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How uncertainty and crises affect productivity

How do we respond to uncertainties that crises create? Are they holding us back in investing, hiring and innovating? Or can crises make us more agile and resilient, perhaps even more creative and inventive? And what might that mean for productivity? These are some of the questions that are critical to the UK economy.

To help answer these questions, The Productivity Institute’s Managing Director Bart van Ark spoke to TPI member Paul Mizen, Professor of Monetary Economics at the University of Nottingham.

Firstly, in what ways do firms respond to uncertainties? Are there differences?

There are certainly differences; we can think about, for example, accommodation and food and recreational services during COVID, which were massively affected by the circumstances of that particular shock, both in terms of sales and employment. Because of this, there are some firms that are more firmly lodged in the bottom tail and have experienced a very adverse effect.

There are also some winners. There are some firms up in the upper tail that are benefiting; firms that have sold their goods and services online have done better than those that were reliant on bricks and mortar locations.

Consequently, we have the distributional effect, where there is an increase in the spread of the distribution, which shows the increased uncertainty. Crucially, uncertainty is the killer for investment. Firms do not invest when there is more uncertainty. They wait and see what is going to happen and stall their new investments until there is greater clarity. It is undoubtedly the case that, with the three major shocks of Brexit, COVID and the war in Ukraine, that uncertainty has been a great deal higher. As a result, investment has been lower in the UK, which you can see in the comparison with other G7 countries.

Furthermore, what we have learnt is that different sectors have had very diverse experiences. The sectors that have benefited from the shocks in some way and those that have been adversely affected are located in different places and this is something that has led to a lot of geographic inequality. Moreover, within different sectors across the income spectrum there has been quite a lot of inequality in terms of which workers have been most affected as well.

While there is some reallocation taking place, this has happened much more in sales than it has in employment. As a result, the process of reallocation between industries and between firms within industries has got to continue.

Is there anything that can be done to create positive outcomes from government intervention?

There have been some successes with government intervention; the furlough scheme did prevent the separation of employees and employers, to some degree, by providing some insulation to the businesses to keep workers employed, rather than letting them go. That has been a welcome step but a very costly step. It is much more difficult to know quite how government can do the same thing for investment. That is a much more challenging decision from a policy perspective.

The super-deduction, which allows companies to cut their tax bill by up to 25p for every £1 they invest, goes some way to helping, but it is focused on a very narrow part of investment – tangible investment. It would be well worth the government looking at intangible investment and the areas where investment takes place in very productive companies to see if that could also be encouraged to try to offset some of the effects of uncertainty.

Do we have any evidence to find out how firms are responding to schemes that are in place?

I have been involved in the Management and Expectations Survey for the Office for National Statistics, which found that the better managed firms – the firms that were implementing better management practices pre-COVID and pre-Ukraine – were in a favourable position to forecast and understand the changing environment they were in.

These companies are more likely to innovate and adopt new practices, not just in management but also in the implementation of new technology, new ways of working, new processes, and new products. They are thereby more able to pivot in the face of the shock and these businesses were able to adapt to their circumstances much more readily during the recent economic shocks. These firms have got the edge.

But what can the government do about that? There are some policies in place to encourage businesses to learn from the best-managed firms – Help to Grow, Be the Business – these are good schemes to try to spread that knowledge and encourage best practice. However, the real challenge is that many of the firms that would really benefit from learning these practices seem somewhat reluctant. Perhaps they are just too busy firefighting at the moment to be able to take them up. As such, the catalyst could be to create the right environment in which struggling companies would be able to learn from the better-performing, better-managed firms. Helping them to become more resilient, more resourceful, and better able to pivot in the face of future shocks may well be the key.

This is where policy can be introduced to encourage good practice and investment from the very best firms in technology and training. This will lead to some further reallocation in employment and higher productivity gains. We are seeing firms indicating that they are prepared to divert their investment away from certain areas, towards technology, training, software and IT, and that these will benefit those industries in the medium term.

Additionally, the fact that there is more working from home means that these benefits then get spread more widely, geographically speaking. The whole footprint of any industry is now much larger than it would have been five years ago when, essentially, we all had to be within commuting distance of the main office. I think that is another factor that’s going to transform the UK.

So hopefully these will all impact on inequality in a positive way and lead to higher productivity.

This blog has been adapted from the Productivity Puzzles podcast episode 14, ‘Staying productive in uncertain times’.