NCN Summit 2001: Professor Rowthorn, University of Cambridge
UK Competitiveness, Productivity and the Knowledge Economy

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1. The Business Cycle. The current downturn in US economic activity has destroyed the myth that information and communications technology (IT for short) means the end of the business cycle. It was in progress well before the recent terrorist attacks occurred. The downturn has also strengthened the case of sceptics who thought the importance of the information revolution was exaggerated. Now is a good time to put this revolution into perspective.

2. Historical precedent. The recent American expansion is not without precedent. The US also experienced a rapid growth of output and productivity during the 1960s. Then came a marked slowdown that gave rise to much heart-searching about the decline of American power and its alleged loss of economic leadership. This in turn was followed by a prolonged economic recovery that culminated in the spectacular boom of the late 1990s. This boom was accompanied by widespread investment in computers and other forms of IT, and according to every standard measure (output per worker, output per hour, total factor productivity) there was a dramatic increase in productivity. However, taking the 1990s as a whole, growth in output and productivity was no faster than during the 1960s. With the US now entering recession, the quantitative judgement must be that recent economic performance was impressive, but not unprecedented.

3. The role of IT in the US economy. A country can benefit from the information revolution in two ways - as a supplier of IT products and a user of such items. It is universally agreed amongst economists that the US has enjoyed a remarkable boom in IT production (computers, peripherals, etc.). Between 1995 and 2000 the output of office, accounting and computing machinery grew by 535%, whilst the output of other electrical machinery and apparatus rose by 276%. These huge figures reflect both improvements in quality and increases in quantity. They were achieved with virtually no change at all in employment in the industries concerned. It is also agreed that the use of computers and related equipment has raised labour productivity substantially in most of the US manufacturing sector. However, economists disagree about the extent to which computers have raised productivity elsewhere in the economy, for example in the service sector. I shall not enter into this debate here, except to say that I agree with what Bob Solow had to say on the subject.

4. IT in the British economy. The UK does not compare to the US as a supplier of IT products. Any expansion that we have enjoyed in this sector is dwarfed by what has happened in America. However, as a user of IT products, our performance has been quite impressive. British firms have invested more heavily in the application of IT than most other European countries, and as a share of GDP our expenditure on computers, peripherals and software has been similar to that of the US. Despite this investment and despite recent improvements, our labour productivity in most industries is still below that of the Americans and in some areas the gap has widened significantly in recent years. The gap is relatively small in the service sector and is getting narrower, whereas in manufacturing the opposite is the case.

5. Services. It is difficult to generalise about services since they are very diverse in nature their output is difficult to measure. Official statistics suggest that on a comparable basis output per worker is now around 30 percent lower in this country than in America (Chart 1). Part of the difference is due to the fact that more part-timers are employed in Britain and that full-timers in this country tend to work shorter hours than their US counterparts. On an hourly basis the productivity gap in services is probably in the region of 20 percent. This gap cannot be explained by American investment in information technology since it predates the information revolution and has been getting narrower in recent years. Productivity growth in UK services has not arisen simply because we supply the same kind of services more efficiently than before. It is also reflects a shift towards high value-added, knowledge-based services. This can be seen in our balance of payments. In 1990 the UK had a combined trade surplus of £7 billion in insurance, finance, computing, technical and other knowledge-based services. By 2000 the surplus had risen to £28 billion. Thus, although our productivity in services is still on average below the American level, our export performance in knowledge-based services has been impressive

6. Manufacturing Productivity. For at least a century observers have noted and debated the huge gap in manufacturing productivity between Britain and the United States. Missions sent have been sent from this country to the US to see why they do things better than we do. For some decades after the war, it seemed that the gap was starting to close, but over the past few years it has widened again as American manufacturers have used information technology to achieve a spectacular increase in productivity (Chart 2). Between 1995 and 2000, output per worker in US manufacturing increased by 34% as compared to 7% in this country. As a result, the gap is now back to its old level. The average American manufacturing worker now produces about twice as much as his or her British counterpart. This gap is not simply due to a superior use of information technology. It also reflects long-standing differences. American firms invest more heavily in capital equipment of all kinds than British firms and they employ more skilled personnel such as engineers and managers.

7. Manufacturing Matters. The US boom was associated with a big rise in manufacturing production. This was most obvious in the IT industries (computers, peripherals, telecommunications, etc.), but it was also evident elsewhere in the manufacturing sectors. With the exception of a few sunset activities, such as clothing or footwear, the typical manufacturing industry in the US increased its output by around 10-20% over the period 1995-2000. Much greater increases were, of course, recorded in IT manufacturing. The picture in the UK was quite different and production in most of our manufacturing industries either stagnated or fell during the period 1995-2000. Chemicals and other transport equipment were the only non-IT manufacturing industries in the UK that experienced a significant increase in output during this period. The contrast between the two countries is not confined to recent years but goes back to the first Oil Shock in 1973. British manufacturing industry never really recovered from this shock and, apart from a brief spurt in the late 1980s during the so-called Lawson boom, this sector has virtually stagnated. For American manufacturing industry, however, the Oil Shock was merely a brief hiatus and for most of the past quarter of a century this sector has grown strongly. Since the 1973 shock, British and American manufacturing output have increased by 14% and 114% respectively. It would be an exaggeration to say that American prosperity is based exclusively on manufacturing, but it is clear that the manufacturing sector has played a central role in the country's modern economic growth. The American experience gives the lie to the claim that manufacturing is of vanishing importance in advanced economies. It shows that manufacturing is a central part of the so-called knowledge economy. The US is a great manufacturing country and will continue to be so.

8. The Enigma of the UK manufacturing. Productivity growth in UK manufacturing has tailed off a bit recently, but over the medium term it has been quite impressive - similar, in fact, to that of the US and other advanced economies. Yet output growth over this period has been almost negligible. As a result employment in the UK manufacturing sector has fallen dramatically (Chart 3). In the US, by contrast, manufacturing employment has remained virtually constant whilst output has risen. American firms now produce more than twice as much output with the same number of workers as they did in 1973, whereas British firms produce almost the same as before with only half as many workers. Productivity growth in the UK has been almost entirely of the labour-shedding variety. This has, perhaps, been the greatest failing of our economy and may be the area where we have the most to learn from the American experience.

9. An alternative perspective. The comparisons so far have been based on productivity measures, such as output per worker. An alternative approach is to consider output per head of population. This measure indicates how much a particular economy produces for the use of its own population or for export. It reflects the number of workers employed in each sector and the amount that each worker produces. Chart 4 shows the per capita output of services and manufactures in the UK and the US since 1960. The per capita output of services has been increasing almost continuously throughout the period in both countries. This is partly due to higher productivity and partly to the rapid growth of service employment. Although the gap is now closing, the per capita output of services is still significantly higher in the US than in this country. The chart shows clearly the contrast between the two countries in terms of manufacturing performance. Apart from a few short-lived interruptions, the per capita output of manufactures has been rising strongly in the US ever since 1960. Manufacturing output was also rising quite strongly in the UK prior to the first oil shock in 1973, but since then it has almost stagnated. In 1973, the US produced an estimated 22% more manufactured goods per head of population than the UK. By 2000 the difference was 91%. The chart confirms my earlier claim that America is a great manufacturing nation. The same can no longer be said about this county.

10. Does it matter? Does the poor performance of UK manufacturing really matter? Why can the UK not become a specialist service producer, importing the manufactured goods we require and exporting knowledge-based services to pay for them? For example, America or continental Europe could supply us with equipment and we could supply insurance and financial services in return. This is certainly possible from a theoretical point of view. In practice, however, there are two major objections. Our export performance in knowledge-based services is impressive by international standards, but even today they still represent only a modest fraction of our total export earnings or our national expenditure on manufactured goods. In 2000, our combined earnings from the export of all types of knowledge-based services were less than one third of our receipts from manufactured exports and only one-quarter of our expenditure on manufactured imports. In just three years, between 1997 and 2000, our trade balance in manufactured goods deteriorated by £18 billion. Over the same period, our surplus on knowledge-based services increased by £10 billions. On this evidence, it seems unlikely that growth in knowledge-based services will be sufficient to offset the weakness of our manufacturing sector.

11. The regional question. Quite apart from the issue of national solvency, there is the regional question to consider. Although most parts of the UK have derived some benefit from the growth of knowledge-based services, this expansion has been disproportionately concentrated in the south of the country. Comparatively few of the new services are located in the old industrial conurbations of the North that have been hit most badly by the decline of manufacturing employment. The result is a serious regional imbalance. Much of the South has boomed, whereas the old conurbations have still not managed to fill the gap left by the decline of manufacturing employment. If this decline continues, their task will become even more difficult.

12. Summary. Compared to the USA, the UK has on average done quite well as an IT user, but badly as an IT producer. The performance of the UK service sector has been especially good. Exports and domestic sales of this sector have been growing strongly and in recent years the productivity gap with the US has been closing. However, British manufacturing is a cause for increasing concern. Labour productivity in this sector is still well below the US level and in recent years the gap has widened. Moreover, manufacturing output has been virtually stagnant in this country whilst in the US it has grown strongly. These failings suggest that IT has not been adequately utilised by the UK manufacturing sector and also that this sector suffers from other serious problems. A key issue for the UK is the future of manufacturing. As the US experience shows, manufacturing still matters. For reasons of national solvency and regional development, the weakness of our manufacturing sector is a cause for concern. The old balance of payments problems, which for so long haunted us, may yet return. And the old North-south divide is still with us. Both are rooted in our poor manufacturing performance.

13. Concluding Remarks. What are the implications for the MIT-Cambridge project? This project has three objectives. One is to encourage research into new techniques of production. Another is to aid the development of technically-equipped managers and experts. The third is to encourage collaboration between university and industry, particularly at the local level. Such collaboration can play a major role in encouraging innovation and a supply of suitable graduates to British industry. This was recognised by Germany in the nineteenth century when it created technical universities with the explicit objective of catching up with Britain, the then industrial leader. At one time British "provincial" universities also had close ties with local industry, but these decayed with the decline of traditional manufacturing. However, this process is now going into reverse and in many parts of the UK new linkages are being forged between university and industry. We in Cambridge are keen to encourage and participate in these developments. From a Cambridge, and a wider British perspective, MIT has a great deal to offer in this respect. MIT has extensive experience of successful collaboration with industry at all levels and many would see it as a model for Cambridge and other universities to emulate. Hopefully, the benefits will not all be in one direction. As a great scientific and technical university, we also have something to offer MIT.