Startups and the productivity puzzle

The productivity puzzle continues to puzzle. It seems to be too puzzling for our politicians to talk about but lots of other people are on the case. Duncan Weldon wrote a piece earlier this week looking at both the economic and social factors.

This comment set me thinking:

It could be that the nature of Britain’s recovery explains the low productivity growth. Rather than lower productivity leading to lower real wages (as companies cannot afford to increase pay), it may be that lower real wages have encouraged firms to hire workers rather than investing in new equipment. This could have lowered productivity.

Where are Britain’s startups in all this? Entrepreneurs are supposed to come into the market and disrupt it, investing, innovating and bringing in new ideas which eventually improve productivity. At least, that’s the theory.

But there is little evidence that new firms are doing much to improve productivity. If anything, they are making things worse. As this NESTA research by Albert Bravo–Biosca and Stian Westlake found:

Most start-ups were not particularly special from an economic point of view. The average new British business was no more productive than the average existing business, either at its foundation or after five years of existence. While some new firms contributed positively to labour productivity growth during this period, this was offset by the negative contribution of other new firms.

So, while some new firms might have been highly productive, their contribution was more than cancelled out by those that weren’t. The net effect of new firms coming into the market was to reduce productivity.

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A recent Bank of England paper on firm level productivity found something similar and suggests that the trend has continued through the recession. For most years over the past decade, the overall contribution of new firms to productivity has been negative.

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Back to Duncan’s comment then. If existing firms are hiring cheaper workers rather than investing in technology, might a similar process of labour substitution be going on among startups? Perhaps new firms are coming into the market not because they have developed new products or services but simply because they have found a way to make a profit by exploiting cheap labour.

Mike Haynes gave an example of this a couple of weeks ago when he discussed the rise of the hand car wash.

A hand car wash is labour intensive and forgoes technology that has been developed to replace it. Normally technology is used to increase the efficiency of output and make an economy more productive – economists call this capital deepening and it’s traditionally a marker of good economic growth.

As the economies of wealthier nations evolved, the machine car wash was one of many technical changes that accompanied capital deepening. Major garages and petrol stations are equipped with expensive machines that now stand idle, while people queue for the hand car wash. This, despite the machines being good at what they do. They are unlikely to scratch your car. They wash it cleaner, use less water and the detergents are more safely taken away. Some countries even ban hand car washing because of the waste and pollution involved.

The return to an inefficient, labour-intensive model – as with the hand car wash – is therefore an odd regression. It is only possible in a rich economy like the UK’s because labour is relatively cheap – and those working in hand car washes tend to be paid at the minimum wage or below it. They experience long periods of under-employment as they wait for customers and few have proper contracts or conditions. People working these kinds of jobs, in part, explains the UK’s productivity problem.

In other words, it’s easier to make money by using cheap labour than by investing in machinery. Furthermore, in this example, people would be mad to invest in new machinery because they would be unlikely to make enough to cover their investment. The media love to talk about high-tech entrepreneurship. There may be a few such firms but most of Britain’s startups are low tech or no tech.

Has this county become an El Dorado for cheap labour? Does the business opportunity now lie in setting up a business to exploit what the Economist described as Britain’s pitiful pay and its even more impoverished freelancers? That might explain why, far from improving the country’s productivity, Britain’s startups are making it worse.


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10 Responses to Startups and the productivity puzzle

  1. sdbast says:

    Reblogged this on sdbast.

  2. rogerh says:

    Pity the rebloggers, poor things.

    Whilst there are obvious problems with the UK’s housing and transaction costs I fear there is a fundamental problem all developed economies will face – the humans are too expensive and we cannot leverage sufficiently the clever ones. We might improve the teaching a little but I suspect we are reaching the limits, an economy based on people doing clever stuff is unsustainable. Something else is needed to balance the economy – natural resources, a thiving industrial base, a transport hub.

    For historical reasons the UK allowed its troublesome industrial base to wither and replaced it with finance and services – and then took its eye off the finance ball. We can and do invest overseas but getting the income back home and spread around is problematic. We could get into robots and AI but please don’t put that beastly business park in my back yard and you certainly cannot import all those Asian software engineers.

  3. Immensely interesting post!

    A few thoughts. Mariana Mazzucato has been banging the drum about productivity and innovation not being driven by start-ups for some time and has done plenty of research in to this for her excellent book The Entrepreneurial State.

    The other huge issue here is the way we measure start-ups – i.e. by the number of company / VAT / self employed registrations. Most measures tend to count all of these. In the wake of the financial crisis we know there was an explosion of new registrations, the vast majority of which have been individuals registering as self employed. My other half was one of them, when she began doing some childminding here and there. This is generally low paid work and she has to fit it around other commitments so from a pay and productivity perspective she is really dragging down the numbers! Anecdotal evidence suggests a lot of these sorts of registrations could be household members other than the main breadwinner taking up work because of rising living costs and stagnant wages making it more and more difficult to be a single earner household. So many are taking up ad hoc self employed work that has to be fitted around other day to day commitments (notable childcare but possibly study and other things). None of these people – through any fault of their own – will be making positive contributions to UK productivity. Quite the reverse. This also fits with the idea (strongly advocated by former MPC-er David Blanchflower) that we are still a long way from the NAIRU, hence the total absence of wage growth and inflation pressure despite an apparently bouyant labour market.

    As for the labour subsitition point, i think a lot more evidence is needed to back up the idea that firms are choosing people over technology and investment. It’s certainly possible, but if firms are discouraged from investing and innovating, what evidence do we have that taking on more labour is substituting that? I’d expect the two things to go together. Take the example of a haulage firm. If they are not convinced that buying more rigs is a good idea given market conditions, they won’t buy more rigs and nor will they take on more drivers. Or the classic “widget” manufacturer. If they’re not convinced it’s worth investing a new and more efficient production line that produces more widgets, why would they then take on more staff?

    Don’t have the answers, but all very fascinating nonetheless!!

    • P Hearn says:

      To your question on labour substitution, humans have the obvious advantages of being cheap, flexible and right now, readily available without much delay. They can be trained to do simple tasks quickly and cheaply, and will do so at a basic level for as long as they’re told to. If demand dips, you fire them and everything stops, so risk is minimised at the cost of reduced profits.

      Ergo, your widget manufacturer, unsure about demand, may well opt for a less efficient but equally less capital intensive way to produce his wares by hand, until such time as he sees demand being strong enough to take the risk of investing in the shiny new production line. If he has a supply of willing, cheap imported labour, then this becomes the rational thing to do and investment can be delayed indefinitely.

      Aside from the risk reduction, the mentality today is still one of ‘see if it works, and if it does, scale up and move production to a low-cost country’. So, in some ways, productivity will always be constrained until low-wage economies’ cost bases catch up, and manufacturing becomes viable again in the UK. Until then, it’s more low wage, low productivity hairdressers, coffee shops, graphics people and business ‘consultants’.

      Final point – I’m not sure why anyone expects small companies to be super-productive? Almost by definition, these enterprises will be garden shed, Heath Robinson affairs, and if and when they get scale, capital is brought in and productivity rises (or production moves offshore). That’s common sense, and why economists even cite it as worthy of mention is always amusing.

  4. metatone says:

    A few thoughts:

    1) I’m often to be found railing about this in the comments at stumblingandmumbling, but if you study “countries like us” who have a history of doing better than us with productivity (e.g. Germany, Japan, S. Korea, France, Scandanavian countries) then the whole “entry/exit” theory starts to look less compelling. (In the US, entry/exit has been more of a productivity driver, but there are lots of good reasons to think we can’t replicate their model on a small island.)

    So, if not entry/exit, then what? Well, those countries actually show something that doesn’t happen much in the UK (and thus Chris @stumbling… often claims cannot happen) – major firms getting more productive – repeatedly. (Some of the graphs above bear what I’m saying out, even in the UK context, but economists largely prefer the entry/exit model for policy discussion, it seems.)

    2) Startups are still important (and still have to be nurtured) because are an important transmission point between “new technology” and “industrial productivity” in the long run. But that often takes 20 years to actually show up.

    3) You can’t get away from aggregate demand. The startup I’m part of is a B2B concern. Loosely, we supply material technology and a process that helps larger firms do certain things better/quicker (and thus, sometimes literally cheaper, but often just more productively). We are heading for 5 years old. (As an aside, we’re still only just getting traction, if you wanted to measure our impact on productivity figures as a whole, it won’t show up for another couple of years at least – and then it shows up in the productivity of our customers, not us.) Anyway, across that 5 years we’ve sold and continue to sell, much more outside of the UK (and indeed outside of Europe) than inside. Lots of reasons for that, but experience in the selling process suggests a lot of it is about aggregate demand. If firms aren’t seeing it, then they aren’t putting money into anything new very often.
    (As another aside, a big issue here is that what we offer increases productivity, but what companies facing shrunken demand in the UK are looking for is quick cost cutting.)

    4) High tech entrepreneurship costs money. Look at the returns of the VC industry as a whole in Silicon Valley, it’s not great.

    Now of course there’s more to the story, but once you see those figures, it’s much easier to see how an overactive financial sector with a game-able asset class (e.g. Housing in the UK) could drain away the investment money that might have made for a vibrant UK high-tech scene.

  5. Hugo Evans says:

    Did you ever play the Walter Benjamin game? As you walk around try to spot the alternative histories of fixed capital growth that never happened in the UK after 1979. Take a trip on an intercity 125, 40 year old stock, and think of the APT cancelled in 1983. Go past system built tower blocks built in the early 60,s designed for 30 years, because they believed they would have been replaced with superior systems by 1990. Each one surprised to find itself still standing. Then pass a gang of Portuguese brickies putting up buy to leave by hand. Count the bridges on the M4 with cladding on concrete rot, as you sit in traffic on the hard shoulder. Maybe pick up a lady bird book on future flight in a charity shop, one in row, none of them paying business rates. There’s a new laundrette opening, do people really still use those? Take the book on a trip down the river thames, passing the futuristic towers of Canary Wharf on your way to the thames barrier, where you can watch the film about how it was built in the visitor centre. Then blog about it with a sub 1 meg internet connection and reflect on all the things that got once got made and dream of all things that never happened.

  6. metatone says:

    So – a darker thought – which connects perhaps to secular stagnation – and to P Hearn’s point.
    Demand (i.e. the desires of those with money) just doesn’t begin to be enough to employ all of those without money at this point in history. This is exacerbated by the arrival of even more cheap labour. If you don’t have a shortage of humans, you don’t get productivity increases, as in the short term it’s always easier to just scale up linearly.

  7. jpd says:

    Reblogged this on DAMIJAN blog and commented:
    Zanimiva razlaga, zakaj produktivnost ne raste. Nizka cena delovne sile spodbuja podjetja, da namesto vlaganj v nove tehnologije raje zaposlujejo vec cenen delovne sile. Podobno velja za start-upe (nova podjetja), ki v agregatu znizujejo produktivnost celotnega gospodarstva, namesto da bi jo povecevali.

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