04The composition of London’s productivity stagnation
Looking at the performance of different parts of London’s economy helps to identify the likely sources of the Capital’s recent stuttering. This section explores the breakdown of productivity growth in the city by sector, firm and geography.
Productivity is largely determined by a city’s ‘export’ base
Not all sectors and businesses should be expected to contribute equally to productivity as they play different roles in an economy. Those that sell to regional, national and international markets (exporters) have higher productivity and drive productivity growth. In contrast, local services companies (such as restaurants and hairdressers) employ a lot of people but tend to have both low productivity levels and growth.13
Given this, the following focuses on the performance of London’s export sector and, in particular, the high-skilled, knowledge-intensive parts. Box 3 sets this out in more detail.
Box 3: Classification of exporters, local services and the definition of knowledge-intensive exporting services
In general, there are three types of private sector business. Local services (also known as business to consumer or B2C, or ‘non-tradable’ businesses), such as hairdressers or newsagents, sell direct to the consumer, so typically serve a very local market. Their locations, therefore, are decided predominantly by where their customers live, work, or trade. Exporting businesses (also known as tradable businesses) sell to regional, national or international markets and form the export base of the local economy. The markets these businesses sell to do not tie them to a specific location, as long as they can easily access their target customers. They are broadly divided between goods (e.g. car manufacturers) and services (e.g. computer programming).
Due to the nature of London and other global cities, where manufacturing is not as prevalent as it was decades ago, this paper focuses on service exports that have been classified as knowledge-intensive exporting services.
Given data availability, they are defined as follows:
- When analysing London’s productivity over time, knowledge-intensive exporting services include the following sectors: finance and insurance, information and communication, and professional, scientific and technical activities.
- To compare London’s sectoral performance with other global cities (measured by productivity at purchasing power parity from the OECD), administrative and support service activities, which are not considered to be mostly knowledge-intensive, are grouped with professional, scientific and technical activities. Due to data limitations, they are included to make the sectors comparable across different cities.
In the following sections, when measuring knowledge-intensive exporting services as a share of GDP, this is based on the lowest sectoral level available, which is a combination of 1-digit and 2-digit SIC codes.14 They include the following: information and communication, financial and insurance activities, head offices and management consultancy, architectural and engineering activities, and other professional, scientific and technical activities. This excludes legal and accounting activities from professional, scientific and technical activities, which are considered local services. For London, this is less likely to be the case than elsewhere in the UK due to the international nature of the city’s law firms. However, the data does not allow a distinction between local property conveyancers and international law firms.
Finance was driving London’s productivity, but stagnation goes beyond it
Before 2008, finance was a major driver of London’s productivity growth. The finance and insurance sector had the strongest productivity growth at around 6 per cent a year, which was almost twice the Capital’s overall rate.
This sector, however, was not the sole contributor as it is sometimes claimed. Before the financial crisis, other knowledge-intensive exporting sectors, for example information and communication and professional, scientific, and technical activities, grew strongly at 3.5 per cent a year or above (Table 1).
Table 1: The productivity slowdown occurred in almost all services
| Annualised change in output per job (constant prices) | Type | 2000 to 2008 | 2010 to 2019 |
| All Industries | – | 2.7 | 0.6 |
| Finance and insurance | Knowledge-intensive service exporter | 5.9 | -1.1 |
| Information and communication | Knowledge-intensive service exporter | 3.7 | 1.7 |
| Professional, scientific and technical activities | Knowledge-intensive service exporter | 3.5 | 2.1 |
| Accommodation and service activities | Local services | 3.1 | 0.9 |
| Services (excluding finance) | – | 2.8 | 0.7 |
| Real estate activities | Local services | 2.6 | -0.3 |
| Wholesale and retail trade | Local services | 2.1 | 0.4 |
| Human health and social work activities | Local services | 1.6 | 2.0 |
| Transportation and storage | Local services | 1.4 | -0.8 |
| Administrative and support service activities | Local services | 1.1 | 2.9 |
| Arts, entertainment and recreation | Local services | -1.0 | 0.9 |
The productivity slowdown after the financial crisis is often associated with the decline of the financial sector. However, productivity growth pre-2008 cannot be fully explained by finance and the same can be said about the current slowdown.
The sector moved from having the fastest productivity growth to having the worst, with productivity declining. But as Table 1 above shows, the post-crisis slowdown happened in most sectors, and finance and insurance only accounted for one quarter of the drop.15 The remaining knowledge-intensive exporting services (i.e. information and communications and professional, scientific and technical activities) performed better than average between 2010 and 2019, but experienced a significant slowdown compared with their pre-2008 growth rate (from 3.5 to 3.7 per cent a year between 2000 and 2008 to 1.7 to 2.1 per cent between 2010 and 2019).
Knowledge-intensive exporting services are doing better in other global cities
The weak performance of knowledge-intensive exporting services following the financial crisis in London becomes even more evident when compared with its international peers.
Figure 5 shows that, based on 2008 productivity levels, the Capital was highly productive in finance and insurance – second only to Brussels – and relatively productive in information and communication’ services. But between 2008 and 2018, the four cities analysed either converge or surpass London in those two activities.16 Taking high productivity levels as a proxy for having a competitive advantage, London is becoming globally less competitive in several knowledge-intensive exporting services. Tackling these issues will require developing competitive advantages within these sectors (for example, FinTech within finance) and in new areas of exporting activity as they emerge.
Figure 5: London lost its competitive advantage in finance and insurance
In London, the only knowledge-intensive exporting service that saw productivity grow faster than its global peers was professional, scientific and administrative services.17 As the Capital had a comparatively low level of productivity in this sector in 2008, this may be a sign that it is catching-up rather than emerging as an innovative and globally competitive sector that can drive productivity growth in the future.
The slowdown is likely to have been led by ‘superstar’ firms
The decline in London – especially within its exporting activities that are lagging its international peers – is likely to be driven by a stuttering of superstar firms – the 10 per cent most productive companies in the cohort.
Bank of England research shows that pre-crisis, national productivity growth was led by a set of superstar firms. But afterwards, the cohort saw a drop in their productivity growth, which the Bank identifies as the main cause of the economy’s wider slowdown.18
Although data from before the crisis is not available at the London level, looking at data from 2008 onward shows three things. The first is that superstar firms are disproportionately exporter businesses – 36 per cent are in exporting activities (12 per cent of all firms). The second is that they are disproportionately located in London – the Capital is home to 20 per cent of exporting superstar firms, compared with 14 per cent of all exporting firms.
The third is that their productivity growth was very sluggish after 2008. It lagged both the growth of less productive exporter businesses, and of superstar firms elsewhere in the country (which underperformed relative to their wider business bases – see Figure 6).
Figure 6: London’s weak productivity growth is likely to be driven by its superstar firms
The low nominal productivity growth for superstar firms in London is likely to be negative in real terms, as the GVA deflator for the same period was 1.5 per cent a year.19
It is not entirely clear whether this underperformance can be mostly explained by weak productivity growth within existing superstar firms, or the absence of new ones emerging in London. Research at the national level suggests it is the former.20
Central London has been at the core of the slowdown
The variation in productivity growth across geographies within the Capital shows a similar pattern. Local authorities in central London (see Box 4 for definitions), where levels are the highest, have had the strongest slowdown since 2007. Box 4 analyses the differences within this geography.
Figure 7: The productivity slowdown was mostly driven in central London local authorities
Figure 7 shows that core city centre productivity growth fell from 2.3 per cent a year (2004 to 2007) to 0.8 per cent (2007 to 2019). One potential explanation may be the location of superstar firms. These businesses disproportionally locate in central London due to the inherent benefits it offers (e.g. access to large numbers of skilled workers and a network of similar companies with which to share information and knowledge).21 Central London local authorities account for 10 per of the Capital’s land and 47 per cent of its GVA. This is even more prevalent for the superstar firms – around 52 per cent of their GVA is generated in central London local authorities.22
Box 4: London’s areas and the role of emerging areas on the fringes of central London
As previously discussed, different parts of a city play different roles. The centres typically provide jobs in high concentrations, while suburban areas offer housing and some local services for residents. To better understand how different areas in London performed over time, this box divides its PUA into three categories: city centre, new city centre and outer London. They are defined using local authorities due to productivity data availability.
- Core city centre: Includes two of the most productive local authorities, the City of London and Tower Hamlets (Canary Wharf), and surrounding local authorities such as Camden, Westminster and Islington.
- New city centre: Includes local authorities adjacent to the city centre, where productivity has been historically low. This includes Hackney, Lambeth and Southwark. In recent years these authorities emerged as new business hubs with premises like the Shard (Southwark) or the Silicon Roundabout (Hackney).
- Outer London: Remaining local authorities included in the PUA definition of London.23
Figure 8: London’s geographical definitions
Source: ONS. Centre for cities.
The areas included in ‘new city centre’ – which include London Bridge and Old Street that have emerged as new business hubs in recent years – had the highest productivity growth since the financial crisis and, unlike other areas, it remained mostly unchanged. While less productive than London’s average, these local authorities have been converging. Their productivity moved from 83 per cent of London’s total in 2004 to 85 per cent in 2019.
Figure 9: Areas on the fringes of the core city centre had the strongest performance since the financial crisis
Source: ONS. Methodology: Geographies based on local authorities.