Progress in understanding the UK’s productivity slowdown requires credible estimates of firm-level Total Factor Productivity (TFP). In this paper, Diane Coyle, John McHale, Ioannis Bournakis and Jen-Chung Mei use data on firms’ revenues and input expenditures to provide new estimates of a measure of quality-adjusted TFP.
Understanding the disappointing productivity performance of the UK economy since the financial crisis is complicated by the well-known challenges of estimating total factor productivity using revenue data.
To address this, we have developed a framework to estimate quality-adjusted total factor productivity based on an estimated firm-level revenue function. Our structural identification relies on the inclusion of deflated industry revenue in the firm-level revenue function.
Furthermore, as we allow quality changes to act as shift factors for firm-level demand, the resulting measure of total factor productivity combines product quality and technical efficiency components.
We use the Blundell-Bond System GMM estimator to apply this structural identification technique to micro data for two important sectors of the UK economy – manufacturing and ICT – for the period 2008 to 2019.
For manufacturing, we find a consistent fall in revenue-weighted within-firm quality-adjusted total factor productivity that is reinforced by adverse reallocation effects. For ICT, we find a small fall in within-firm quality-adjusted total factor productivity that is more than offset by favourable reallocation effects.
These results are generally robust to imposing constant returns to scale on the production function and to allowing for a fixed component in labour costs. We conjecture that the declines in the within-firm component are explained by adverse relative quality effects for UK firms in international markets, rather than outright technological regression.
