Economy bogged down by low-performing firms
The UK economy is suffering from an ever-lengthening tail of low productivity businesses, according to a new report from BCG.
Between 1997 and 2023, the number of firms below the 25th productivity percentile nearly doubled, rising from 444,500 to 873,000, while the total number of firms increased by 70 per cent.
At the other end of the productivity distribution, the number of firms above the 75th percentile only increased by 62 per cent, suggesting that more productive firms make up a smaller share of the economy than they did in 1997.
Raoul Ruparel, chief UK economist at BCG’s Centre for Growth, said a lack of “business dynamism” was partly to blame for the proliferation of low productivity firms. “We’ve seen lower productivity firms being able to survive for longer,” he said.
“Interventions should tackle the long tail of unproductive firms by encouraging dynamism, with an element of encouraging creative destruction and facilitating labour redistribution.”
The research also showed that the sectors which drove productivity growth before the financial crisis have dropped off the pace, even if the star firms have still recorded productivity growth.
Three sectors – information and communications, manufacturing, and financial services – accounted for 84 per cent of productivity growth across the economy between 1997 and 2007. Since then that share has dropped significantly, to 46 per cent between 2008-2018, and just 34 per cent in 2019-2024.
“Previously, the UK was able to thrive despite aggregate productivity growth being concentrated in a small number of large, high-performing sectors. However, while these sectors remain the main drivers of productivity growth, they are contributing much less,” the report said.
The productivity problem
Productivity, a measure of output per hour, is directly connected to growth in wages and living standards.
Since the financial crisis, productivity growth has declined sharply in western economies, with the UK suffering more than many peers. The report noted that if the UK’s pre-crisis trend had continued, then the economy would be around £557bn larger.
Successive Chancellors have tried to address the UK’s productivity challenge, but without much success. BCG’s paper suggests that to truly address the productivity challenge, the government must develop targeted solutions for different sectors.
In manufacturing, for example, productivity growth has slowed across the board, suggesting the sector faces structural headwinds. Ruparel pointed to high energy prices as a likely cause.
In info and comms, by contrast, the most productive firms have performed relatively well in the past few years, while lower and mid-tier firms struggled. This implies that the diffusion of new ideas and technologies from frontier firms to the laggards has been slow, a long-term problem for the UK economy across a variety of different sectors.
Ruparel pointed to a 2018 speech by Andy Haldane, then chief economist at the Bank of England, which argued the UK’s diffusion difficulties were a major cause of the productivity slowdown.
“We align with his view that we have a diffusion problem. We have some of the most innovative firms and, at the top end, our most productive firms have been growing productivity strongly…But then there is this long tail, and we’ve really struggled to spread best practice, whether that’s management techniques or new innovations.”