The decline of Britain’s manufacturing sector is not in dispute, though the causes of that decline have prompted much debate. The popular candidates are the general shift of manufacturing toward lower-cost developing countries and the recent high value of the pound sterling. But while such exogenous factors doubtless play a part, the troubles of the UK manufacturing sector result in large measure from a factor that, fortunately, lies squarely within its managers’ control: labor productivity. The proof lies in the productivity of foreign-owned plants in the United Kingdom. In US-owned plants there, for example, labor is about 80 percent more productive on average than it is in UK-owned plants—in every sector. As a result, overall productivity is suffering and so, consequently, are both UK manufacturing’s contribution to the country’s gross domestic product and the financial performance of individual manufacturers.

While it is true that—with the exception of the United States—developed nations generally have lost trade in manufactured goods to developing markets over the past ten years, manufacturing’s share of GDP fell faster in the United Kingdom than in any other Group of Seven (G-7) country, reaching just 17.7 percent at the end of 1999. This shrinkage isn’t explained by extraordinary growth in the United Kingdom’s nonmanufacturing sectors, whose average annual gain in output from 1989 to 1999 was 2 percent a year. By contrast, manufacturing’s average annual growth over the same period was only 0.4 percent. In Canada, France, and the United States, manufacturing has actually gained share in recent years; in Germany, Italy, and Japan, the losses have been smaller than those in the United Kingdom.

Some argue that the relatively weak recent growth of the UK manufacturing sector is attributable in part to its dependence on faltering old-economy industries such as food processing, paper, and textiles. In the United States, by contrast, the faster-growing electronics and mechanical-engineering industries, which support the new economy, dominate manufacturing. But even after the disparity between the sector mix in the United Kingdom and the United States is factored out, figures for the period from 1995 to 1999 show that the US manufacturing sector still grew at a rate of almost 4 percent a year while its UK counterpart notched growth of just half a percent.

On the financial front, UK manufacturing has destroyed more than £80 billion ($110 billion) in value over the past ten years, and the already substantial difference between the UK and the US manufacturing sectors’ net rate of return appears to be widening (Exhibit 1). So too does the gap in total productivity between manufacturing in the United Kingdom, on the one hand, and in Canada, France, Germany, Italy, Japan, and the United States, on the other. Total US productivity, for example, which was 29 percent greater than the United Kingdom’s in the period from 1994 to 1996, had become 38 percent greater by 1998.

Many observers suggest that an increase in capital investment will bridge the gap. A close look at the figures, however, suggests that the level of capital investment is not the problem, nor is raising it the solution. The United Kingdom’s rate of capital expenditure has been growing, and at 14 percent of the value of output in 1998 it now matches the levels of the country’s strongest competitors: Germany, with 15 percent, and the United States, with 13.6 percent. Capital intensity—the ratio between the contributions of capital (the numerator) and labor (the denominator) to production—remains low in the UK manufacturing sector because of its previously low capital spending. But while the United Kingdom’s capital stock is catching up—albeit from a low base—there are diminishing returns to further capital investment in terms of labor productivity. Even if the sector achieved the capital intensity of the United States, it would have closed only a quarter of the gap in labor productivity between the two countries (Exhibit 2). UK manufacturing cannot invest its way out of its labor productivity problem.

In fact, according to the 1998 McKinsey Global Institute report Driving Productivity and Growth in the UK Economy, low labor productivity is the scourge of nonmanufacturing sectors as well. But unlike similarly low performers in highly regulated domestic industries such as food retailing and hotels, UK manufacturers face ominously fierce competition in the home and export market alike. If their labor productivity were on a par with their competitors’, output would be higher at no increase in cost, financial returns would improve, and the sector would attract more investment—establishing a new, virtuous cycle of growth.

Clearly, the gap has nothing to do with the quality of the UK workforce. Foreign-owned companies in the United Kingdom, drawing from the same pool of frontline labor as do their UK-owned competitors, are achieving much higher levels of productivity. The real reason, according to a recent McKinsey study of 18 typical plants located in the United Kingdom,¹ is that poorly performing UK manufacturing companies—that is, those returning less than their cost of capital—have failed to adopt three practices that have long since proved themselves elsewhere. The first problem is that these companies rarely use lean-manufacturing techniques, which minimize waste. The second is a failure to set goals for individuals and then to offer rewards for achieving those goals or to impose sanctions for not doing so. The third is that poorly performing manufacturers are also poor at attracting high-caliber managerial talent.

Many UK manufacturing companies claim, and probably believe, that their production processes and financial and human-resources policies embody best practices. We found that the plants that really applied them were doing much better than those that merely claimed to be. Six out of the eight struggling plants almost ignored individual managers’ performance, for example, while six of the good performers paid close attention to it.

It is worth glancing at what one foreign company actually did. When Ford Motor acquired the Jaguar facility at Browns Lane, in 1989, the Coventry automotive plant was notorious for low quality and poor labor relations. Ford introduced training for every employee in lean production. Since then, the number of faults per vehicle has fallen from 246 (against an industry average of 151 the year Ford acquired Jaquar) to 88 (against a current industry average of 86), and the business, following a string of losses, has generated positive returns for the past five years.

If the tools for increasing UK labor productivity are at hand, surely UK management will seize them. Or will it? It may have to do so in order to survive. The stock market value of the United Kingdom’s manufacturing sector has fallen by 16 percent in the past year. It is now at a level that could make UK companies with poor labor productivity look like low-hanging fruit to efficient overseas buyers. UK labor has become dramatically more productive when employers faced external shocks such as the recession of the early 1990s or the recently high value of sterling.² Labor productivity stops improving when the threat recedes. Will the threat of takeover be enough to spur UK managers into action?