Skip to content

Boosting economic growth

23rd Jan 2017

One area where behavioural economics has had surprisingly little impact – rather ironically – has been economic policy. The UK’s Industrial Strategy, published today, starts to change this.

Adam Smith wrote extensively of the role of sentiment. Keynes highlighted how shocks and booms are driven by ‘animal spirits’. More recent work by Akerlof and Shiller, Thaler and others has laid bare the inadequacies of economic models based on ‘econs’.

Yet despite these failings, economic policy still has held, very deeply, onto the view that humans are rational utility maximisers; with information flowing freely; and markets necessarily finding optimum equilibria. The logical corollary is that the best that governments can do is to get out of the way, perhaps occasionally breaking up monopolies and ensuring that externalities are correctly priced (for example by supplying basic skills training and taxing polluters).

An alternative view, woven through the new Industrial Strategy is that markets are riven with deep behaviourally-based failures. Fortunately, there is a great deal that governments can, and should, do to fix these failures. This can boost growth rates and ensure that growth is more widely spread.

Improving B2B markets

How does a business know if a consultant will help their growth or is just selling snake oil? How can an SME know if it’s worth switching their accountant, bank, lawyer, or web designer? Many of these judgements are dominated by inertia, word-of-mouth information, and error-prone intuition.

Behaviourally-based market failures are increasingly familiar in consumer markets. Millions of consumers could get better deals on their energy or banking, yet never switch. These failures are likely to be at least as bad in business-to-business (B2B) markets where transactions are less frequent, and information more shrouded (how many businesses want to share that they spent millions on an IT system that didn’t work?).

Mike Luca has shown how sharing feedback between consumers fundamentally changes market functioning. Such feedback boosts the growth of better-rated suppliers, and particularly that of smaller, otherwise less well-known suppliers. As is often remarked, no-one gets fired for hiring IBM. But in a world where it becomes possible to identify which providers are doing a good job, businesses can ‘take a chance’ on a small innovative provider. Actively promoting the development of feedback platforms in B2B markets – a ‘trip advisor’ for every sector – provides a direct way of stimulating innovation and productivity growth. And a pretty good place to start is with providing market feedback from the biggest private sector purchaser of all – government itself.

Helping managers be better managers

Pretty much everyone thinks they’re better than average, and managers are no exception. But the stats lay bare a long tail of low productivity and poor management practice.

How do decisions about taking on extra workers, or investing in new plant, get made? These decisions rely on the same mental shortcuts as everything else humans do. Managers are influenced strongly by what they think others are doing, and by confidence and mood. Similarly, the process by which best-practice spreads is slow and imperfect. It is estimated to take 17 years for new life-and-death practice to diffuse in medicine, where a whole array of institutions are dedicated to active training and spread of best practice. Realistically, most widget producers across the UK don’t spend their weekends reading Mike Norton’s latest work on incentives in Harvard Business Review.

In this respect, initiatives such as Charlie Mayfield et al’s new Productivity Council is a key addition to the landscape. Imagine a world where businesses can actually find out how good their productivity is relative to the best in their sector – not least using HMRC and other existing data – and then receive support to improve. This may range from optimising production lines, to how to give constructive feedback to staff. Supporting the UK’s David Brents (cf the Office) to be a little better offers the promise of an enormous productivity gain and economic boost.

Supporting user-generated innovation

There is a well-rehearsed concern about the ‘valley of death’ – how promising university research fails to turn into commercial products. But there is an even more neglected channel: the ideas that users come up with.

As documented by Eric Von Hippel, products ranging from the mountain bike to the disposable nappy were originally developed by users (not companies). It has been estimated that in the UK alone, there are around 3 million serial user-innovators – people that regularly adapt or alter products in their sheds, kitchens and workplaces, most of which never diffuse. Lots of these adaptions will be crazy, but some of them will be tomorrow’s mountain bike. Running competitions, and creating an infrastructure, to flush out more of these ideas is a rich new seam for innovation and economic growth, and especially in a nation of Heath Robinsons.

Testing, and spreading, what works

Tucked away in the strategy is another quietly revolutionary idea: that we will test, learn and adapt what works to boost economic growth. Last week, at an event at LSE, Henry Overman – head of the UK’s What Works centre for local economic growth – presented an overview of what the last 50 years of research from across the world has shown.

We have learnt quite a bit. But what is really shocking is just how thin the evidence remains in so many areas. There are loads of studies, but when you scratch the surface you find that most are of poor quality, including many previous government-funded evaluations. Improving access to finance? 1450 studies. Fantastic. But wait – only 27 of these 1450 are actually impact studies, and of these only 11 reach a decent methodological standard (6 show positive results). The same is seen again and again.

It cannot be overstated how radical and important this is. The truth is that, of all the billions spent by national, local and EU funds, we know shockingly little about what actually boosts local growth.

Growth policy has been based on weird, unrealistic assumptions about human behaviour. When we have intervened, we’ve generally failed to check whether what we do works. Can you imagine what might be possible if we address these deficits?