The Changing Place of Britain in the World Economy: a Long-Term Perspective Nick Crafts Leverhulme Globalisation Lecture, University of Nottingham, November.

The Changing Place of Britain in the World Economy: a Long-Term Perspective

Nick CraftsLeverhulme Globalisation Lecture,

University of Nottingham, November 19, 2008

Themes

• Relative Economic Decline

• De-Industrialisation

• Regional Disparities

• Adjusting to Changing Comparative Advantage

• Policy Implications

Real GDP/Person

UK/USAUK/West Germany

UK/France

1870 130 173 170

1913 93 135 141

1950 73 162 132

1979 70 86 88

2007 75 109 104

Relative Economic Decline

• Was most apparent from the 1950s through the 1970s

• Was associated with a period of protectionism and weak competition

• Has possibly been reversed in the recent past

• Britain’s time as the ‘workshop of the world’ has gone; de-industrialisation is a fact of life and there is a new international division of labour

Shares of World Manufacturing Production

1880 1913 1955 1973 2007

UK 23 14 8 5 3

China 12 4 2 4 11

Shares of World Manufactured Exports

1880 1913 1953 1973 2007

UK 38 27 18 7 4

China 0.6 0.7 11

De-Industrialisation• Common experience of advanced economies

and has been continuous in Britain since the late 1960s

• Reflects income elasticities of demand, productivity growth, comparative advantage and trade policy

• Accelerated with move away from high tariffs and then Thatcherism

• Structure of employment has changed greatly over the long run

Employment Shares (%)

1911 1951 1979 2008

Agriculture 11.8 6.4 2.8 0.9

Industry 44.1 44.5 37.0 15.9

Services 44.1 49.1 60.2 83.2

Detailed Employment Shares (1) Percent

1911 1951 1979 2008

Textiles & Clothing 12.4 7.1 2.9 0.4

Engineering 6.7 11.2 8.6 2.8

Metal Manufactures 4.1 4.6 4.9 1.4

Detailed Employment Shares (2) Percent

1911 1951 1979 2008

Financial & Business Services

1.1 3.5 9.2 21.2

Education 1.5 1.5 5.8 8.9

Health 0.7 1.7 5.6 12.7

Reversing Relative Economic Decline

• Required improved incentive structures to improve TFP and reduce NAIRU

• TFP gaps have been much reduced and Beveridge Curve shifts in

The Beveridge Curve

UV1

UV2

Unemployment rate

Va

can

cy r

ate

Reversing Relative Economic Decline

• Required improved incentive structures to improve TFP and reduce NAIRU

• TFP gaps have been much reduced and Beveridge Curve shifts in

• Key ingredient was increasing competition in product markets

• Openness in both capital and trade flows matters

• Realising gains from trade is important

Trade Exposure [(X+M)/GDP] (%)

1830 17.6

1870 40.3

1910 44.0

1960 40.0

2000 56.8

The Payoff from Globalisation (% GDP)

1830-70 38.7

1870-1910 2.7

1910-1960 -2.7

1960-2000 12.5

Based on similar assumptions to HMT (2003) and Bradford et al. (2006)

UK Comparative Advantage

• Has changed markedly over time

• Victorian staples were neither high-tech nor human-capital intensive but today’s manufactured exports are often both

• World market share in services in now twice that in manufactures

• Responding to these changes requires both sectoral and spatial adjustment

• Agglomeration plays a key role

Revealed Comparative Advantage in Manufacturing: Top 3 sectors

1913 1937 1979 2006

Rail & ShipAlcohol & Tobacco

Aerospace Pharmaceuticals

Textiles Textiles Pharmaceuticals Aerospace

Iron & Steel Rail & Ship Office MachineryElectrical & Electronic Equipment

Lancashire Textiles and Globalization (Leunig, 2005)

• Lancashire a high wage industry: 6 x India and Japan in 1910

• But continued to dominate world trade (60% world market share in cottons in 1910)

• Unit costs lower than India or Japan even before adjusting for output quality

• Lancashire flourished because of agglomeration benefits ..... its productivity exceeded other British locations by 33%

Revealed Comparative Advantage, 2006: Top 6, All Sectors

Financial Services 4.68

IT Services 2.37

Communication Services 2.26

Personal, Cultural & Recreational Services 2.09

Other Business Services 2.07

Pharmaceuticals 1.84

Regional Implications of Globalization

• Contraction of tradables that lose comparative advantage hurts East Anglia (then), West Midlands (now)

• Growth of invisibles boosts London (then and now) and South East and East Anglia (now)

• Globalization undermines North West which has been in long term relative economic decline since mid-19th century

Source: Crafts (2005)

Regional GDP/Person (% deviation from British average)

-40

-20

0

20

40

60

80

1871 1911

London Rest SE East Anglia West Midlands North West

Source: ONS

Regional GDP/Person (% deviation from British average)

-20

-10

0

10

20

30

40

50

60

1971 2006

London Rest SE East Anglia West Midlands North West

Source: Rice & Venables (2003)

Correlations When One City has Higher Productivity

Y/L Skills W Density HP

Y/L 1 + + + +

Skills 1 + + +

W 1 + +

Density 1 +

HP 1

Equilibrium Regional Disparities

• These regional differences are consistent with an equilibrium …. no market failure

• Real earnings for each skill level converge quickly across regions (Duranton & Monastiriotis, 2002)

• Can only be eliminated if productivity gap is closed

• If that is impossible, best to let favoured city get bigger

Sub-Optimal Size of British Cities

• Optimal locations for big cities today different from mid-19th century

• Successful 19th century cities expanded dramatically but not allowed today; (Blackburn and Preston vs. Oxford and Cambridge)

• Both expansion and contraction distorted by policy interventions

• Key symptom of city that is too small; high urban land values

Death of Distance?

• Transport and communications costs melt away: all locations equally good, so go where labour is cheap

• Greatly exaggerated; ICT is rearranging geography not abolishing it

• Agglomeration benefits still matter a lot

• Offshoring offers gains from trade in services not decimation of British economy

Source: UBS (2008)

Wage Levels, 2008 (New York = 100)

0102030405060708090

100110

Frankfurt London Barcelona Prague Shanghai Mumbai

Source: A. T.Kearney (2007)

Top 10 Offshoring Locations

1) India

2) China

3) Malaysia

4) Thailand

5) Brazil

6) Indonesia

7) Chile

8) Philippines

9) Bulgaria

10) Mexico

Note: based on financial attractiveness (40%), people and skills (30%), and business environment (30%)

Offshoring: Evidence• 14 million US service sector jobs ‘vulnerable’

(96 million not)

• Offshoring of business services grew 20-fold in 5 years to 2007; typical cost saving 20%-40%

• Offshoring works for routine activities where performance is easy to verify and face to face interaction is not needed

• Payroll services, IT services, transaction processing, telemarketing etc

• It is win-win when markets work well

London as a Financial Centre

• Agglomeration where size matters

• Benefits from thick labour markets and importance of proximity for deal-making

• Clerical jobs will increasingly be offshored

• This will strengthen the core business

UK Asset Management: Core BusinessOXERA (2005)

Importance Score

Financial Infrastructure 4.00 3.96

Size of Labour Pool 3.96 4.24

Quality of Life 3.77 3.36

Market Liquidity 3.69 4.29

Regulatory Regime 3.69 3.40

UK Asset Management: Back-OfficeOXERA (2005)

Importance Score

Total Labour Cost 4.00 2.74

Size of Labour Pool 3.92 4.08

Flexibility of Labour Market 3.89 3.22

Property Rentals 3.59 2.11

Financial Infrastructure 3.42 3.85

Agglomeration Economies• External economies of scale from localisation

and urbanisation economies

• Increase with city size (though not without limit)

• Much bigger in services: financial services = 0.25, manufacturing = 0.04 (Graham, 2007)

• Central to British competitive advantage under globalisation

• Are foregone if transport inadequate or city size restricted

Source: Leunig & Overman (2008)

Welfare Loss

NW3

NW2

NW1

NANB N

New Net Wage Curve

Welfare Loss

Old Net WageCurve

A

B

A1

NW

Planning Laws Need a Major Re-Think

• UK is failing to take full advantage of the opportunities presented by globalisation

• Spatial adjustment is severely constrained

• Planning restrictions imply massive distortions in land use: housing/agricultural land values 400/1 (Cheshire &

Sheppard, 2005); office space more expensive in Manchester than in New York (Cheshire & Hilber, 2008)

• Local Communities, especially in the South East, can and should be incentivised to want development

Conclusions

• Positive response to globalisation has been important in reversing relative economic decline

• Regional disparities are an inherent part of this and per se do not signal need for policy intervention

• Flexible adjustment to globalisation was the hallmark of 19th-century Britain and needs to be facilitated in 21st-century Britain