What drives regional productivity and how can the UK improve its performance?

November 26, 2019

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by Yong Jing Teow Economist

Email +44 (0)7525 281974

Productivity is a major driver of a nation’s economic prosperity and, in the long run, is vital for wages and standards of living.

Although the UK is notable for falling behind its G7 peers on various measures of productivity, as we explore in our latest UK Economic Outlook, the issue for many parts of the UK is less about how to catch up with other countries than about how to catch up with cities and regions much closer to home.

For starters, gaps in regional productivity are large and widening over time: London – the most productive LEP – is now more than twice as productive as the least productive LEP in 2017, compared to 1.8 times in 2002.

One possible reason for this gap is the industrial composition of each local area. A place with a greater concentration of relatively high productivity sectors, such as financial services and manufacturing, would be more productive than an area with a greater focus on lower productivity activities, such as hotels and food, retail and administrative services. At the national level, there has indeed been a small but discernible shift in the share of people employed towards lower productivity sectors between 2000 and 2017.

To understand whether regional differences may be explained by differences in their economic activity, we decompose productivity differences between local areas into:

  • Compositional or ‘between’ effects, where one area has a greater share of workers in industries that are more productive.
  • ‘Within-industry’ effects, where one area enjoys superior productivity within the same industries.

We do this for Thames Valley Berkshire (TVB) – the highest-performing LEP outside London – and Cornwall and the Isles of Scilly (C&IS).

The decomposition for TVB relative to the UK average is shown in Figure 1, and C&IS is shown in Figure 2. The ‘between effect’ shows the extent to which the productivity differential may be attributed to the different mix of economic activity that takes place in TVB (C&IS) compared to the UK as a whole, while the ‘within effect’ shows us where productivity differences exist as a result of differing productivity levels within the same sector in TVB (C&IS), versus the UK.

Figure 1: Decomposition of productivity differences – UK vs Thames Valley Berkshire, 2017

UKEO_Nov_Figure 1

Figure 2: Decomposition of productivity differences – UK vs Cornwall & Isles of Scilly, 2017

UKEO_Nov_Figure 2

Both figures show that there is a small ‘between effect’ at work relating to differences in industrial structure. TVB has a much larger employment share within high value services (31%) compared to the UK on average (20%), which enjoys productivity levels that are 44% higher than the UK average. C&IS, in contrast, has a much higher share of employment (46%) in low value services (predominantly tourism-related) compared to the UK (39%), which are a third less productive than the UK average.

However, it is the ‘within sector’ component that accounts for a larger proportion of these differences. This suggests that differences in the industrial structure explain only part of the story, and that other factors are more important.

The critical role of skills and connectivity in driving regional productivity differences

Looking across all English Local Economic Partnership (LEP) areas, we find that two factors in particular appear to matter more for productivity than others. Regional variation in workplace skills is one. Higher-skilled workers tend to be better able to adopt external knowledge and best practices to improve their output, for example through using digital technology, or adopting new production and management techniques.

The second is the extent to which local areas are connected to major economic hubs, such as London, Manchester and Birmingham, through local transport links. Businesses that are closer to large pools of potential customers can access bigger markets for their wares. Being closer to their potential suppliers also allow them to collaborate with them more effectively. The advantages for people are similar – greater connectivity boosts opportunities to cross-pollinate ideas and access more job opportunities than they would otherwise be able to reach. It also means shorter commuting times, which provides an added benefit to people’s wellbeing.

It’s clear that no single factor can fully explain why some areas are more productive than others. However, our analysis shows that there are things that local areas, businesses and workers can do to close the productivity gap.

The first is to support the education and training of people of all ages, especially in the skills and knowledge required by the modern digital economy. There needs to be greater emphasis on continuing skills development over people’s working lives to enable them to adapt to the needs of a rapidly-changing economy. As our recent research on upskilling shows, the risk of automation offers an even greater incentive to prioritise this as workers increasingly have to continually upskill themselves to stay relevant in the labour market. Businesses can support this through workplace training and upskilling.

Second, local areas, supported by local and central government, can work together to improve transport connectivity between regions, especially (but not only) in the North where infrastructure investment needs are particularly acute. Improving digital connectivity by rolling out high speed broadband across the country will also enable companies to accelerate adoption of new innovations and compete on an international stage.

Getting this right could deliver significant economic benefits. If LEPs and countries that are currently performing below the UK average can halve this productivity gap, we estimate that it could lift UK GVA by around £83 billion (or 4%). Such a significant increase in productivity could deliver greater prosperity across the UK, while also helping to address the significant geographically income inequalities across the UK. Looking beyond Brexit, achieving this should be a top priority for the next UK government.

by Yong Jing Teow Economist

Email +44 (0)7525 281974