The UK Innovation Report 2022

Policy questions and key messages

1. How has the structure of the UK economy changed in the last few years?
2. Are these changes affecting economic performance?
3. How does this compare with other countries?

In the last two decades high-productivity sectors such as manufacturing and mining have reduced their participation in the UK economy in favour of sectors such as construction and services

• The manufacturing productivity growth rate was among the highest in the UK economy between 1998 and 2019, but it was also the sector whose share in the economy decreased the most (from 16.1% to 9.7%) during this period.
• Services whose share of the economy increased during this period include (change in value-added shares in brackets, percentage points): human health and social activities (2.1); professional, scientific and technical activities (2.0); and administrative service activities (1.4).

Finance was the main driver of productivity growth prior to 2008 but its contribution became negative in the post-crisis period

• In the period 1998–2007, finance was the main driver of productivity growth in the UK, adding 0.37 percentage points, on average, each year to aggregate productivity growth. After the crisis, finance’s contribution to national productivity became negative.
• Administrative services, construction, information and communication, and professional, scientific and technical activities were among the top contributors to aggregate productivity growth in the post-crisis period (2011–19).
• Following  the COVID-19 pandemic the main contributor to productivity growth was human health and social activities.

The loss of manufacturing has imposed a penalty on UK productivity growth of half a percentage point each year, on average, for the last two decades

• The reduction in manufacturing share in economies is a common feature across most of the economies examined between 1998 and 2017. But as a result of its high-productivity growth rates, manufacturing is one of the sectors that makes the largest contribution to aggregate productivity growth in the best-performing countries.
• During 1998–2017, manufacturing was responsible for around 30% of the aggregate productivity growth in China and almost half of productivity growth recorded in Taiwan during 1998–2017. Manufacturing also contributed to around 30% of aggregate productivity growth in Korea between 2005 and 2017 and 15% of productivity growth in Singapore between 2005 and 2017.
• In contrast, manufacturing had a negative contribution to aggregate productivity growth in the UK during this period, mainly due to a reduction in its participation in the economy (as reflected in a negative allocation effect of -0.5 percentage points).

Labour productivity: international comparison

Source: Authors’ computation based on data from APO Productivity Database 2020 Ver.1 (August 05, 2020); OECD STAN Industrial Analysis (2020 ed.); Korea Productivity Center; Singapore Department of Statistics; Singapore Ministry of Trade and Industry; Manpower Research & Statistics Department; Taiwan Statistical Bureau UK Office for National Statistics; US Bureau of Economic Analysis and US Bureau of Labor Statistics.

• In the pre-crisis period (1998–2007) UK labour productivity growth rates were similar to those observed in other developed countries such as Germany and the US. China, Korea and Taiwan recorded the strongest performance during this period.
• In the aftermath of the financial crisis (2008–10), most countries analysed experienced a significant slowdown in productivity growth. However, the UK was hit the hardest, recording a negative growth rate of -0.5%.
• In the post-crisis period (2011–17) the strongest productivity performance was recorded by China, Korea and Germany (7.3%, 3.2% and 2.3%, respectively). Productivity growth in the UK, the US and Taiwan was considerably weaker (0.7%, 0.7% and 1.1%, respectively).

UK economic structure and sectoral productivity (a)

Note: N/A not available. 1/Chain volume measure (CVM) prices. 2/ Productivity of the real estate sector is distorted by the inclusion of imputed rents from owner occupied dwellings in the value added of this sector. Source: Own computation based on data from the UK Office for National Statistics.

• Sector-level analysis reveals the key structural factors behind the relatively slow rates of productivity growth in the UK. The contribution of economic sectors to aggregate productivity growth depends on how productive they are (usually measured by value added per hour), their rate of productivity growth and their relative size in the economy (usually measured in terms of value added and employment shares).
• In 2019 the most productive market sectors in the UK economy included (overall value added per hour worked in brackets): mining and quarrying (£163.2), electricity and gas (£98.9), water supply (£98.8), financial and insurance activities (£63.9), information and communication (£50.4) and manufacturing (£39.1).
• The case of manufacturing stands out. While manufacturing productivity growth was among the highest between 1998 and 2019 (with an annual growth rate of 2.2%), it was the sector with the largest decline in value-added shares during this period (-6.5 percentage points).
• Meanwhile, mining and quarrying almost halved its labour productivity, while reducing its value-added share by 0.5 percentage points during this period.

UK economic structure and sectoral productivity (b)

Source: Own computation based on data from the UK Office for National Statistics.

• Chart 1.3 shows the productivity in 2019 and the changes in value-added shares between 1998 and 2019 for selected sectors.
• The participation of manufacturing in the economy declined significantly during this period (by 6.5 percentage points). Meanwhile, construction and both high- and low-productivity service activities increased their participation in the economy.
• Services that experienced the largest increase in value-added shares during this period include (changes in percentage points in brackets): human health and social activities (2.1); professional, scientific and technical activities (2.0); and administrative and support-service activities (1.4).

Sectoral sources of UK productivity growth

Note: Contribution to aggregate productivity is computed as the sum of intra industry productivity growth (within) effect and allocation (between) effect. Figures correspond to average annual contributions. Source: Own computation based on data from the UK Office for National Statistics.

• Sectors contribute differently to aggregate productivity growth because of disparities in their productivity performance and their participation in employment and output.
• In the pre-crisis period (1998–2007) financial and insurance activities were the main driver of productivity growth in the UK, with an average annual contribution to productivity growth of 0.37 percentage points. In contrast, manufacturing had a negative contribution (-0.31).
• In the post-crisis period (2011–19), the contributions of the financial and insurance sector to aggregate productivity growth declined to negative levels (-0.17 percentage points), with real-estate activities, administrative and support services and information and communication having among the largest contributions (0.19, 0.14 and 0.10, respectively).
• A likely explanation for the decline of the financial sector is that, in the pre-crisis period, high growth was mainly driven by unsustainable increased debt and higher risk tolerance.^[1]
• It is important to note that the contribution of the real-estate sector is distorted by the inclusion of imputed rents from owner-occupied dwellings in the value added of this sector.^[2]
• The increasing demand for health and social services during the COVID-19 pandemic meant that this sector was responsible for the largest contribution to aggregate productivity growth in 2020 (1.97 percentage points). Meanwhile, accommodation and food-service activities had a negative contribution (-1.18 percentage points).

---

^[1] Teneyro, S. (2018). The fall in productivity growth: causes and implications.

^[2] Riley et al. (2018). Below aggregate: a sectoral account of the UK productivity puzzle.

Sectoral sources of UK productivity growth, pre-crisis

Note: 1/Chain volume measure (CVM) prices. Source: Own computation based on data from the UK Office for National Statistics.

• In the decade before the financial crisis (1998–2007) the sectors with the largest contributions to aggregate productivity growth were: financial and insurance activities (0.37); construction (0.29); human health and social activities (0.29); professional, scientific and technical activities (0.29); and information and communication (0.23)
• The contributions of financial and insurance activities, information and communication and professional, scientific and technical activities during 1998–2007 were mainly driven by the growth of productivity in each of these sectors (intra-industry productivity effect).
• Meanwhile, the contributions of the construction and human health and social activities sectors during this period are largely explained by their expansion (allocation effect).
• At 4.2%, the productivity growth rates of the manufacturing sector were among the highest during 1998–2007 (resulting in an intra-industry productivity effect of 0.57). However, its employment share declined by 5.5 percentage points (resulting in a negative allocation effect of -0.89). As a result, the contribution of manufacturing to productivity growth in this period was the lowest in the economy (-0.31).

Sectoral sources of UK productivity growth, pre-crisis

Note: (1)Chain volume measure (CVM) prices. Source: Own computation based on data from the UK Office for National Statistics (2011,2019).

• In the decade after the financial crisis (2011–19) the sectors with the largest contributions to UK aggregate productivity growth included: real-estate activities (0.19); administrative and support-service activities (0.14); construction (0.11); information and communication (0.10); and professional, scientific and technical activities (0.08).
• Except for real-estate activities, the contributions of these sectors are largely explained by relatively higher productivity growth rates (intra-industry productivity effect).
• The sectors with the weakest contributions to aggregate productivity in the reference period include: financial and insurance activities (-0.17); mining and quarrying (-0.08); manufacturing (-0.07); public administration (-0.06); and wholesale and retail trade (-0.06).
• Except for mining and quarrying, the negative contributions of these sectors were due to their contraction in size (allocation effect). Among these activities, the wholesale and retail trade sector experienced the largest contraction in employment.

Sectoral sources of UK productivity growth, COVID-19

Note: (1)Chain volume measure (CVM) prices. Source: Own computation based on data from the UK Office for National Statistics (2019, 2020).

• During the COVID-19 pandemic (2019–20) the sectors with the largest contributions to aggregate productivity growth included: human health and social activities (1.97); real-estate activities (0.63); education (0.56); public administration (0.53); and financial and insurance activities (0.62).
• Other sectors (not presented in the table) with relatively large positive contributions in the reference period include professional, scientific and technical activities (0.28) and information and communication (0.10).
• The sectors with the weakest contributions to aggregate productivity in the reference period include: accommodation and food services (-1.18); administrative and support services (-0.64; construction (-0.56); manufacturing (-0.44); and  transportation and storage (-0.41).
• The negative contributions of accommodation and food services and transportation and storage during this period are explained by both deterioration in productivity growth (negative intra-industry productivity effect) and a reduction in size (negative allocation effect). Meanwhile, the negative contributions of administrative and support-service activities, construction and manufacturing are a result of their reduction in size.

Sectoral productivity: international comparison

Note: N/A not available. *2010-2017 annual average is computed for Singapore. Source: APO Productivity Database 2020 Ver.1 (August 05, 2020); OECD STAN Industrial Analysis (2020 ed.); Singapore Department of Statistics; Singapore Ministry of Trade and Industry; Manpower Research and Statistics Department; Taiwan Statistical Bureau; UK Office for National Statistics; US Bureau of Economic Analysis and US Bureau of Labor Statistics.

• Between 1998 and 2017 China and Korea experienced the strongest productivity growth among the eight economies studied (8.9% and 5.1% on average per year, respectively).
• The UK showed the lowest productivity growth rate in this period. However, some UK sectors performed relatively better. Service sectors in which the UK may have comparative advantages include (average annual growth rate in brackets): information and communication (4.0%); financial and insurance activities (2.3%); professional, scientific and technical activities (2.3%); and administrative and support services (2.3%).
• In contrast, UK market sectors that performed relatively worse than those in other countries in the reference period include (average annual growth rate in brackets): mining and quarrying (-2.8%); transportation and storage (0.4%); wholesale and retail trade (1.4%); and manufacturing (2.5%).

Structural change: international comparison

Source: APO Productivity Database 2020 Ver.1 (August 05, 2020); OECD STAN Industrial Analysis (2020 ed.); Korea Productivity Center; Singapore Department of Statistics; Singapore Ministry of Trade and Industry; Manpower Research & Statistics Department; Taiwan Statistical Bureau; UK Office for National Statistics; US Bureau of Economic Analysis and US Bureau of Labor Statistics.

• The shrinking of manufacturing is a major structural change observed in most of the economies examined between 1998 and 2017.
• The biggest declines in manufacturing shares were recorded in (changes in percentage points in brackets): Singapore (-8.6), the UK (-5.9%) and China (-5.6). There have, however, been some exceptions. Manufacturing output shares expanded in Germany (0.7), Korea (3.6) and Taiwan (7.4). And while Singapore reported the largest decline in manufacturing output shares among the countries examined (-8.6), this trend has reverted in the years since 2017.
• Meanwhile, service activities have expanded in most of the countries analysed. This is true for both knowledge-intensive services and other services (see note).
• The largest expansions in output shares of knowledge-intensive activities were seen in (changes in percentage points in brackets): China (5.7), Singapore (4.3) and the UK (4.1). Other service activities have also expanded; changes range from 1.7 percentage points in Germany to 12.5 in China.

---

Note: Knowledge-intensive services group together information and communication, financial and insurance activities, professional, scientific and technical activities, and education, with the exception of China, which only groups together financial and insurance activities. Other services include wholesale and retail, transportation and storage, accommodation and food-service activities, real-estate activities, administrative and support-service activities, public administration and defence, human health and social work activities, arts, entertainment and recreation, and other service activities, with the exception of China, which groups together wholesale and retail, transportation and storage, and community, social and personal services.

Sectoral contribution to aggregate productivity growth: international comparison

Source: Authors’ computation based on data from APO Productivity Database 2020 Ver.1 (5 August 2020); OECD STAN Industrial Analysis (2020 ed.); Korea Productivity Center; Singapore Department of Statistics; Singapore Ministry of Trade and Industry; Manpower Research & Statistics Department; Taiwan Statistical Bureau; UK Office for National Statistics; US Bureau of Economic Analysis and US Bureau of Labor Statistics.

• As a result of its high productivity growth rates and relatively large output shares, manufacturing is one of the sectors with the largest contributions to aggregate productivity growth in the best-performing countries.
• Manufacturing was responsible for around 30% of the aggregate productivity growth in China and almost half of the productivity growth recorded in Taiwan during 1998–2017. Manufacturing also contributed to around 30% of the aggregate productivity growth in Korea between 2005 and 2017 and 15% of the productivity growth in Singapore between 2010 and 2017.
• In contrast, manufacturing had a negative contribution to aggregate productivity growth in the UK during this period, mainly due to a reduction in its participation in the economy (as reflected in a negative allocation effect of -0.5, on average).
  §This means that the loss of manufacturing imposed a penalty on UK productivity growth of half a percentage point per year between 1998 and 2017.
• Another distinctive feature of the UK economy is a lower intra-industry productivity growth effect (due to lower productivity growth) than the other countries analysed across most sectors.
• Across the countries studied, the contraction of the manufacturing sector has been mirrored by a greater contribution of services to aggregate productivity growth.
• Between 1998 and 2017, the contribution of knowledge-intensive services was positive in all of the countries analysed (ranging from 0.2 in Taiwan to 0.55 in the UK and 1.2 in China). The positive contribution of knowledge-intensive services is mainly explained by high productivity growth rates (as reflected in positive intra-industry productivity growth effects).
• In comparison, other services contributed less to aggregate productivity growth in the UK than they did in the other seven countries during this period. The contribution of other services to UK productivity growth was 0.65, compared to 3.44 in China, 1.91 in Korea and 1.88 in Singapore.Note: Knowledge-intensive services group together information and communication, financial and insurance activities, professional, scientific and technical activities, and education, with the exception of China, which only groups together financial and insurance activities. Other services include wholesale and retail, transportation and storage, accommodation and food-service activities, real-estate activities, administrative and support-service activities, public administration and defence, human health and social work activities, arts, entertainment and recreation, and other service activities, with the exception of China, which groups together wholesale and retail, transportation and storage, and community, social and personal services.