1. society
2. work
3. unemployment

Invest for Growth
theTheSTRATEGY
Business &
Economic Case
Scotland Means Business
CONTENTS
Page
1 KEY POINTS ..............................................................................1
2 INTRODUCTION ........................................................................4
3 UK ECONOMIC STRATEGY ..........................................................6
4 INVESTING FOR GROWTH .......................................................13
5 EXPORT BASED GROWTH ........................................................19
6 ADDRESSING INEQUALITY ......................................................24
7 INNOVATION ..........................................................................31
8 INFRASTRUCTURE ...................................................................35
April 2015
This report has been prepared for N-56 by BiGGAR Economics,
Midlothian Innovation Centre, Pentlandfield, Roslin, Midlothian,
EH25 9RE, Scotland
[email protected]
www.biggareconomics.co.uk
1
KEY POINTS
The UK’s economic strategy is not working, either for Scotland or
for the UK as a whole.
A new economic approach undertaken by a new Government after the
General Election is required, based on investment to generate
economic growth.
Over the long term, the UK has declined from the wealthiest country in
the world a century ago to an average performing advanced economy,
at best. During this relative decline the centre of gravity of the UK
economy has shifted to the south, inequality has increased significantly
and manufacturing has declined to a much greater extent than in other
advanced economies, with financial services becoming a more
prominent part of the economy.
Almost all advanced economies suffered recession following the
financial crisis in 2008. However, the UK recession was one of the
deepest and longest lasting and it took until 2014 for the economy to
recover to 2007 levels of output, meaning that the recent recession
lasted even longer than the Great Depression of the 1930s.
Had the UK economy matched the average for advanced
economies since 2007, economic output in 2015 (measured in
GDP) would be 15% higher, equivalent to £4,250 per person in
the UK. UK GDP would have been £272 billion higher (and Scottish
GDP would have been around £24 billion higher).
Surprisingly in the context of the biggest economic crisis in modern
times, in recent years the political debate in the UK has tended to
focus not on how to increase economic growth, but the state of public
finances, in particular, the public sector deficit and public sector debt.
The UK Government’s strategy of tackling the deficit by reducing
spending has not worked. As well as failing in terms of the UK’s
economic performance (when compared with other advanced
economies), austerity has also missed the projections made in 2010
and failed to reduce public sector debt.
Perhaps even more worrying for the future prospects for the UK
economy are trends in investment. In 2014, total investment (by the
public and private sectors combined) in the UK was 15% of GDP, 32nd
out of the 35 OECD members, compared with more than 20% for a
typical advanced economy. Only Iceland, Greece and Cyprus invested
less than the UK.
The UK is investing considerably less than the average for the largest
advanced economies, the G7, and the average for advanced
economies as a whole. If the UK had matched the OECD average
there would have been additional investment of almost £150 billion –
this “investment gap” needs to be filled if the UK wants to continue to
be an advanced economy.
Invest for Growth: The Business & Economic Case
1
Low levels of investment are a significant concern because investment
contributes to the economy now and creates the productive capital
(buildings, machinery, infrastructure, intellectual property, software
etc.) on which the economy of the future should be based.
While the UK economy has been growing, much of that growth has
been based on increased consumer spending. Household debt has
now overtaken the levels seen in the lead up to the financial crisis (in
nominal terms) and the combination of rising consumer debt and low
levels of investment must call into question how long lasting or
sustainable this growth can be.
Invest for Growth Strategy
The alternative approach is an invest for growth strategy. Given
the current state of the UK public finances such an approach would
require additional levels of borrowing. However, there is a world of
difference between borrowing to meet income shortfalls and borrowing
to invest and such borrowing would be designed to stimulate economic
growth and so reduce the public sector deficit.
The invest for growth strategy should focus on four main, and interrelated, priorities, each of which would be expect to stimulate growth
in the economy:
•
Infrastructure: particularly where public sector investment would
be expected to stimulate private sector investment;
•
Innovation: particularly in the green economy, where Scotland in
particular and the UK has areas of expertise and there are
opportunities to build comparative advantage for the future;
•
Growing exports: by focusing on increasing productivity in
exporters and potential exporters; and
•
Addressing inequality: at source rather than by redistribution, to
ensure that all the economic resources that could be available are.
The extent of the investment required should not be determined by
setting arbitrary targets, although the size of the UK’s investment gap,
some £150 billion per year, gives some indication of the scale of the
challenge. The extent of the investment for growth should be
based on assessments of the quality of the investment
opportunities identified. Where it can be shown that
investments will generate growth and provide an economic
rate of return, the expectation should be that they should be
part of the national investment programme.
The public sector national investment programme will stimulate private
sector investment, by providing better conditions for investment and
increasing business confidence in the future prospects for the
economy.
Two conditions need to hold for the invest for growth strategy to be a
Invest for Growth: The Business & Economic Case
2
better approach for the public finances than the current approach
based on austerity – and they are closely related:
•
The strategy needs to generate sufficient growth to ensure that
enough taxation receipts to meet cost of servicing the debt (and, at
least in the longer term, to begin paying down the debt).
•
The focus on investment is in areas that will increase productivity
rates.
There are also wider economic and social reasons that make the case
for an invest for growth strategy compelling. In a shrinking or static
economy it is difficult to re-balance the economy so that issues such as
geographic imbalance, sectoral imbalance and inequality can be
tackled. An invest for growth strategy can take such objectives into
account and can create the dynamism that is required to address such
issues.
This relationship between government and business can be
transformed by a collaborative approach to economic policy making, as
has previously been recommended by N-56, based on analysis of
practice of what happens in small successful advanced economies such
as Denmark and Singapore. There are also examples of this approach
in larger successful advanced economies, notably in Germany and at
the city level, notably Chicago.
This collaborative approach goes beyond consultation and lobbying,
with government, business and others committing to working in the
longer term on the development and implementation of economic
strategy. Such strategy must be all encompassing, covering all areas
of public policy.
Given the scale and nature of the UK, not least the different
challenges, strengths and opportunities that exist across the UK’s
nations and regions, it will be necessary to apply this approach at the
level of the UK nations, and in the case of England at a regional level.
The collaborative approach means that business expertise is brought to
bear in identifying the opportunities. It also means that the private
sector is aware of and understands the rationale behind the long term
strategy, providing the confidence that is required to stimulate the
significant private sector investment that will accelerate economic
growth.
Invest for Growth: The Business & Economic Case
3
2
INTRODUCTION
2.1
N-56 Objectives
N-56 is an independent business organisation whose strategy is to
promote an economic plan to elevate Scotland among the top 5
wealthiest and fairest nations in the world. Fundamental to that
objective is the adoption of a national collaborative approach especially
between public and private sectors.
The objectives of N-56 are to:
•
provide an independent
performance and potential;
analysis
of
Scotland’s
economic
•
promote a culture of collective strategic decision-making about
what is best for Scotland’s economy;
•
raise the level of the debate on Scotland’s economic future;
•
ensure that the debate is open, inclusive and informed by a wide
range of stakeholders;
•
engage businesses from all sectors of Scotland’s economy in the
debate and bring focus to the importance of the private sector; and
•
learn from international success stories.
These objectives are intended to ensure that the economic debate
moves on from a discussion of economic powers for Scotland to also
consider what should be done with those economic powers.
While the focus of N-56’s activities to date has been on Scotland, many
of the implications of the research published and the policy
recommendations apply as much to the UK as a whole, and certainly to
the other nations and regions that make up the UK.
2.2
Previous Reports
N-56 published two major reports in June 2014:
•
Scotland Means Business: The Facts, analysed issues such the UK’s
and Scotland’s economic performance, public finances, the
performance and economic policies of successful small advanced
economies and the future potential of the Scottish economy,
including growth sectors and factor conditions; and
•
Scotland Means Business: The Strategy, set out a range of policy
proposals and approaches to economic policy making that will help
to ensure that Scotland can fulfil its potential as one of the best
performing economies and societies in the world.
Copies of these reports are available at www.n-56.org as are the
reports that have been published since then, covering the financial
services sector, the oil and gas sector, infrastructure investment and
Invest for Growth: The Business & Economic Case
4
export based growth.
2.3
Objectives of this Report
N-56 has already published reports that set out the case for and
starting point for a comprehensive economic strategy to grow the
Scottish economy.
This report is narrower in focus, highlighting the critical area of the
overall approach of the UK Government to managing the UK economy
and providing the conditions for economic growth in Scotland and in
the UK’s other nations and regions.
The report is structured as follows:
•
Section 3 reviews the performance of the UK economy and the
outcomes from recent economic policy;
•
Section 4 introduces the alternative invest for growth approach;
•
Section 5 sets out an export based growth strategy;
•
Section 6 discusses how addressing inequality and economic
growth are mutually supportive;
•
Section 7 highlights how investment in innovation can generate
growth and long term comparative advantage; and
•
Section 8 summarises the case for and benefits from infrastructure
investment.
Invest for Growth: The Business & Economic Case
5
3
UK ECONOMIC STRATEGY
3.1
Long-Term Trends
The N-56 report “Scotland Means Business: The Facts” reviewed the
performance of the UK economy over the long term. That report
includes wide ranging analysis, which is summarised here.
One hundred years ago, the UK was the wealthiest country in the
world in terms of Gross Domestic Product (GDP) per capita (economic
output per person) and Scotland, as a centre of manufacturing and
trade, was of central importance to UK economic success. However,
the last century has seen relative economic decline and a shift in the
economic centre of gravity.
The UK’s relative economic decline has been part of a pattern that has
seen convergence amongst advanced economies. However, the UK
decline has been steep with output per person now only average for an
advanced economy.
There are a wide range of other indicators of economic and social
performance. The UK ranks strongly amongst advanced nations for
economic competitiveness and innovation. However, in other areas the
UK ranking is much weaker, in particular for human development,
equality and sustainable development.
Over the last four decades UK economic policy has encouraged the
development of the financial services sector, with the City of London
positioned as a global financial centre. Meanwhile, even prior to the
recession, the contribution of the manufacturing sector to the UK
economy has declined more than any other advanced economy, from
30% of the economy in 1971 to 10% in 2008.
The UK’s economy is also geographically imbalanced. The South of
England accounts for more than half of UK output and the UK has the
largest difference between its richest and poorest regions in Europe.
3.2
Recent Economic Performance
The recession caused by the financial crises impacted on most
advanced economies. However, the recession in the UK was deeper
and lasted longer than most.
The UK economy did not return to the pre-recession (2007) level until
2014.
Since 2007, the UK has been 28th out of 35 Organisation for Economic
Co-operation and Development (OECD) advanced economies in terms
of GDP trends.
So, while GDP growth figures for the UK since 2009 might seem to
have compared well with other advanced economies, this is because
the UK recession was deeper than most others and the growth has not
been sufficient to recover the lost ground.
Invest for Growth: The Business & Economic Case
6
As a result the UK has fallen further behind many other advanced
economies in terms of GDP per capita in recent years. The
International Monetary Fund (IMF) estimates that the UK was 11th out
of 35 advanced economies in 2007, falling to 17th in 2015.
As Figure 3-1 shows, the recession in the UK was far deeper and
longer than in the advanced OECD economies as a whole, than the EU
as a whole (including Greece, Spain, Portugal and Italy as well as the
better performing northern European economies) and than in the other
large G7 advanced economies.
Figure 3-1: UK GDP since 2007 Compared with other Advanced Economies
Source: International Monetary Fund, World Economic Outlook Data, October 2014
Had the UK economy matched the average for advanced economies
since 2007, GDP in 2015 would be 15% higher than it is expected to
be. The IMF expects UK GDP to be £1,774 billion in 2015, so if it had
been 15% higher that would have been an additional £272 billion. The
UK population is almost 64 million, so this is equivalent to £4,250 per
person.
Scotland accounts for 8.8% of the UK economy in the most recent year
for which figures are available (2013-14) and so Scottish GDP would
have been £24 billion higher if the average for advanced economies
since 2007 had been matched.
3.3
Nature of UK Economic Recovery
With the UK economy in 2015 likely to be only slightly larger than it
was in 2007, it is debatable whether the current situation could be
described as an economic recovery.
3.3.1
An Economy Built on Debt?
The economic recovery has relied heavily on consumer spending and
Invest for Growth: The Business & Economic Case
7
with levels of household debt in the UK relative to income, this is
unlikely to be sustainable.
While the focus of political debate in the last five years has been on the
level of public sector debt, the indebtedness of UK households is also a
significant issue for economic policy. In the late 1990s and early
2000s, household debt was equivalent to around 100% of household
annual income. In the build up to the financial crises, household debt
increased sharply. While household debt fell as a proportion of
household income during the recession, it stayed high in nominal terms
and in 2014 reached a record high of £1.6 billion, an average of
£25,000 for every person in the UK.
Figure 3-2: Household Debt and Disposable Income
Source: ONS, UK Economic Accounts Time Series Dataset, Q4 2014
High levels of household debt are not necessarily a brake on economic
progress, since many households also have assets, both financial
assets and physical assets such as houses. However, economic growth
based on debt funded consumer growth can not be maintained
indefinitely and if interest rates rise, this will depress spending as
mortgages and the costs of servicing other debt account for a larger
proportion of household budgets.
The Bank of England’s Quarterly Bulletin published in September 2014
included analysis of this issue, highlighting that increasing levels of
debt, including mortgage debt, stimulated spending and growth in the
decade up to 2007 but then made the recession worse. The findings
set out in the Bulletin include that: “in the second half of the 1990s,
households with mortgage debt to income ratios greater than two
appear to have increased the share of their income spent on nonhousing consumption by more than mortgagors with lower debt to
income ratios” and “but these higher debt mortgagors subsequently
made larger-than-average reductions in spending relative to income
Invest for Growth: The Business & Economic Case
8
after the financial crisis.”
The recent increases in debt and housing price rises suggest that the
lessons from the recession have not been learned and the UK is in
danger of making the same mistakes again.
3.3.2
Investment
Perhaps even more worrying for the future prospects for the UK
economy are trends in investment.
In 2014, total investment in the UK was 15% of GDP, 32nd out of the
35 OECD members, compared with more than 20% for a typical
advanced economy. Only Iceland, Greece and Cyprus invested less
than the UK.
This investment includes all public and private sector investment and
so includes everything from public infrastructure to private sector
capital investment and research and development.
Figure 3-3: UK Investment 2014 Compared with Other Advanced Economies
Source: International Monetary Fund, World Economic Outlook Data, October 2014
The UK is investing considerably less than the average for the EU, the
G7, and OECD advanced economies as a whole.
Invest for Growth: The Business & Economic Case
9
Figure 3-4: UK Investment 2015 Compared with Other Advanced Economies
Source: International Monetary Fund, World Economic Outlook Data, October 2014
If the UK had matched the OECD average there would have been
additional investment of almost £150 billion – this “investment gap”
needs to be filled if the UK wants to continue to be an advanced
economy.
The Scottish share of this investment gap would be £13 billion,
although, given the high share of investment in areas such as
infrastructure in the London region, it could be considerably higher.
Low levels of investment are a significant concern because investment
contributes to the economy now and creates the productive capital
(buildings, machinery, infrastructure, intellectual property, software
etc.) on which the economy of the future should be based.
3.4
Public Finances
In 2010, the Office for Budget Responsibility set out projections for the
public finances, based on an analysis of the UK Coalition Government’s
economic and fiscal plans. The forecasts were that:
•
the public sector deficit of more than 10% of GDP in 2010-11 would
be reduced to just over 2% of GDP by 2014-15 (which would mean
borrowing of £38 billion in 2014-15);
•
public sector debt would increase from 62% of GDP to 70% of GDP
in 2012-13, and then would stablise and fall, to 69% of GDP by
2014-15 (which would imply total UK public sector debt of £1,255
billion in 2014-15).
However, what has actually happened:
Invest for Growth: The Business & Economic Case
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•
the public sector deficit was 5% of GDP in 2014-15 which meant
that borrowing of more than £90 billion was required, £50 billion
more than planned (see Figure 3-5);
•
public sector debt increased to 80% of GDP in 2014-15, to £1.5
trillion, around £200 billion more than planned (see Figure 3-6).
So, while the UK Coalition Government did half the deficit as a share of
GDP, it increased net public sector debt by around £200 billion more
than it had planned. Net public sector debt is now almost £23,000 for
every person in the UK, more than £3,000 more than was planned in
2010.
So as well as failing in terms of the UK’s economic performance (when
compared with other advanced economies), austerity has also missed
the projections made in 2010 and failed to reduce public sector debt.
Figure 3-5: UK Public Sector Deficit Since 2010 and Forecasts Made in 2010
Source: OBR Economic & Fiscal Outlook Reports, 2010-2015
Invest for Growth: The Business & Economic Case
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Figure 3-6: UK Public Sector Debt Since 2010 and Forecasts Made in 2010
Source: OBR Economic & Fiscal Outlook Reports, 2010-2015
Invest for Growth: The Business & Economic Case
12
4
INVESTING FOR GROWTH
4.1
Why Austerity Has Failed
There should be no surprise that the recent UK economic strategy has
not worked since the economy is not like household or company
finances. The political references that are often made to credit card
bills or balancing the books are not valid comparisons. This is because
decisions on public spending have consequences for what taxation
revenues are collected, and vice versa.
So, for example, if spending cuts lead to less employment in the public
sector and the private sector does not grow to compensate for the
cuts, then there will be fewer taxpayers and those no longer in
employment may require additional spending (for example,
unemployment benefits).
There can also be longer term consequences. If public sector
investment is cut in an effort to reduce the public sector deficit that
impacts on the long term competitiveness of the economy, as well as
having immediate economic effects (for example, on the construction
sector).
The judgment that was made in 2010 was that public sector cuts
would be more than compensated for by private sector growth. The
performance of the UK economy and the public finances over the last
five years shows that this has not happened to the extent that was
hoped.
4.2
Invest for Growth
There is an alternative approach that can be taken, one which ended
the Great Depression and one which is advocated by many leading
economists, including members of the Scottish Government’s Council
of Economic Advisors such as the Nobel prize winning Joseph Stiglitz
and the recently recruited innovation economist Mariana Mazzucato.
The alternative approach is an invest for growth strategy.
Given the current state of the UK public finances such an approach
would require additional levels of borrowing. However, there is a world
of difference between borrowing to meet income shortfalls and
borrowing to invest. Borrowing for investment is designed to stimulate
economic growth and so reduce the public sector deficit over time.
The extent of the investment required should not be determined by
setting arbitrary targets, although the size of the UK’s investment gap,
some £150 billion per year, gives some indication of the scale of the
challenge. The extent of the investment for growth should be based on
assessments of the quality of the investment opportunities identified.
Where it can be shown that investments will generate growth and
provide an economic rate of return, the expectation should be that
they should be part of the national investment programme.
Invest for Growth: The Business & Economic Case
13
Two conditions need to hold for the invest for growth strategy to be a
better approach for the public finances than the current approach
based on austerity – and they are closely related.
The first is that the strategy needs to generate sufficient growth to
ensure that enough taxation receipts to meet cost of servicing the debt
(and, at least in the longer term, to begin paying down the debt).
Given that interest rates are at historically low levels, these costs are
less than they have been for generations. While there could be some
risk that the UK’s cost of borrowing could raise, lenders’ primary
concern is that the debt can be serviced (and re-paid on maturity of
the gilts). So if the case can be made that the investment will generate
growth, then the cost of borrowing is unlikely to rise.
Generating the necessary returns from growth should not be that high
a barrier, since growth impacts on public finances in at least two main
ways: additional taxes and reduced demand for spending that is
associated with economic underperformance (e.g. unemployment
benefits).
This is provided that the second condition is also met, that the focus on
investment is in areas that will increase productivity rates.
There are also wider economic and social reasons that make the case
for an invest for growth strategy compelling. In a shrinking or static
economy it is difficult to re-balance the economy so that issues such as
geographic imbalance, sectoral imbalance and inequality can be
tackled. An invest for growth strategy can take such objectives into
account and can create the dynamism that is required to address such
issues.
4.3
Comprehensive Strategy
The approach to government management of the economy discussed
above should be set in the wider context of overall economic strategy
and public policy as a whole.
N-56 believes that the overriding objective of Scotland’s economic
strategy should be to increase economic growth so that, over time,
Scotland becomes one of the wealthiest five countries in the world,
measured in economic output per person. This can be achieved
through a set of policies that are designed to:
•
increase economic participation: to match the employment rate of
the top five advanced economies; and
•
deliver export-based growth: increase Scotland’s trade volumes to
match the average for small advanced economies.
A range of mutually reinforcing transformational strategies has been
suggested by N-56 in the Scotland Means Business reports, as a
starting point for the development and implementation of a new
economic strategy. These include:
Invest for Growth: The Business & Economic Case
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•
Exports: a new exports strategy including development of a
Scottish brand, enhancing the productivity of exporters, learning
from success stories such as oil services and whisky on sales and
distribution channel development;
•
Infrastructure: a new national development plan, including a
substantial investment in infrastructure, which could be funded by a
Scottish infrastructure bond, available on international bond
markets and as a long term savings product in Scotland;
•
Renewables:
realising
the
economic
opportunities
by
commercialising new generation technologies such as wave and
tidal power, for global markets, as the Danes have done in wind
turbines, including developing co-investment models;
•
Frankfurt of the North: support for the financial services sector
where long term growth opportunities exist, including the global
growth markets for fund management. Measures include consistent
regulatory and fiscal regimes, supporting innovation and skills
development;
•
Growth Sectors: strategies to build competitive advantage in a
range of other sectors where global growth niches exist, including
tourism, transport, food and drink, creative industries, life sciences,
universities and healthy ageing;
•
Energy: building on the recommendations of the Wood Review, a
range policy measures in support of the oil and gas sector,
including exploration incentives, ensuring fiscal stability, stimulating
R&D and investment, incentives for the relocation of corporate
headquarters to Scotland, education and skills initiatives and
development of the Scottish engineering brand;
•
Human Capital: continued investment in the education sector
including taking advantage of the highly skilled workforce that is
associated with Scotland’s university and college system and labour
market initiatives to promote high economic participation;
•
Innovation: protecting investment in the existing innovation system
and efforts to promote entrepreneurship to build longer term
competitiveness in emerging sectors in the UK economy, including
mechanisms to facilitate the provision of expansion capital, for long
term growth;
•
Entrepreneurship: ensuring that public policy is supportive of
business-led advice and support initiatives, including a tax system
with low business compliance costs and incentives for investment in
new businesses; and
•
Taxation system: reforming the tax system that applies in
Scotland, based on the Mirrlees recommendations for a simpler tax
system. The reforms will learn lessons from others that have
simplified their tax systems such as the New Zealand.
Invest for Growth: The Business & Economic Case
15
The new economic strategy should be at the top of the hierarchy of
policy, providing a framework for all other areas of policy and ensuring
integration across all areas of policy.
While N-56 has focused on the Scottish economy, similar
comprehensive strategies are also required for all of the nations and
regions of the UK. These should be based on the challenges and
opportunities in different parts of the UK, and together form the basis
for a balanced economic growth strategy for the UK as a whole.
4.4
Scotland’s Economic Strategy
Since the N-56 reports were published in the summer of 2014, the
Scottish Government has published a new economic strategy,
Scotland’s Economic Strategy1. It focuses on the two mutually
supportive goals of increasing competitiveness and tackling inequality.
The Strategy has four priorities where the Scottish Government
believes that its actions can make a substantial difference:
•
Investing in our people and our infrastructure in a sustainable
way;
•
Fostering a culture of innovation and research and development;
•
Promoting inclusive growth and creating opportunity through a
fair and inclusive jobs market and regional cohesion; and
•
Promoting Scotland on the international stage to boost our trade
and investment, influence and networks.
Figure 4-1 – Scotland’s Economic Framework
Source: Scotland’s Economic Strategy, March 2015
These priorities are consistent with many of the recommendations that
have been made by N-56 and so Scotland’s Economic Strategy is to be
welcomed.
1
2
Scottish Government (March 2015), Scotland’s Economic Strategy
World Trade Organisation Statistics (September 2014), Rank in World Trade, 2013.
Invest for Growth: The Business & Economic Case
16
However, the strategy is limited in scope since it focuses on devolved
powers. A more comprehensive strategy is required for the Scottish
economy that encompasses both devolved and reserved policy areas.
4.5
Collaborative Approach to Strategy
The approach that is recommended in this report is not one that is
commonly proposed by business groups, at least in the UK. There can
sometimes by mistrust between business and government and part of
that can be a view in the business community that the electoral cycle
will encourage governments to make spending commitments that
appeal to voters in the short term rather than spending that generates
long term growth (and therefore provides the taxation revenues
required to fund spending and borrowing commitments).
This relationship between government and business can be
transformed by a collaborative approach to economic policy making, as
has previously been recommended by N-56, based on analysis of
practice of what happens in small successful advanced economies such
as Denmark and Singapore. There are also examples of this approach
in larger successful advanced economies, notably in Germany (where
the collaboration is often at the sub-national or regional level) and at
the city level, notably Chicago.
A collaborative approach to policy making means that government,
business and other representatives of society work together on the
development of policies and integrated strategies designed to exploit
competitive advantages. This approach is consistent with both
Christian Democrat and Social Democrat traditions in European politics.
This collaborative approach goes beyond consultation and lobbying,
with government, business and others committing to working in the
longer term on the development and implementation of economic
strategy. Such strategy must be all encompassing, covering all areas
of public policy.
Given the scale and nature of the UK, not least the different
challenges, strengths and opportunities that exist across the UK’s
nations and regions, it will be necessary to apply this approach at the
level of the UK nations, and in the case of England, at a regional level.
Integration of policy can also lead to better outcomes that take a more
holistic and longer-term view of the costs and benefits of policy
change. For example, an energy policy that was informed by economic
development objectives as well as costs, security of supply and
environmental impact may prioritise the commercialisation and growth
of new sectors with export potential.
In addition to a more strategic decision making process and the
integration of policy, a collaborative approach also reduces the chances
of policy shocks that businesses had not been expecting.
Both the process of developing a comprehensive strategy and the role
of the strategy of providing an overarching framework for public policy
Invest for Growth: The Business & Economic Case
17
will deliver a range of benefits. These will include:
•
a framework that coherently sets out the needs, opportunities and
preferences of Scotland and the other UK nations and regions;
•
a long term perspective on priorities and strategic objectives,
above and beyond the political cycle (at least in the many areas
where there is a degree of consensus);
•
a framework that provides the long term stability sought by
investors who wish to understand and manage the risks associated
with investing;
•
a mechanism to prioritise scarce resources on the challenges and
needs identified as strategic priorities. These include public sector
resources as well as human, natural and technological resources;
•
a mechanism for the integration of policy since the strategy will
provide the framework within which more detailed policies and
sector based strategies can be developed; and
•
the process of developing and reviewing strategy encourages a
regular review of the progress that is being made and
benchmarking against and learning from the best.
The collaborative approach means that business expertise is brought to
bear in identifying the opportunities. It also means that the private
sector is aware of and understands the rationale behind the long term
strategy, providing the confidence that is required to stimulate the
significant private sector investment that will accelerate economic
growth.
4.6
Investment Priorities
The invest for growth strategy should focus on four main, and interrelated, priorities, each of which would be expect to stimulate growth
in the economy:
•
Infrastructure: particularly where public sector investment would
be expected to stimulate private sector investment;
•
Innovation: particularly in the green economy, where Scotland in
particular and the UK has areas of expertise and there are
opportunities to build comparative advantage for the future;
•
Growing exports: by focusing on increasing
exporters and potential exporters; and
•
Addressing inequality: at source rather than by redistribution, to
ensure that all the economic resources that could be available are.
productivity
in
Each of these is discussed in more detail in the remaining four sections
of this report.
Invest for Growth: The Business & Economic Case
18
5
EXPORT BASED GROWTH
N-56 published a report on export-based growth in February 2015. The
invest for growth strategy recommended in this report should
encompass investments that will facilitate export growth and so the
main recommendations of that report are summarised here.
The recommendations have a Scottish focus but a similar approach can
be taken elsewhere in UK, based on the strengths and opportunities of
the other UK nations and regions.
5.1
Trade and Economic Growth
Trade has been identified as an important driver of economic growth
for a number of reasons. At the global level, trade facilitates the forces
of comparative advantage while at the country or company level,
exposure to foreign competition (while in domestic or export markets)
means that domestic companies need to ensure they remain efficient
and innovative.
5.2
UK and Scottish Trade
Trade is an area where differences might be expected between the UK
and Scottish economies as small advanced economies tend to trade
more than larger advanced economies. An understanding of the trade
position of the UK and Scotland is therefore important in understanding
the economic performance and prospects of both.
The UK continues to be a major trading nation ranking 8th in the world
in 2013 for merchandise exports (and 6th for merchandise imports) and
2nd in the world for the export of commercial services (5th for service
imports)2.
Trade has been an important driver of global economic growth, with
annual average growth in trade of 10% between 1946 and 20083 while
UK trade growth since the 1980s was an average of 8%. The UK’s
share of global trade has therefore been declining over the long term.
The UK also has a trade deficit, that is, the value of imports exceeds
the value of imports. As Figure 5-1 shows, the UK trade deficit has
grown because the surplus in the trade in services has not been as
great as the increase in the deficit in the trade of goods. In 2013, the
UK exported £306.8 billion of goods and £209.1 billion in services and
imported £419.4 billion in goods and £103.3 billion in services, giving
an overall trade deficit of £33.7 billion (made up of a deficit in goods of
£112.6 billion and a surplus in services of £78.8 billion).
2
World Trade Organisation Statistics (September 2014), Rank in World Trade, 2013.
Department of Business, Innovation and Skills (November 2010), BIS Economics Paper
8: UK Trade Performance: Patterns in UK and Global Trade Growth
3
Invest for Growth: The Business & Economic Case
19
Figure 5-1 – UK Balances of Trade in Goods & Services, 1980-2013
Source: National Statistics, Balance of Payments Dataset (December 2014)
Scottish trade statistics that are directly comparable with the UK trade
statistics are not available. However, there are a number of sources
that allow a picture of Scottish imports and exports to be painted.
Scotland has a balance of trade deficit of almost £4.0 billion with the
rest of the UK and a trade surplus of almost £16.0 billion with the rest
of the world, a total surplus of £12.0 billion. Scotland’s total trade
volume (exports plus imports) of £185 billion would be equivalent to
126% of GDP, £34,878 per capita.
Small advanced economies tend to trade more than larger advanced
economies. This can be attributed to the larger domestic markets that
exist in larger countries and the greater global connections that can be
observed in smaller advanced economies. The average annual trade
per capita in the 34 advanced economies in 2013 was almost $56,400.
However, for the 18 small advanced economies (population of less
than 10 million), the average was just over $77,000 while the average
for the larger economies was around $34,000 (Figure 5-2).
In Europe, two medium-sized countries, Belgium and the Netherlands
perform well. The UK’s trade levels are lower (78% of the average)
than would be expected for a larger advanced economy, just under
two-thirds of German trade levels, for example.
Scottish levels of trade are higher than some of the small advanced
economies in Europe (such as Sweden, Iceland and Finland) but well
behind economies such as Ireland (which has high levels of trade
associated with foreign direct investment), Switzerland, Norway and
Denmark. Scotland’s trade volumes ($54,500 or £34,878 per capita)
are considerably less than the average for small advanced economies.
Trade would need to increase by more than a third (40%) to match
Invest for Growth: The Business & Economic Case
20
that average; and if oil and gas exports were excluded, Scottish trade
would need to increase by 63% to match the small advanced economy
average.
Figure 5-2 – Trade Volumes Per Capita, 2013
Source: World Trade Organisation (WTO) Statistics Database (September 2014) &
BiGGAR Economics Calculations (Scotland)
5.3
Export Based Growth Strategy
The policy package required to support an exports-based growth
strategy will therefore require a number of elements, including:
•
building on current strengths: innovation policy and education and
skills;
•
addressing perceived
connections;
•
targeted fiscal policies in areas with greatest export potential: those
sectors where Scotland has existing strengths and potential; and
•
supporting initiatives that will require government and business
collaboration, including investment in the development of a Scottish
brand.
weaknesses:
infrastructure
and
global
Export growth is driven by productivity growth and therefore the best
policies to promote export growth are those that enhance the
productivity of exporters and potential exporters, such as investment
in infrastructure, research and development and education. In
addition, an exports-based growth strategy will require targeted fiscal
policies in those sectors where Scotland has existing strengths and
potential. Therefore, export growth should be more prominent in
Scotland’s economic strategy.
Invest for Growth: The Business & Economic Case
21
Scotland has global comparative advantage in a number of fast
growing sectors. Scotland has a worldwide reputation for producing
premium food and drink products. In 2013, exports of these products
amounted to around £5.0 billion. Following the successful examples of
whisky and, more recently, salmon, the food and drink sector also has
the potential for export growth. The Year of Food and Drink 2015 is a
good example of an initiative that is targeting further export growth.
Universities and schools can continue to grow their competitiveness in
the international education market, based on the reputation of Scottish
education. Four Scottish universities rank amongst the top 200
universities in the world, which means Scotland has the second highest
number of top performing universities per capita.
The tourism sector supports almost 181,500 jobs, contributes more
than £3.0 billion to the Scottish economy each year and earns £1.2
billion in exports. Scotland’s history and environment provides a
competitive advantage in the tourism sector that is impossible for
other countries to replicate.
These and other sectors provide a large number of opportunities for
the Scottish economy but Scotland cannot expect to be dominant in
any of these global markets at the macro level. However, with
globalisation a small country like Scotland can perform well
economically by developing niche competitive advantages.
A number of factors will play a role in supporting Scotland to achieve
export growth. Expanding exports will be dependent on maintaining
access to global markets with Scotland’s continued membership of the
European Union providing the easiest access to markets. In addition,
successful Scottish exporters have demonstrated the importance of
sales and distribution networks. There may be potential to reach
agreements for large companies to work with small and medium sized
companies in export markets, as well as a role for government
agencies to assist businesses to establish new distribution channels,
particularly in emerging markets.
Developing sales and distribution networks also requires the necessary
skills to be available. Although English is increasingly the language of
international business, businesses which do most to respect and
understand the culture of the countries in which they operate,
including language are likely to do better. An export-based growth
strategy will therefore require that skills gaps in sales and languages
are addressed.
The development of a national brand can also assist businesses in
export markets, since it provides a foundation on which they can build
their own brand, if they choose to. The Anholt-GfK Roper Nation
Brands Index examines the image of 50 nations. Scotland’s score
(61.8) and rank (17th) on the index show that Scotland already has a
strong national brand. Across all dimensions, with the exception of
exports, Scotland is ranked within the Top 20 countries indicating that
there is room for improvement in the exports dimension.
Invest for Growth: The Business & Economic Case
22
The small country case studies of New Zealand, Singapore and other
countries highlight the benefits of being able to invest behind a specific
brand – and particularly one that is supported by a coherent policy
approach. Other lessons that can be drawn from these case studies
include the necessity of a realistic and authentic national brand. The
focus therefore should be on generating outcomes, not simply
investing in marketing or PR. This is important because the branding
efforts need to be consistent and sustained and to be linked to policy
settings. The development of a national brand for Scotland is an
initiative that should be developed by collaboration between
government and business.
The Scottish Government could also provide opportunities for Scottish
businesses by targeted international engagement. That might include
applying to join the Nordic Council to participate in programmes like
the Green Growth initiative and establishing a leadership role in the EU
in energy.
In summary the main recommendations made in the N-56 Exportbased growth report were:
•
export growth should be more prominent in Scotland’s economic
strategy, since it is associated with productivity growth and
improved economic performance;
•
continued access to global markets is critical with Scotland’s
continued membership of the European Union providing the easiest
access to markets;
•
the potential to reach agreements for large companies to work with
small and medium sized companies in export markets, as well as a
role for government agencies to assist businesses to establish new
distribution channels, particularly in emerging markets, should be
explored;
•
an export-based growth strategy will require that skills gaps in
sales and languages are addressed;
•
a realistic and authentic national brand should be developed for
Scotland, building on existing initiatives and learning from best
practice elsewhere, particularly New Zealand. This is an initiative
that should be developed by collaboration between government
and business; and
•
the Scottish Government should take a leadership role in
internationalisation, including applying to join the Nordic Council
(whose members include nation-states and devolved territories).
Invest for Growth: The Business & Economic Case
23
6
ADDRESSING INEQUALITY
The invest for growth approach should encompass measures to
address inequality and imbalances in the UK economy.
The UK has greater levels of income inequality than most other
advanced economies. There are also imbalances in terms of male and
female participation in the paid workforce and large regional
differences.
These issues are politically difficult to address by redistribution in a
static or slow growing economy since such an approach means there
are losers as well as winners.
An invest for growth approach provides opportunities to invest to
tackle some of the root causes of inequality. However, this can only be
successful if combined with other measures that will stimulate demand
in the economy, and therefore use the additional resources available,
productively.
In addition to supply-side labour market measures, there will also be a
need for demand side initiatives, for example to create more jobs in
deprived areas, promote terms and conditions attractive to parents
and carers, or ensure work places are accessible for people with
disabilities.
6.1
Geographic Imbalances
The financial crisis and recession has highlighted the extent to which
London and the financial sector dominates the UK economy.
Research by the Bank of England has found that in the decade before
the financial crisis, the UK financial services sector grew by 6% per
year, more than twice as fast as the UK economy as a whole and the
sector’s share of the economy also grew significantly and by more than
most other major advanced economies, to almost 10%4.
London has a more dominant position in the UK economy than most
other capital cities. Eurostat analysis has found that economic output
per person in Inner London is almost three times the UK average and
almost five times the UK’s poorest region (West Wales & the Valleys).
4
Bank of England Quarterly Bulletin, Q3 2013
Invest for Growth: The Business & Economic Case
24
Figure 6-1 – GDP at Current Market Prices by Regions (2010) as % of UK
200%%
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Comparing this regional disparity to other EU countries shows that the
UK has the largest difference between its highest level of regional GDP
per inhabitant and its lowest level of regional GDP performance. Four
other countries exceeded a factor of 5 to 1, Germany, France, Poland
and Romania. However, the UK reached a factor of 10.5 to 1 (i.e. Inner
London has an output per head more than ten times that of West
Wales and The Valleys). The differences within Scotland are more
typical of distributions in other EU countries.
Figure 6-2 – Regional Variations in GDP per Capita in EU
GDP"per"inhabitant,"in"purchasing"power"standard"(PPS)"by"NUTS2"regions"(2011)"
(%"of"the"EUE27"average,"EUE27"="100)""
Austria)
Belgium)
Bulgaria)
Cyprus)
Czech)Republic)
Denmark)
Estonia)
Finland)
France)
Germany)
Greece)
Hungary)
Italy)
Luxembourg)
Malta)
Netherlands)
Poland)
Portugal)
Romania)
Slovakia)
Slovenia)
Spain)
Sweden)
UK)
Scotland)
0"
50"
100"
150"
200"
250"
300"
350"
Source: Eurostat
Invest for Growth: The Business & Economic Case
25
There has been a level of political consensus on the need to address
the balance of the UK economy. David Cameron has said that the UK is
too reliant on a few industries and regions, particularly London and the
southeast and that, “We are determined that should change.” Peter
Mandelson has called for “more real engineering and less financial
engineering”. Vince Cable has said that, "London is becoming a kind of
giant suction machine, draining the life out of the rest of the country.
More balance in that respect would be helpful.”
However, recent economic trends show that London is becoming even
more dominant. For example, Centre for Cities has found that London
accounted for 79 per cent of national private-sector jobs growth
between 2010 and 2012, almost 10 times more private-sector job
creation than the second fastest-growing city (Edinburgh)5.
One of the consequences of London’s dominance of the UK economy is
that the public policy needs of the London economy will increasingly
diverge from that of the rest of the UK; one example is the housing
market.
This highlights the need for an economic strategy for Scotland (and for
the other regions and nations of the UK) that is designed to meet the
needs of the Scottish economy, which would help to address the
current imbalances in the UK economy.
Those strategies also need to address imbalances within the nations
and regions, which are of a lesser scale than for the UK as a whole.
Within Scotland, even at local authority level, there are significant
differences in employment rates.
Figure 6-3 – Employment Rate in Scotland by Local Authority, 2012
80.0%)
70.0%)
60.0%)
50.0%)
40.0%)
30.0%)
20.0%)
10.0%)
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5
Centre for Cities (January 2014), Cities Outlook
Invest for Growth: The Business & Economic Case
26
A range of education, training and labour market interventions will be
required to address the geographical differences in economic
participation.
6.2
Gender Inequalities
Scotland and the UK have lower employment rates than many other
advanced economies. While Scotland has a higher employment rate
(74.0%) than the UK as a whole (73.3%), it is only 14th in the OECD.
The top five are Iceland, Switzerland, Norway, Netherlands and
Sweden6, all of whom have prioritised gender equality policies.
An alternative measure is economic activity, which also takes account
of the unemployed. The gap between male and female economic
activity rates in Scotland is 6.2%. For the UK as a whole the gap is
even bigger, 10.5%. This represents a significant under-utilisation of
human resources and an opportunity for growth.
If female economic activity rates were to match that of males, that
would bring an additional 107,000 into the workforce in Scotland and
2.1 million to the total UK workforce.
Figure 6-4 – Employment & Economic Activity Rates by Gender
Source: ONS Labour Force Survey (November 2014-January 2015)
6
Source: High Level Summary of Statistics Trend – Labour Market (February 2014),
Scottish Government
Invest for Growth: The Business & Economic Case
27
6.3
Income Inequality
Income inequality creates economic and social challenges. According to
the OECD, it can stifle upward mobility7. The OECD finds that
“intergenerational earnings mobility is low in countries with high
inequality such as Italy, the UK and the United States, and much
higher in the Nordic countries, where income is distributed more
evenly. The resulting inequality of opportunities will inevitably impact
economic performance as a whole even if the relationship is not a
straight forward one.”8
The most widely used measure of income inequality is the Gini
coefficient. A Gini coefficient of zero expresses perfect equality, where
all values are the same (for example, where everyone has the same
income). A Gini coefficient of one (or 100%) expresses maximal
inequality among values (for example where only one person has all
the income).
Historically, Scotland has performed better than the rest of the UK by
this measure of income inequality. The Gini coefficient in Scotland in
2010 was 34.8. For the UK as a whole it was 35.7. The UK is the 7th
most unequal country of the OECD countries. The OECD average is
31.4, while European countries with a similar population to Scotland
have Gini coefficients up to ten points lower than Scotland and lower
than the OECD average. Within this context Scotland’s Gini Coefficient
of 34.8 begins to look less impressive.
A 2014 report published by Stirling University describes inequality in
Scotland and sets out its trends and drivers9. The authors state that by
international standards, the inequality in Scotland is relatively high much higher than in the Nordic countries for example. They find that
there has been virtually no increase in net income inequality in
Scotland (after taxes and benefits are taken into account) since 1997.
Increased government transfers, particularly to families with children
and the elderly, have offset the small increases in earned income
inequality that occurred.
The level and trend of inequality is similar in Scotland to that in the
rest of the UK outside London10. University of Stirling analysis finds
that whilst inequality has remained relatively unchanged since the late
1990s, the very highest 1-2% of earners have increased their share of
income. The richest 1% of Scotland’s adult population earned 6.3% of
total pre-tax incomes in 1997, rising to 9.4% by 2009. And a number
of commentators argue that the outlook for inequality is bleak.
7
OECD (2011) An Overview of Growing Income Inequalities in OECD Countries: Main
Findings, in Divided We Stand, Why Inequality Keeps Rising.
8
Ibid.
9
Inequality in Scotland: trends, drivers, and implications for the independence debate,
David Bell and David Eiser, Division of Economics, Stirling Management School, University
of Stirling
10
Constitutional change and inequality in Scotland, David Comerford, David Eiser Division
of Economics University of Stirling
Invest for Growth: The Business & Economic Case
28
6.4
The Relationship Between Inequality and Growth
Researchers from the IMF published work in 2011 which demonstrated
that income equality increased the duration of countries' economic
growth periods more than free trade, low government corruption,
foreign investment, or low foreign debt11. The authors found that the
difference between countries that can sustain rapid growth over many
years and the others that see growth spurts fade quickly may be the
level of inequality. Countries may find that improving equality will also
improve sustainable long-term growth.
While its focus is not on developed economies, the IMF’s commentary
on its research resonates with arguments about the causal link
between inequality and growth in Scotland and the UK. It finds that
while inequality is integral to the effective functioning of a market
economy and the incentives needed for investment and growth, it can
also be destructive to growth. This is because: it may amplify the
potential for financial crisis; bring political instability which can
discourage investment; make it harder for governments to make
difficult choices in the face of shocks (such as raising taxes or cutting
public spending); and reflect poor people’s lack of access to financial
services, which gives them fewer opportunities to invest in education
and entrepreneurial activity12.
6.5
Investment Priorities
Addressing inequality is often seen as a social policy issue. However, it
is fundamentally an economic issue since addressing inequalities will
provide human capital that will help to drive economic growth.
There are a range of policy areas where growth can be enhanced and
inequality reduced. Addressing inequality also reduces the need for
welfare spending, freeing up resources for investment.
The relationship between inequality and growth is complex and there is
a plethora of theoretical literature on the link between them, with no
general consensus emerging. That said, it is the case that specific
structural reforms that aim at raising average living standards also
influence the distribution of income13.
The OECD provides a qualitative summary of the findings of new
research on the GDP per capita and inequality effects of various
structural reforms. It suggests that growth-enhancing policies can be
divided into three broad categories: i) those that are likely to reduce
labour income inequality; ii) those that are likely to raise it; and iii)
those that seem to have an ambiguous effect.14
11
Berg, Andrew G.; Ostry, Jonathan D. (2011). "Equality and Efficiency". Finance and
Development (International Monetary Fund), September 2011, Vol. 48, No. 3
12
Ibid.
13
OECD 2012; Reducing income inequality while boosting economic growth: Can it be
done? in Economic Policy Reforms: Going for Growth, Part 2, Chapter 5
14
Ibid.
Invest for Growth: The Business & Economic Case
29
Growth enhancing policy reforms that are likely to reduce inequality
include:
•
improving the quality and reach of education;
•
promoting equity in education;
•
reducing the gap between employment protection on temporary
and permanent work;
•
increasing spending on active labour market policies;
•
promoting the integration of immigrants;
•
improving labour market outcomes of women;
•
fighting discrimination; and
•
taxing in a way that allows equitable growth.
As these policy areas demonstrate, there is not necessarily a trade off
between economic growth and equality. Indeed, addressing
inequalities will provide the human capital to drive economic growth –
and will reduce the need for welfare spending, freeing up resources for
investment.
Invest for Growth: The Business & Economic Case
30
7
INNOVATION
The research and development (R&D) system in Scotland differs from
most other advanced economies. As set out in Scotland Means
Business The Facts:
•
Business Enterprise R&D (BERD) expenditure in Scotland was
0.56% of Scottish GDP in 2011, which places Scotland in the fourth
quartile of OECD countries, ahead of only the Slovak Republic and
Poland;
•
Higher Education R&D (HERD) expenditure in Scotland was 0.77%
of GDP in 2011, higher than any other region or nation of the UK
and behind only Sweden and Denmark in the OECD; and so
•
total expenditure on R&D in Scotland was 1.56% of GDP, behind
1.79% for the UK and 1.94% for the EU but much higher than
might be assumed if the BERD figures were considered out of
context, given the key role played by universities in the Scottish
innovation system.
There is a long-running and widely held perception that Scotland is
good at the process of discovery and invention but not so good at
realising their commercial and economic benefits. Improving Scotland’s
track record on commercialising scientific and technological
breakthroughs to create companies of scale, based in Scotland, would
have significant positive economic impacts.
The interaction between government and business in innovation and
entrepreneurship has been important in terms of historic economic
performance and could be even more important in the future. This is
an area that has often been ignored in policy making which focuses on
creating conditions for growth that is limited to institutions,
macroeconomic management and infrastructure. However, this is also
an area where policy makers in several countries are currently
examining and considering changes.
Recent work by Professor Mariana Mazzucato15 (the RM Philips Chair in
the Economics of Innovation at the University of Sussex and recently
appointed to the Scottish Government’s Council of Economic Advisors)
is increasingly being referenced by policy makers. Mazzucato’s
research reviews some of the most significant technological
breakthroughs, in pharmaceuticals to the internet and some prominent
innovative companies, including Apple, and demonstrates how many of
the risks taken in the commercialisation of the products, as well as in
the research and development, were taken by public sector
organisations.
The global technology giants of today
commercialised technology that emerged
have developed and
from publicly funded
15
Mariana Mazzucato (2013), The Entrepreneurial State: Debunking Public vs. Private
Sector Myths
Invest for Growth: The Business & Economic Case
31
research programmes. However, they also received public investment
in commercialisation and in their early growth phases. In the US
companies such Apple, Compaq and Intel were supported with funding
from the Small Business Innovation Research (SBIR) scheme. Indeed,
Silicon Valley has benefitted from the vision of the public sector as well
as targeted investment.
Mazzucato argues that the role of the state is and should be beyond
investing in infrastructure and demand to expand production when the
private sector freezes in a downturn and that there is a role in
promoting and funding high risk, high reward innovation.
She identifies an opportunity for the public sector to invest in
innovation in the green economy, as a route to recovery from the
current economic crisis. The observation for the global economy is that
emerging markets cannot follow the resource and energy intensive
path of the past due to limited resources and the brake of global
warming. The development of green technologies will therefore find
market opportunities and can deliver both economic growth and
sustainable development. However, such an approach will require both
a long-term effort and policy consistency (which she argues has not
been the case in the UK).
This approach requires the public sector to take a more active role than
in correcting market failure; the role includes shaping and creating new
markets. Rather than “crowd-out” private investment, the public sector
can “dynamise-in” the private sector by creating the vision, mission
and plan for innovation.
The policy recommendations emerging from this work include:
•
supporting private sector R&D; however, if R&D tax credits are
used they should be focused on supporting R&D workers, as in the
Netherlands, rather than R&D spend (which is more problematic to
define);
•
setting up an innovation fund, paid for by royalties from successful
commercialisation, which can be re-invested in future technologies.
This could be achieved by attaching conditions to loans and grants
where royalties are paid when profits rise above a threshold (in a
similar way as conditions for student loans);
•
direct investment in technology companies, by state investment
banks (a model that is common in Germany, for example);
•
avoiding innovation policies that would not result in profits arising
from innovation being re-invested in innovation (such as the UK’s
preferential tax treatment of profits arising from patents); and
•
additional investment in public agencies with a remit for near
market research (such as the Technology Strategy Board, in the
case of the UK), investing directly in research through agencies,
using the US model of the Defense Advanced Research Projects
Invest for Growth: The Business & Economic Case
32
Agency and, more recently, the Advanced Research Projects
Agency – Energy.
While some of the policy recommendations represent savings to the
taxpayer, rather than costs, in an environment such as Scotland,
where the objective would be to make a step change in innovation, it is
likely that a net investment will be required. However, there is payback
from that investment. For example, the Brazilian State development
bank, BNDES, which has been investing in innovation in both cleantech
and biotechnology, made a return on equity in excess of 20% in 2010.
There are also benefits to the taxpayer from the additional taxes
associated with the economic growth stimulated.
Such models work in small advanced economies as well as in the large
emerging economies. Singapore is one model from which Scotland
might learn. While Singapore has a reputation as a relatively low tax
economy, the state is active in the corporate sector. This includes
sovereign wealth funds such as GIC Private Limited (formerly the
Government of Singapore Investment Corporation) and Temasek.
These funds invest, long term, both domestically and internationally.
The scale of funds are significant. Temasek has a portfolio in excess of
£100 billion, almost a third of which is invested in companies in
Singapore. While it has delivered impressive returns (delivering total
shareholder return of 16%) its charter has wider objectives translated
into investment themes such as “deepening comparative advantages”
and “emerging champions”.
The focus of the public sector should build on investment in the
research base, providing the long-term patient finance required to
bring new technologies to market. While it must be accepted that there
will be failures as well as successes (since innovation is high risk), the
successes can pay for the failures, providing mechanisms are in place
for the public sector to share in the proceeds of success.
The approach is already being debated by politicians in several
European countries (for example, in the Netherlands, Denmark and
Norway) and by the European Commission where it is consistent with
the Horizon 2020 strategy of delivering smart and inclusive growth.
Scotland might be the ideal place to take these policy lessons on
board, given the strength of the academic research but the failure to
grow and retain companies of scale in Scotland.
Twenty years ago, Scottish Enterprise undertook a ‘commercialisation
inquiry’ that considered Scotland’s track record in research and
development and in commercialisation. That process led to a number
of new programmes and investment including the expansion of
technology transfer offices, the development of science parks, coinvestment schemes (focused mainly on seed and early stage capital),
programmes to link businesses with universities, proof of concept
funds to assist academics with commercially promising ideas and R&D
funding programmes for small companies. Many of these programmes
have been replicated in other European countries, where Scotland and
Invest for Growth: The Business & Economic Case
33
the UK are considered to be leaders in innovation and policies to realise
economic benefits from the academic research base.
However, the range of programmes has not delivered any technology
based companies of scale. The development of a new economic
strategy for Scotland presents an opportunity to re-open the
commercialistion inquiry to assess the lessons that have been learned
over the last 20 years and what action is now required to make the
next step in transforming Scotland into an innovation economy.
These actions are likely to focus on how to provide long term, patient
funding for high growth technology companies. Securing investment
may require direct investment by the public sector as well as
leveraging in private sector investment. The public sector investment
could be from state investment banks, learning from the model that
has been successful in Germany and the sovereign wealth fund
approach that has been successful in Singapore.
The taxation system can also encourage the provision of long term,
patient capital.
The returns to the taxpayer from such investment are possible in the
form of financial returns from successful companies and economic
returns from the growth that is generated.
Invest for Growth: The Business & Economic Case
34
8
INFRASTRUCTURE
N-56 published a report on infrastructure growth in July 2014. The
invest for growth strategy recommended in this report should
encompass infrastructure investments that will facilitate growth and so
the main recommendations of that report are summarised here.
The recommendations have a Scottish focus but a similar approach can
be taken elsewhere in UK, based on the needs and opportunities of the
other UK nations and regions.
8.1
Why Infrastructure Matters
While economic growth in an advanced economy depends on
productivity growth, driven in turn by human capital and innovation,
the foundations required for growth include infrastructure that meets
the needs of a changing economy. The Economist newspaper has
described infrastructure as: “The economic arteries and veins; roads,
ports, railways, airports, power lines, pipes and wires that enable
people, goods, commodities, water, energy and information to move
about efficiently.”
Empirical evidence from the OECD16 has concluded that investment in
network infrastructure can boost long-term economic growth in
advanced economies as a result of the effect of the capital investment
and because of its impact on economies of scale, network externalities
and competition enhancing effects. The UK Government’s National
Infrastructure Plan17 identifies a number of specific ways that
investment in infrastructure can increase productivity, by enabling
businesses to:
8.2
•
sell products to customers more efficiently (e.g. through quicker
and cheaper transport of goods, services or data, or lower costs of
production);
•
produce higher value products, including new intellectual capital
(e.g. through improved facilities for research and innovation); and
•
access larger markets (e.g. through improved links between
production centres and ports/airports or through internet sales).
Benefits of Infrastructure Investment
The Civil Engineering Contractors Association (CECA) recommends that
investment in infrastructure should be maintained at least at 0.8% of
GDP. For Scotland that would be £1.2 billion per annum and given the
historic under-investment in infrastructure, there may be a case for
substantially higher levels of investment over the next 5-10 years.
To put this in some context, the new Queensferry Crossing, the biggest
16
Balazs Egert, Tomasz Kozluk & Douglas Sutherland (March 2009), Infrastructure and
Growth: Empirical Evidence, OECD Economics Department Working Paper 685
17
HM Treasury (2011), National Infrastructure Plan
Invest for Growth: The Business & Economic Case
35
ever infrastructure project in Scotland is budgeted at around £1.4
billion, with construction taking place over a five-year period. The M74
extension in Glasgow cost almost £700 million.
CECA estimates that the cost to the UK economy of failing to increase
infrastructure investment back to the levels more typical for advanced
economies could be an annual loss to the economy of some £90 billion
by 2026. Scotland’s share of that loss could be at least £7.5 billion per
annum.
However, investment in infrastructure generates both immediate
economic impacts and a sustained contribution to economic growth.
CECA estimates that each £1 billion in infrastructure investment:
•
increases GDP by £1.3 billion as a result of economic multiplier
effects (e.g. associated supplies for the construction and the knockon benefits from construction employment); and
•
increases overall economic activity by £2.8 billion, by creating a
competitive environment for business.
The role of infrastructure could be even more important to the future
of the Scottish economy than in the past. The growth and economic
dominance of London is not an isolated phenomenon; other large
global cities have grown, taking advantage of agglomeration effects,
where businesses and people clustering together deliver economies of
scale from network effects to drive economic growth. If Scotland is to
compete in such a global environment, the role of infrastructure in
connecting the main cities and towns, physically and virtually, becomes
more important.
8.3
Trends in UK Investment and Infrastructure
The trends in net public sector investment suggest that there has been
a significant decline in infrastructure investment in the UK. In the mid1960s net public sector investment was more the 7% of GDP and has
fallen to around 1.5% of GDP now (Figure 8-1).
Invest for Growth: The Business & Economic Case
36
Figure 8-1 – UK Net Public Sector Investment, 1967-68 to 2017-18
Source: HM Treasury Public Sector Finances Databank (30 January 2013)
Some of the change will be the result of privatisation with investment
(for example, in power networks) now classified as private sector
rather than public sector. However, Professor John Kay18 estimates
that this would add only around 2% and so there has been significant
real decline in infrastructure investment.
Professor Kay’s sectoral analysis of trends in spending found that the
largest decline was in social housing expenditure. While this can be
explained partly by the increasing role of the private sector in providing
housing in the UK, there are now significantly fewer houses being built
than in the 1960s.
There have also been reductions in spending on gas and electricity
infrastructure, capital related to education and health and the water
sector. Communications spend has been static, but this can be
explained by reduced equipment costs.
With these trends it is not surprising that the World Economic Forum’s
Global Competitiveness Index19 ranked the UK only 28th in the world on
overall quality of infrastructure. Given the link between infrastructure
and long-term economic growth, these trends give cause for concern
about the future of the UK and Scottish economies.
Research published by CECA20 on UK infrastructure trends also found
that infrastructure spending fell below a threshold level of 0.8% of GDP
in early 2003 and was as low as 0.5% of GDP by 2007.
8.4
Approach to Infrastructure Investment
Decisions on infrastructure investment in the UK and in Scotland tend
18
Professor John Kay (September 2008), The Fabric of Scotland Lecture, Edinburgh
World Economic Forum (2014), The Global Competitiveness Report 2013–2014
20
Civil Engineering Contractors Association (May 2013), Securing our economy: The case
for infrastructure
19
Invest for Growth: The Business & Economic Case
37
to be made on a case-by-case basis. There are well-developed
processes in place to prepare and assess cases for investment. These
include, for example, the Scottish Transport Appraisal Guidance
(STAG) system of appraising transport projects.
A STAG appraisal is prepared when Government funding, support or
approval is required for transport projects. The STAG appraisal system
is comprehensive and claims to be objective-led rather than solutionled, that is, designed to start with a definition of the transport problem
rather than a pre-conceived solution.
However, the starting point for such analysis is the current transport
system and a set of objectives for changing it. Moreover, in most cases
the STAG is undertaken by or commissioned by the local authority or
transport authority promoting a project and so a STAG appraisal that
identifies an alternative solution to the proposed project would be rare.
An alterative approach would be more strategic, taking the national
economic strategy as the starting point and identifying the investments
required in pursuit of the objectives set out. It seems likely that such
an approach would generate a long list of projects, far in excess of the
capital funding likely to be available. However, the advantage of a
strategic approach is that projects are not accepted or rejected for
funding; rather they are prioritised in a long-term programme, with
projects that will do most to facilitate economic growth given the
highest priority.
The example of the process used in Ireland shows how such a strategic
approach to infrastructure investment can work.
8.5
Ireland’s National Development Plan
Ireland can be a case study for the delivery of significant
improvements in infrastructure within one generation. Anyone who
lived, worked or visited Ireland in the 1980s or even in the 1990s as
“Celtic Tiger” economic growth rates were being delivered, will
remember long and frustrating journeys between the major cities and
towns. Ireland now has a motorway network and has invested in rail
and other public transport capital, such as the bus fleet.
In most countries, infrastructure projects are assessed on a project-byproject basis, sometimes based on cost benefit analysis cases and
sometimes on political priorities. Infrastructure plans are often
published, but these are often summaries of previously announced
spending priorities.
A more strategic approach has been taken in Ireland with the first
National Development Plan (NDP), published in 1999, covering the
seven-year period 2000-06. The NDP also served as the Operational
Programme document for prioritising European funding with €1.42
billion of the €26 billion of investment from the EU regional
development and cohesion funds. The plan set out a range of proposed
spending priorities covering national roads and public transport,
Invest for Growth: The Business & Economic Case
38
environmental infrastructure, sustainable energy, housing and health
facilities, in order to meet a number of objectives:
•
maintaining
growth;
sustainable
national
economic
and
employment
•
the consolidation and improvement of Ireland’s international
competitiveness;
•
fostering balanced regional development; and
•
promoting social inclusion.
A second NDP covered the period 2007 to 2013, was bigger in scale
(setting out €187 million of infrastructure investment) and wider in
scope, covering
economic infrastructure (transport, energy,
environment and ICT), enterprise, science and innovation (investment
in the R&D base, foreign direct investment, indigenous business
development, tourism and rural development), human capital (skills
development, modernising schools and higher education), social
infrastructure (housing, health, justice, culture and sport) and social
inclusion (pre-school education, social and economic participation,
older people, people with disabilities and local and community
development).
The advantage of the approach taken by Ireland is that infrastructure
investment can be prioritised based on economic and social policy
priorities. The NPD also provided a mechanism for achieving a broad
consensus across the political spectrum and in wider society, including
businesses and trade unions.
The development of the NDP involved extensive consultation, in
particular with the social partners (the Government, representatives of
industry such as the Irish Business and Employers Confederation and
the Construction Industry Federation, trade union representatives the
Irish Congress of Trades Unions, the voluntary and community sector)
as well as research into Ireland’s economic and social needs and
opportunities and evaluations of the previous NDP.
Another feature of the NDP was the integration of different measures.
So, for example, a regional dimension focused more per capita
resources in the Border, Midland and Western (BMW) region and
ensured that the transport and other infrastructure was in place to
service greenfield industrial sites which were the focus of inward
investment promotional activities.
The strategic approach has been maintained in the Infrastructure and
Capital Investment plan for 2012-16, part of the Irish Government’s
Medium Term Exchequer Framework. The plan sets out capital
investment of more than €17 billion over 5 years, including €4.4 billion
in transport infrastructure.
The NDP approach was not an alternative to assessing the costs and
benefits of individual investment decisions; indeed, the use of cost
Invest for Growth: The Business & Economic Case
39
benefit analysis has increased in recent years. However, it has ensured
that national (and initially EU) investment in infrastructure was focused
on projects that aligned with national economic and social objectives.
Perceptions about the quality of infrastructure have depressed
Ireland’s performance in international rankings of competitiveness.
However, investment in infrastructure has seen improvements; for
example, in 2005 the IMD World Competitiveness Yearbook scored
Ireland 4.48 out of 10 for perception of infrastructure but this had
increased to 7.96 by 2011.
Over the last two decades, the average investment in what would be
defined as infrastructure in Scotland (the Irish definition is wider,
including both housing and health services investments) has exceeded
€2 billion per year.
The Scottish Government’s Infrastructure Investment Plan follows
good practice in that it is also set in the context of the Government
Economic Strategy. However, the collaborative approach to policy
development and implementation recommended by N-56 means that
the plan will need to be reviewed and refreshed as part of the
development of the new economic strategy for Scotland.
8.6
Scotland’s Infrastructure Needs
While the Irish approach to infrastructure planning has been
highlighted as an example, the position of Scotland’s infrastructure is
not comparable with the situation faced by Ireland in the late 1990s,
which, for example, still had a road network that predated the
acceleration of Irish economic growth and was constraining further
growth.
However, the business leaders who have contributed their views to N56 believe that Scotland has less well developed infrastructure than
many of its competitors and the analysis presented earlier shows how
UK investment in infrastructure has been in long term decline.
In the context of the Scottish economy, there are two types of
infrastructure investment that could drive economic growth.
The first applies to any advanced economy and consists of
infrastructure investment that facilitates productivity growth. This
would include:
•
physical infrastructure such as transport and information and
communications technologies (including net generation access
broadband) which can deliver better market access and efficiency
gains; and
•
investments that might be expected to deliver innovation and
technological advance (such as investment in the R&D base).
Such priorities would need to be well integrated with Scotland’s
economic strategy. So, for example, if renewable energy continued to
Invest for Growth: The Business & Economic Case
40
be a priority, then infrastructure priorities should include electricity grid
development (including investment in grid technologies, the domestic
grid and international grid connections).
The second would be based on an assessment of any particular
opportunities
that
might
exist
given
Scotland’s
particular
circumstances.
8.7
Infrastructure Needs and Business Opportunities
Airport and port services are two areas where a more entrepreneurial
approach may be appropriate since Scotland’s geographical location
presents opportunities that are worthy of further examination.
One potential project could be the development of hub airport services,
in the same way that other small advanced economies including
Denmark, Iceland and Singapore have done. Scotland is particularly
well placed geographically to be a European hub for links to North
America.
An increase in international air connections with Scotland would also
have the advantage of addressing the concerns of business leaders and
the tourism industry about air links to London and other global
business and population hubs.
Scotland is well placed for air transport links between North America
and Europe. However, Edinburgh airport, with 9.8 million passengers in
2013 was Europe’s 42nd busiest airport and Glasgow, with 7.4 million
passengers in 2013 was the 59th busiest. To put this in context, the
four busiest air hubs in Europe in 2013 were London Heathrow (72.4
million passengers), Paris Charles de Gaulle (62.3 million), Frankfort
(57.5 million) and Amsterdam (52.6 million).
While it might not be realistic for Scottish hub airports to compete with
the busiest hubs in Europe, the development of Copenhagen airport
demonstrates what might be possible. With 24.1 million passengers in
2013, it was Europe’s 16th busiest airport. It is the hub for
Scandinavian Airlines (SAS) and for Norwegian and has flights
operated by most European airlines and other international carriers.
Passenger numbers have increased from 17 million in 1998 and there
are plans to increase to 40 million. The airport is well connected by
road and rail to Copenhagen and the rest of Denmark and, via the
Oresund Bridge, to Sweden.
Another example of an airport development that has taken advantage
of its geographic position, despite a limited domestic market, is
Iceland’s Keflavik International Airport. While it only has 2.8 million
passengers a year, the population of Iceland is only 300,000 and the
development of hub services has allowed regular flights to both North
American and European cities, reducing Iceland’s peripheral
disadvantages.
The successful hub airports elsewhere have good road and rail links
with the cities and regions in which they are based, an issue that would
Invest for Growth: The Business & Economic Case
41
have to be addressed in Scotland, whether hubs were developed at
existing airports or at a new site.
There may also be an opportunity for Scotland associated the
increasing use of the Northern Sea Route linking the Pacific and
Atlantic, north of Norway and Russia (as an alternative to the Suez
Canal).
While hub airport services and an international freight port would
provide services to Scottish businesses and residents, their feasibility
will depend on securing a share of European and global markets.
The development of hub services at Scottish airports and of improved
sea freight services would lower the barriers to exporting for Scottish
companies and could also help to ease the congestion at the London
airports, particularly Heathrow.
8.8
Transport Links within the UK
Transport links between Scotland and the rest of the UK will continue
to be important since the rest of the UK is an important market for
Scottish firms (and Scotland is the second largest ‘export’ market for
rest of UK firms, after the United States).
The development of High Speed Two (HS2) rail links could improve
these links, and deliver significant economic benefits for Great Britain
(the business case21 puts the net benefits of phase one and phase two
at £70 billion, and possibly as high as £99 billion). However, the
majority of the wider economic impacts will be delivered when HS2
moves into phase two, north of Birmingham.
However, the planning of the project has assumed that the
construction will start in London; consideration should be given to also
constructing connecting high speed services from Scotland. This would
improve transport connections between Scotland and Northern English
cities as well as with London. There would also be environmental
benefits associated with reduced demand for short haul air services.
8.9
Internal Infrastructure Priorities
Global trends such as the growth of global cities, taking advantage of
agglomeration effects, also means that road and rail infrastructure that
improves access between Scotland’s centres of population will become
increasingly important to competitiveness, to facilitate the
development of critical mass in key economic clusters.
However, planning should avoid focusing on connecting the rest of
Scotland with the capital since that could lead to the economic
dominance of the economy by one city, in the same way as has
happened in the UK as a whole. Given the distribution of the Scottish
economy a networked approach is more appropriate than a ‘hub and
spokes’ centralisation of activity.
21
Department of Transport (October 2013), The Economic Case for HS2
Invest for Growth: The Business & Economic Case
42
It is not the role of this report to identify individual projects. Indeed,
the recommended approach to infrastructure planning is that it should
be driven by the priorities set out in the economic strategy. This has
not always been the case for transport planning in Scotland. For
example, the Scottish railway franchise has only recently had tourism
issues added as one of the requirements of the bidding process.
An example of how infrastructure can support economic strategy can
be found in the North East of Scotland. Aberdeen City and Shire
Economic Future has developed the Energetica project, which builds on
the existing energy related assets in the 30-mile Aberdeen to
Peterhead coastal region (such as Peterhead Port, Peterhead Power
Station and proposed carbon capture and storage demonstrator,
Aberdeen Science and Energy Parks, Aberdeen Harbour and the
proposed European Offshore Wind Deployment Centre).
The area’s transport connections will be considerably improved by the
Aberdeen Western Peripheral Route. However, the improvement of
roads infrastructure in the Energetica corridor itself would remove
potential constraints on the delivery of this ambitious project.
8.10 Funding Model for Infrastructure
The Scottish Government’s Infrastructure Investment Plan shows
capital investment of between £2.1 billion and £2.7 billion per year
over the period to 2029-30. However, this compares with more than
£3.5 billion in 2007-08 and more than £4.0 billion in 2009-10 and
includes social infrastructure (health, schools, further and higher
education, culture, housing, regeneration, justice and sport) as well as
economic infrastructure (transport, digital, energy, water and
environment).
As discussed earlier, CECA recommends that investment in (economic)
infrastructure should be maintained at least at 0.8% of GDP (i.e. £1.2
billion in Scotland) and there may be a case for substantially higher
levels of investment over the next 5-10 years to address historic
under-investment in infrastructure. It seems unlikely that this will be
possible under current capital budgets.
However, investment in infrastructure need not be entirely funded
from public sector sources. By definition, the benefits of infrastructure
are long term and so there is merit in also spreading costs out over
time.
There may be opportunities to fund infrastructure privately, particularly
more ambitious projects, which have the potential to generate revenue
income. There are many examples of such a model around the world;
these include the Panama Canal, funded by Citibank.
One potential model would be Scottish Infrastructure Bonds, which
could be offered to international bond markets and as domestic
savings products. The long-term nature of infrastructure projects is a
good fit with the increasing need for long term savings products that
Invest for Growth: The Business & Economic Case
43
will increasingly be required as the ageing population structure
increases the need to save to fund pensions.
There are several international examples of combining the need for
infrastructure investment with domestic savings systems. One example
is Singapore’s Central Provident Fund model, originally a plan for
funding pensions but subsequently expanded to fund education, health
and housing. Employers (13%) and employees (20%) are required to
contribute a proportion of wages to the Fund, which then invests in
government bonds. The government uses these bonds to finance
infrastructure (as well as investing in government owned businesses).
The feasibility of such a model for Scotland should be examined, since
it has the potential to both address the need for pension and saving
reforms and expansion and the need to invest in infrastructure to
facilitate acceleration of economic growth. The model may require
taxation treatment that promotes the long-term savings that would be
required to encourage take-up.
Invest for Growth: The Business & Economic Case
44
Invest for Growth: The Business & Economic Case
45
N-56 aims to provide a new focus for Scotland’s business
community to work with government and others
throughout the country, to plan a more prosperous future
for the whole of Scottish society.
The ultimate aim is to ensure that Scotland attains a position
among the top five advanced economies in the world.
If you would like to learn more about N-56, its aims and
activities, please visit our website www.N-56.org
112 George Street, Edinburgh, EH2 4LH
Scotland Means Business
[email protected] / www.N-56.org / Follow Us on
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