One of the great curiosities of the UK economy is that productivity has stagnated. Output per hour has fallen in the last four years and has grown by only 1.1% a year over the last 10 years.
This is curious because it seems to contradict the principle of learning by doing. I spend about 10 hours a week playing guitar, and I’ve gotten much better in the last four years. Why, then, have the 900 million-plus hours per week we devote to work not yielded productivity improvements?
Here’s a theory - which I’ll overstate for expositional reasons. It’s that companies are institutionally stupid. They are incapable of learning.
Three pieces of evidence are consistent with this:
- 90% of the growth in total factor productivity in UK manufacturing in the 1980s came from plants entering and exiting (pdf) the market, rather than from incumbents improving productivity.
- The statistical distribution of corporate deaths is very similar to that of species’ extinction. This, says Paul Ormerod, suggests (pdf) that “firms have very limited capacities to acquire knowledge about the true impact of their strategies.”
- Alex Coad has found that corporate growth is largely random and unpredictable. This is consistent with the possibility that there is no “corporate intelligence“ that leads to growth (Or it could be that such intelligence is uncorrelated with observable variables - but why?)
But why don’t firms improve with practice in the way that individuals' musical or sporting performance improves? Here are four possible differences:
1. Within firms, there’s no mechanism for translating individuals’ learning, or incremental knowledge, into corporate knowledge. As Hayek said, hierarchies are terrible at using fragmentary, tacit, dispersed knowledge.
2. Job turnover means that job-specific human capital gets lost.
3. Bosses are selected for overconfidence. But overconfidence militates against learning.
4. In companies, the feedback that’s necessary for improvement gets warped by adverse incentives or ego involvement. If I play a phrase or chord badly, my ears tell me to practice it more. But if a company gets some adverse feedback - falling sales, say - no-one has an incentive or desire to say “I screwed up: I‘d better improve.” And formal efforts to generate feedback, such as performance reviews, often backfire.
What I’m saying is what every methodological individualist knows: companies are not individuals writ large. The differences between them can mitigate against learning by doing.
And herein lies the cost of the banking crisis. Because productivity growth comes from entry and exit rather than firms’ learning on the job, anything that retards the entry process - such as a lack of finance - will retard aggregate productivity growth, and hence economic growth.
Another thing: What’s true of firms is probably true of other organizations such as government departments. Organizational stupidity might well contribute to Baumol’s cost disease.