01Executive summary

While the UK’s productivity puzzle – the flat lining of national productivity since 2008 – has been subject to much focus from UK economists and policy makers, little attention has been given to the geography of it. While the slowdown happened across the country, this report shows that it was led by London.

The country’s strong productivity growth before the financial crisis was principally the result of the robust performance of the Capital. Productivity in London grew at 3.1 per cent per year (in real terms) between 1998 and 2007, well above the 1.9 per cent growth at the national level (which itself was the second highest growth in the G7). But the Capital has moved from being the leader of UK productivity before the financial crisis to the laggard since – from 2007 it has grown by just 0.2 per cent per year, and accounts for 42 per cent of the overall slowdown seen nationally.

While other developed economies have also seen a productivity slowdown, the performance of London is at odds with the largest cities in these countries. Cities such as Paris and New York have also seen productivity growth slowing down, but their performance since the financial crisis has both been stronger than London and has been above their respective national averages.

London’s slowdown means that the national economy is much smaller than it would have been if the Capital had kept pace with its peers. If London’s productivity performed in line with Brussels, Paris, New York, and Stockholm, it would have added £54 billion to the UK economy in 2019 alone (the equivalent of two Edinburghs). This would have generated around £17 billion extra for the exchequer to spend, which is well above the amount allocated to the Levelling Up Fund (£4.8 billion) and the City Region Sustainable Transport Settlements (£5.7 billion).

A key reason for this slowdown in London appears to be the sharp slowdown of its ‘superstar firms’ – the most productive firms in the Capital’s economy – typically located in the very centre of the Capital. And this goes beyond superstar firms in finance. While finance has been a part of this slowdown, it is not the sole cause. Other exporting services sectors, such as information and communications and professional services, have also stuttered.

It is difficult to identify definitively with the data available what the causal factors are in explaining this slowdown. Given that the countries whose cities were comparators in this report followed similar macro-economic policy such as ultra-loose monetary policy, it seems unlikely to have been a major cause. And Brexit, although it may have compounded the slowdown, did not trigger it – the flat lining of productivity began in 2008.

There are two London specific trends which should be of concern to both the Capital’s and national policymakers.

The first is that investment in tangible assets and real estate appear to have been crowding out other types of investment. Office costs have continued to rise since 2008 despite flatlining productivity. Meanwhile investment in intangibles such as software, databases and R&D, which are likely to be becoming increasingly important for the growth of the UK economy, have performed poorly as a share of GDP. It is plausible that the former has squeezed the latter, with implications for productivity growth.

The second is that increasing housing prices (a London problem caused by national planning policy and its application in London) and a restrictive migration policy (a national policy likely squeezing the most in London) have reduced London’s ability to compete for global talent. The eroding of London’s wage premium because of poor wage growth coupled with rising housing costs, compounded by the fall in the value of the pound and restriction on immigration, has come at a time when London’s share of skills and migrants from more developed countries has also stalled. Again, these trends pre-date Brexit.

To restart growth in London, policy should look to maximise the benefits that a big city offers while minimising as much as possible the costs of doing business in it. In doing so, this would increase the attractiveness of the Capital as a place to do business. To do this the following should happen:

  1. Rather than looking to limit foreign student numbers, central government should facilitate high-skilled migration by extending the graduate visa to five years. This would deepen and widen the pool of higher skilled workers businesses in London (and other cities) can hire from and make the British university system more competitive by making it more attractive to attend a UK university.
  2. Policymakers should address rising housing and commercial space costs by changing the approach to planning. Specifically:
    • Central Government should introduce planning reforms to make redevelopment of both residential and commercial space more certain. The current discretionary planning system makes redevelopment in existing urban areas hard at the scale required, hindering London’s ability to adjust to economic change and grow. A system that is more rules-based would reduce uncertainty and make it easier to build in places like London where planning constraints have the biggest impact.
    • In the meantime, the Mayor and local authorities should use Mayoral Development Orders and Local Development Orders respectively to allow the redevelopment of land near existing public transport, building on the work that has been started by Transport for London. These orders differ from the usual process because they are much more rules-based. Currently, Mayoral Development Orders are not in effect for the Mayor of London so it would require secondary legislation from Government.
    • The Mayor, supported by central Government, should also revise the most costly planning policies in the London plan. While changing the planning system and use development orders may help making development more certain, the London Plan includes further policies which restrict the provision of homes and office space in London. The greenbelt, conservation areas in central London, and protected views are some of them. They should be revised.
  3. Central government should devolve further powers to London, particularly fiscal powers. Not only do more fiscal powers provide greater freedom of policy, but they would also strengthen the incentives to tackle the economic challenges highlighted in this paper by allowing London to keep more of the gains from its growth. Options for this include:
    • A Parisian-style ‘versement transport’ tax on payroll to fund transport services;
    • Powers to capture revenue from land value uplift, which would allow London to raise revenue from who directly benefit from improvements in the Capital’s (i.e. public transport connections). This tool has been used sporadically in London;
    • Changes to the council tax system within London, for example through adding extra bands to increase the charges paid by the most expensive property, or revaluation of all properties in the Capital. This would follow similar reforms done in Scotland and Wales;
    • Give powers to implement a city sales tax similar to cities like New York or assign the Greater London Authority (GLA) a share of VAT raised in London;
    • A tourist tax;
      To deal with any negative fall out that Brexit and Covid-19 may have on London’s economy, which would come in addition to the analysis in this report, the following should also happen:
  4. Central government and the Mayor should work together to reform the Transport for London (TfL) funding model. A competitive London requires a world-class public transport system that links workers to jobs. The pandemic has left TfL in a more vulnerable position than transport systems in Paris, New York and Hong Kong because a much higher share of its revenues comes from ticket revenue than in the other cities. To underpin the sustainability of this key part of the ‘plumbing’ of London’s economy, the Mayor should work with central government to reduce TfL’s dependence on the farebox.
  5. Central government should review and amend the UK’s trading arrangements on services with Europe. While Brexit is not the main cause of London’s poor productivity performance between the financial crisis and Covid-19, restricting the ability of its services firms to EU markets could cause further problems through the 2020s. Despite low productivity growth, the financial sector continues to be a key part of London’s economy and the EU market was 37 per cent of its exports in 2019. By exiting the single market for financial services, London’s position is likely to become weaker.