity at the National Institute of Economic and Social Research (NIESR). Put simply, many UK workers are simply not as good at their jobs as overseas counterparts. So part of the answer, the argument goes, is to invest in education - lower class sizes, improve teaching methods and reform training programmes.

Second, the UK has low levels of capital investment. McKinsey reports that capital investment per hour worked in the UK is around 25 per cent lower than in the US. This means UK technology is often not up to the standards abroad, so it is no surprise that UK productivity levels are lower. So the way forward is for the UK to "invest in investment".

The final argument often used to explain the UK's poor productivity is economies of scale. The UK is not as large as the US, so UK manufacturers tend to be smaller and so have higher unit costs. There is not much one can do about being small, proponents of this say - we should not aim for US productivity levels as we don't have a hope of getting there.

McKinsey, however, argues that many of the traditional "causes" of poor productivity are merely symptoms of a deeper malaise. According to McKinsey, two key causes of poor UK productivity are insufficient competition and over-regulation.

So, McKinsey says, the low labour productivity in the UK car sector is not primarily due to lesser skills or inferior technology. Rather, low skills and low capital investment are the result of an uncompetitive European car market where there is little competitive pressure to invest in people or machines.

And why is the British car market uncompetitive? Because of the voluntary trade restrictions that limit Japanese manufacturers' share of the UK and other key European export markets. Scrap the voluntary trade restrictions, and the market will do the rest.

McKinsey's conclusions about telecoms are similar: regulations on pricing and competition have artificially constrained productivity. The regulatory emphasis on access to the telephone has led to low line-rental charges and high call prices. McKinsey says: "The result has been much lower network capacity utilisation than in the US, where cheap or even free calls have boosted usage." The implication, again, is that the regulatory framework should be changed and market forces will do the trick.

McKinsey's proposals may go some way towards boosting productivity, but many seem unlikely to be put into practice. Some are politically unpalatable. Making access to the phone network more expensive does not sit comfortably with the Government's social objectives. Other recommendations are beyond governmental control - voluntary trade restrictions in the car sector, for example, are a matter for the European Commission.

This all means that on Tuesday Gordon Brown is likely to concentrate on traditional measures of raising productivity - investing in education and encouraging investment in infrastructure. But whatever the Chancellor and Mr Mandelson come up with, the productivity debate will run and run.