The major part of the decline in UK productivity growth following the financial crisis is explained by a widespread productivity shock within firms, according to research by Rebecca Riley, Chiara Rosazza Bondibene and Garry Young, presented at the Royal Economic Society''s 2014 annual conference.
Their new study concludes that while the crisis probably did hamper resource allocation to some extent, a misallocation of resources across firms, caused by an adverse credit supply shock, is unlikely to be a key factor behind the stagnation in UK productivity.
UK labour productivity fell sharply during the recession of 2008/09. It subsequently recovered only sluggishly so that by 2013, in levels terms, output per worker was about 15% below a simple extrapolation of its pre-crisis trend. This is in sharp contrast with previous UK recessions when productivity recovered more quickly.
To shed light on the causes of this productivity weakness, the study decomposes aggregate labour productivity change before and after the Great Recession into that which occurred within firms and that which was due to the restructuring of the UK business population. Among the findings:
· In the four years before the financial crisis, two thirds of labour productivity growth in the non-financial market sector arose from the external restructuring of firms – firm entry, exit and changes in market share.
· The contribution to aggregate labour productivity growth of such external restructuring remained broadly intact following 2007/08, although it was not sufficient to offset the significant decline in productivity that occurred within firms.
· The behaviour of productivity in the recent downturn differed from the recession of 1990, which was not caused by a financial crisis. A stagnation in manufacturing productivity growth was avoided then because productivity growth within firms fell back less than it did in the recent recession and not because the ''cleansing effects'' of recession were stronger.
The researchers also point out that there are patterns in the data that are consistent with the idea that an adverse credit supply shock caused inefficiencies in resource allocation across firms. But in terms of explaining aggregate productivity developments, they conclude that these patterns do not carry much weight in comparison with the large productivity declines observed within businesses.
For example, in contrast with the experience in service sectors that do not rely on bank finance, the productivity contributions of resource reallocation fell sharply between 2007 and 2011 among smaller businesses in bank-dependent service sectors.
The process whereby highly productive firms gain market share and less productive firms either lose market share or go out of business is thought to be a crucial driver of productivity gains. Several empirical studies suggest that such changes in the composition of the business population account for a significant part of both labour and total factor productivity growth. A key objective of this study is to investigate whether the credit crunch reduced the efficiency of resource allocation across businesses, thereby hindering one of the key mechanisms through which productivity growth arises.
When the economy moves from a growth phase to a shrinking phase, the most widely used decomposition techniques tend to lead to an automatic reduction in the productivity contributions of resource reallocation that has little to do with a change in the efficiency of resource reallocation. The study proposes a decomposition technique that avoids this while simultaneously retaining comparability to previous methods.
Rebecca Riley and Chiara Rosazza Bondibene are at the National Institute of Economic and Social Research (NIESR) and the Centre for Macroeconomics (CFM). Garry Young is at the Bank of England, NIESR and CFM. This work was supported by the Economic and Social Research Council grant reference ES/K00378X/1. Any views expressed cannot be taken to represent those of the Bank of England or to state Bank of England policy.