Academic journal article The McKinsey Quarterly

Why Is Labor Productivity in the United Kingdom So Low?

Academic journal article The McKinsey Quarterly

Why Is Labor Productivity in the United Kingdom So Low?

Article excerpt

There's not enough competition

The major culprit is product market regulation

Can social objectives be achieved at lower cost?

In the mid-nineteenth century, the United Kingdom I boasted the highest economic output per capita of any nation in the world, and its material standards of living were without equal. Ever since then, it has gradually lost ground. It now ranks bottom of the league of G7 countries, trailing the leader, the United States, by 30 percent [ILLUSTRATION FOR EXHIBIT 1 OMITTED].

To find out why, the McKinsey Global Institute conducted a detailed study of the United Kingdom's recent economic performance. As well as looking at the economy as a whole, we compared the productivity of UK companies with that of the world's top performers in six key product markets: automotive, food processing, food retailing, hotels, software, and telecommunications. In each case, we sought to uncover the reasons behind differences in performance.

Our principal findings were that:

* Despite the labor and capital market reforms of the past 20 years, output per capita in the market sector remains almost 40 percent behind that of the United States, and 20 percent behind that of West Germany. The root cause of this gap is low labor productivity [ILLUSTRATION FOR EXHIBIT 2 OMITTED]. The results of our productivity case studies confirm this overall trend [ILLUSTRATION FOR EXHIBIT 3 OMITTED].

* Contrary to conventional wisdom, the main causes of low labor productivity area lack of exposure to global best practices and low competitive intensity. The reasons often cited for poor performance, such as low capital investment and poor skills, are consequences of these factors.

* Lack of exposure to global best practices and low competitive intensity are often the result of product market barriers such as trade restrictions, price constraints, and land use regulations. In some cases, these barriers constrain competition and so limit the pressure on management to adopt global best practices. In others, they prevent the implementation of best practices or render it uneconomic.

* Many of these regulations have been put in place to promote legitimate social objectives, yet the economic cost of these objectives has been largely overlooked. Replacing them with more market-friendly alternatives could boost GDP growth by more than a full percentage point a year over the next ten years.

Insufficient competition

All the research carried out by the McKinsey Global Institute attests that the primary engine of productivity improvement is competition within an industry or product market. In the end, there is no substitute for the constant testing of managers by competition. Pressure from capital markets is not enough by itself. Sheltered from competition, as many UK companies are, businesses can make profits and satisfy their investors without achieving high rates of productivity, so they have no incentive to strive for productivity improvements.

Consider the UK hotel industry, for instance, where planning restrictions and high construction costs have limited competitive intensity. Leading international operators have little incentive to invest here, since they are unlikely to generate attractive returns. As a result, weaker players have felt only limited pressure to exit the market; indeed, in many cases, they lack any opportunity to do so, since planning restrictions often prohibit alternative uses for hotel properties. Much of the country's hotel stock is old and unproductive: over 3,000 hotels are in listed buildings, and nearly 50 percent are more than 100 years old [ILLUSTRATION FOR EXHIBIT 4 OMITTED].

Another example can be found in the UK telecoms industry, which remains highly concentrated: in 1996, some 12 years after privatization, BT still accounted for about 85 percent of fixed-line telephone usage. This is at least partly because. …

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