3

Meeting the productivity challenge

Britain faces a clear productivity challenge, with performance lagging behind that of other major economies. The UK's productivity gap with countries such as the US, France and Germany is substantial ­ up to a third. This reflects long-standing problems and weaknesses, not just in one but in many areas. For example: past macroeconomic instability: repeated cycles of boom and bust have damaged investment and long-term growth; a low capital stock: the capital stock per hour worked is 30 per cent higher in the US and 70 per cent higher in Germany; poor skills: seven million UK adults lack basic skills in literacy and numeracy; a weak R&D record: UK companies invest a lower proportion of national income in R&D than the US, Germany or France. a lack of entrepreneurship: the level of entrepreneurship in the UK is about half that of the most entrepreneurial country ­ the US ­ although it compares well with other parts of Europe. In order to address these weaknesses and help close the gap with other major countries, the Government has set out a clear strategy to meet the productivity challenge, focusing on: promoting competition in the economy: by strengthening the framework for competition policy through the new Competition Act; encouraging enterprise and innovation: by taking steps to enhance the UK's enterprise culture and maximise the incentives for innovation; raising the skills base: increasing resources and standards in education and improving the opportunities for life-long learning; creating the right conditions for investment: by delivering both macroeconomic stability and microeconomic reforms to promote incentives to invest; and improving public sector productivity: by setting clear targets for improving efficiency in public service delivery.

THE PRODUCTIVITY CHALLENGE

3.1  Raising productivity is one of the key conditions for meeting the Government's objective of high and stable levels of growth and employment and delivering sustained increases in living standards. This chapter describes the challenges Britain faces to raise its productivity performance, how the Government is contributing towards meeting those challenges, and the environment it is creating for businesses and individuals to raise their performance. It is becoming increasingly important that the UK quickly addresses these issues and meets the challenges associated with the rapid pace of technological change and the evolving nature of business. The Government's long-term economic ambition for the next decade is that Britain will have a faster rise in productivity than its main competitors, as it closes the productivity gap.

3.2  The UK's productivity performance has been poor. There are various ways of measuring productivity, but they all point to a sizeable gap compared with other major economies:

• on the frequently used measure of output per worker or labour productivity, the UK has a gap of 35 per cent with the US, around 25 per cent with France and almost 15 per cent with Germany. Matching the US performance would raise the level of UK income by £5,000 per person;
• output per hour worked is 25 per cent higher in France and Germany and 15 to 20 per cent higher in the US; and
• total factor productivity, a measure of the efficiency of both capital and labour, is almost 20 per cent higher in France and around 10 per cent higher in the US and Germany.

Chart 3.1: The productivity gap

Identifying the problem

3.3  Economic growth can result from:

• greater inputs of labour and capital into the economy; and/or
• better use of these inputs through technical progress or other efficiency gains.

There are important interrelationships between the different factors influencing growth. Strengthening one may also act to strengthen others. For example, increasing investment may help technological progress.

3.4  Comparative studies of the UK against other economies illustrate why the UK's growth performance has fallen short in the past and indicate the areas that must be tackled to generate a world class performance. A number of factors can be clearly identified as having an impact on the UK's poor productivity performance:

• lack of physical investment;
• lack of skills; and
• inefficient use of capital and labour.

Physical investment

3.5  Physical capital increases inputs into the economy and, as it embodies the latest technology, helps diffuse innovation throughout the economy. One of the UK's weaknesses in the past has been low levels of investment. The UK has invested a smaller share of GDP than the OECD average since 1960, leaving the UK with a lower capital stock than its major competitors. The weakness of UK investment in the past reflects:

• macroeconomic instability, making it hard for firms to plan ahead;
• microeconomic difficulties, such as the tax system encouraging firms to pay out profits in dividends rather than reinvesting them; and
• low public sector investment dragging down the capital stock for the country as a whole.

Skills

3.6  Skills directly influence how much each person can produce. Also, access to a skilled workforce will encourage firms to invest, and invest in the latest technology. In the past the UK has been held back by inadequate investment in education. Seven million adults lack literacy skills and even more struggle with basic arithmetic. A lower proportion of the UK workforce has higher skills (degree or above) than the US and a lower proportion have intermediate skills than Germany¹.

Total Factor Productivity

3.7  Growth does not just come from greater labour and capital inputs into the economy, but also from more productive use of these inputs through technological progress or other efficiency gains. This has been a major source of growth in the UK and many other countries, but here again the UK lags.

The productivity challenge

Chart 3.2: The investment gap
Chart 3.3: The skills gap
Chart 3.4: Private sector total factor productivity
Chart 3.5: The R&D gap

3.8  One problem has been a failure to invest in technological development. At both the level of the firm and for the country as a whole, research and development (R&D) expenditure tends to boost growth. But the UK's business expenditure on R&D is lower than in the US, Germany and France. Moreover, the UK has not gained the full economic benefit from its inventions. To do so, inventions need to be diffused throughout the economy. The process of innovation is much broader than invention.

3.9  Firms need to turn new inventions into wealth creating businesses, products and services. The desire of existing businesses to grow and the creation of new businesses, entrepreneurship, creates the incentives to innovate. Entrepreneurial activity in the UK compares reasonably well with most parts of Europe, but on some measures it is only around half that of the most entrepreneurial country, the US.

3.10  Competition forces firms to become more efficient to avoid falling behind. It also forces firms to innovate as they have to introduce newer and better products to survive, and to invest in both physical and human capital to keep up with their rivals. Entrepreneurship is important in part because it increases competition. Similarly trade increases competition in an economy and helps innovation.

Tackling the problem: the five key drivers

3.11  Therefore the best economic environment for encouraging productivity is one:

• which is strongly competitive, so that markets are opened up for new entrants and existing businesses have to be dynamic and entrepreneurial to stay ahead;
• which is supported by a culture of enterprise with incentives for individuals and businesses to be more entrepreneurial, and where new ideas and inventions are exploited successfully through innovation to become new products, services and processes;
• where individuals have the skills and abilities to make the best use of the new technologies that arise;
• where the incentives and environment therefore exist for more, and more productive, investment; and
• that is underpinned by improved public sector productivity delivered through better quality services and increased investment in infrastructure.

3.12  Similar themes also emerged from the consultations the Government held ­ through seminars and roadshows after last year's Pre-Budget Report ­ on how to address the productivity gap. Therefore, in devising policies to improve the UK's productivity, the Government has identified and worked with the five key drivers of a productive economy mentioned above. The Government will also be holding roadshows to consult on the measures in this chapter over the coming months.

3.13  As discussed in Box 3.1, these are not just issues for the UK. All European Member States are committed to structural reforms to increase employability and productivity.

Box 3.1: Economic reform in Europe Raising employment and productivity are major challenges currently facing all EU Member States. For the EU to match US levels requires a commitment to developing an innovative, flexible, knowledge-driven economy with competitive markets and better opportunities for small firms to expand. Member States endorsed the idea of structural reform at the Cardiff European Council in 1998 and reaffirmed this at subsequent European Councils. Comprehensive structural reform - such as recent UK reforms - will allow Europe to increase social cohesion and social justice through the rewards of more efficient and dynamic economies. The chart plots non-employment against productivity in the Member States and compares this with the US. The US appears out on its own with relatively low non-employment and high productivity. The relative positions of Spain, Greece and Portugal on the chart reflect the fact that they are still catching up with the rest of the EU. It is nonetheless apparent that, despite clear leads in Europe in some areas (e.g. investment in skills), there is plenty of scope for all Member States to make progress in raising either employment or productivity, or both, before they match US levels. Convergence on US levels of employment and productivity would imply considerably higher output for all Member States. Non-employment rates and productivity levels in EU countries, 1997 All Member States have introduced, or are in the process of introducing, structural reforms designed to boost employment and productivity. Each Member State is committed to economic reforms that will increase employability, support entrepreneurship, increase adaptability and promote equal opportunities at work. Member State reforms designed to increase productivity include: introducing more competition to make product markets more efficient and deliver a better deal for consumers in terms of lower prices and more choice, for example by liberalising utilities or introducing tougher competition policies; better regulation such as removing restrictions on shop opening hours and reducing taxes on profits; and making capital markets work better by increasing competition and thus availability of capital, helping small firms expand, while protecting investors. A number of Member States have introduced measures to boost investment and innovation such as tax incentives to promote greater provision of risk capital.

COMPETITION

The impact of competition on productivity

3.14  A competitive economy will drive up productivity. In competitive markets, firms face a direct, sharp, ongoing incentive to improve continuously the efficiency with which they produce goods and services, keeping prices down and quality up. They know that if they do not, they will lose business to competitors or new entrants.

3.15  Competition also provides the environment which best encourages enterprise and innovation. New and existing market participants are incentivised to develop new products and new ways of delivering existing products. This in turn means that companies and individuals invest in human and physical capital to stay ahead of the competition and to obtain the rewards from doing so. Conversely, firms in a competitive economy that do not invest in their staff and their capital will fall behind, lose market share and ultimately see their profits eroded.

3.16  The importance of competition and openness has been highlighted in a number of studies, including recent work by the OECD² which emphasises the positive impact on productivity growth that the entry of new, often innovative, firms can have.

The strength of competition in the UK economy

3.17  Competition is a difficult concept to measure, and no single indicator can readily be used to judge how competitive the UK economy currently is. However, the vigour of competition depends broadly on two factors: the openness of markets to overseas firms; and the extent to which there is robust domestically generated competition.

3.18  The level of international trade and foreign direct investment are the principal indicators of openness. Trade and foreign direct investment add directly to the intensity of competition and have positive effects. They stimulate increased product development among indigenous firms in response to increased competition, as well as becoming vehicles for technology transfer, including through the supply chain.

3.19  The UK is relatively open to international trade and has a good track record in attracting foreign direct investment. The Government therefore believes that it should focus on further action to improve the level of domestically generated competition.

The Competition Act

3.20  The new Competition Act 1998 will come into force in March 2000. The Act revolutionises the enforcement of competition policy by enhancing the powers available to the Office of Fair Trading (OFT) to tackle anti-competitive practices and abuses of a dominant position. It also introduces strong penalties for transgressors and ensures that the OFT is able to identify and pursue cases of anti-competitive behaviour entirely independently of Ministers. The key priority for the coming year will be to ensure that the Act is implemented effectively (see Box 3.2).

3.21  The Government also intends to reform the process for controlling mergers. The DTI published a consultation document in August which proposes giving the competition authorities rather than Ministers the responsibility for taking decisions in the vast majority of cases. And it proposes focusing the criteria against which mergers are assessed much more clearly on competition and the interests of consumers, so that most cases are decided solely on these grounds. The Government will be announcing how it intends to take forward these proposals next year.

Box 3.2: Changes in the OFT to meet the demands of the new Competition Act The new regime established by the Competition Act will give the OFT greatly strengthened powers to prevent anti-competitive behaviour. In recognition of this the OFT was provided with an extra £15.4 million of resources over three years in the Comprehensive Spending Review to equip it to ensure that companies comply with the new regime. The OFT has been preparing for implementation of the Act, informed by extensive discussions with the authorities in Europe, North America and Australia. It has already consulted on the penalties regime that will apply to firms which breach the prohibitions in the Act and on a leniency policy to encourage whistleblowing amongst cartel members. The intention is that companies should face a maximum penalty of 10 per cent of their UK turnover for each year of the infringement, up to a maximum of three years. In particular the OFT: is undertaking an extensive programme of educating businesses about the implications of the Act, designed to ensure that companies are aware of the sorts of behaviour which will be illegal in the future and the penalties for non-compliance. The programme includes: developing a comprehensive set of guidelines to ensure that business is aware of how the new Act will be interpreted; publishing a series of simple booklets that explain the new Act, targeted in particular at SMEs; providing talks and business advice open days throughout the country; and making available a video of a "dawn raid" showing the consequences of an OFT investigation; has taken steps to reinforce the quality and capacity of its professional expertise. It has recruited additional economists, lawyers and investigation experts; and is organising a programme of training for its investigation officers, run by HM Customs and Excise, and is purchasing specialist equipment to ensure that it can extract relevant information from the IT systems of firms under investigation. US experience suggests that cartels cost consumers at least 20 per cent of their expenditure on the goods and services concerned. The US authorities are now unearthing an average of two cartels a month with the aid of whistleblowers. The new UK Competition Act and OFT's plans for its implementation will ensure that UK consumers benefit from an equally robust approach to 'cartel busting'.

3.22  The Government is concerned that prices in some sectors in the UK may be too high relative to those in some other countries. It has therefore commissioned an extensive study of the prices of 100 goods and services in the UK, US, France, and Germany which will be published in January 2000. This study will be updated each year, and will be used as a means of focusing attention on areas where prices might need to be investigated. In addition, the Competition Commission is separately investigating competition in the car industry and in food retailing and will be reporting to the Government in due course on the results of its investigations and any recommendations for action it feels are appropriate.

Keeping pace with future developments

3.23  Competition policy needs to adapt to the fast-changing economy. The growth of the service sector has been rapid in recent years and it now accounts for around two-thirds of the UK economy. At the same time, rates of price and wage inflation in the service sector have tended to be higher than in manufacturing. In part, this reflects the movement in relative prices necessary to ensure that resources shift towards higher-growth sectors. But it may also reflect the fact that services face less competition and will resort more readily to price increases when demand is strong. If competition can be increased, not only will this improve productivity but it will also contribute to a better inflation performance and to macroeconomic stability.

3.24  The competition authorities are already responding to the changes in the economic structure of the UK. For example, around 80 per cent of recent reports by the Competition Commission have related to the service sector while the OFT and Oftel have recently announced a study into barriers to competition in e-commerce. The Government is also taking a number of specific steps to ensure that there is effective competition throughout the service sector:

• the November 1998 Pre-Budget Report announced that Don Cruickshank would lead a review of banking, one of the largest sectors within the service economy. The Government announced today that it would be making important improvements to the competition regime in the Financial Services and Markets Bill to take account of recommendations in the Banking Review's interim report. The review's final report will be published next year;
• a Utilities Reform Bill will confer on the energy, water and telecommunications regulators a primary duty to advance the consumer interest through competition wherever possible and appropriate;
• the Government is carrying out a comprehensive review of competition in the water industry and aims to publish a consultation document on options for reform early in the new year. It is also reviewing competition in airports and is currently looking at a wide range of issues with a view to publishing proposals for consultation next year;
• in the light of advice from the Director General of Fair Trading the Government will consider how best to ensure that the current exemptions from the Competition Act for the rules of professional bodies do not unnecessarily restrict or distort competition;
• the Government is working in the EU to develop the single market in financial services. Following a call from the Cardiff Council under the UK Presidency, the Commission's action plan provides a good basis for progress. Deeper, more liquid EU capital markets will help companies, large and small, raise capital for investment; and
• the next World Trade Organisation trade round will commence in Seattle at the end of November. One of the Government's key priorities for this round will be to liberalise trade in the service sector, so increasing both the opportunities for successful UK companies overseas and competition at home.

The role of the consumer

3.25  The best guarantee that individuals will benefit from the development of effective competition is for them to be vigilant, empowered consumers. They must have access to the information they need to make comparisons between rival suppliers. This was the message of the Government's Consumer White Paper, 'Modern markets: confident consumers' (Cm 4410), published in July 1999. It recognised that consumers can help generate a virtuous circle by promoting innovation in companies and stimulating better value, in return obtaining better products at lower prices.

3.26  The Government has added the teaching of consumer awareness and rights and financial education to the new national curriculum (see paragraph 3.94 below). At the same time, the Government is improving the information available to consumers to improve their ability to make informed choices on what are often complex products. For example, the Financial Services Authority has set out proposals for publishing clear and helpful information on products such as personal pensions, endowment policies, Unit Trusts and ISAs.

Regulation and competition

3.27  As Don Cruickshank noted in the interim report of the Banking Review, the Government must also ensure that its own actions, particularly in the field of regulation, do not unnecessarily restrict or distort competition ­ not just in the financial services sector but throughout the economy. So in assessing the impact of regulation, the Government needs to look not only at potential burdens on business but also at whether regulation inhibits the supply of goods and services in new and innovative ways or acts as a constraint on, or deterrent to, new entrants coming into a market. Over the coming months, the Government will be considering how to ensure that this test is applied to all significant new and existing regulations as part of its wider programme to promote better regulation and to remove unnecessary red tape.

ENTERPRISE AND INNOVATION

Enterprise

Creating an enterprise culture

3.28  Vibrant competition spurs enterprise by forcing established firms to respond to change and giving new opportunities for entrepreneurial businesses to challenge incumbents. In such an environment, only those businesses able to embrace and exploit change will survive and flourish. This applies not just to new businesses, which have become the strongest consistent source of net job creation in the economy, but also to established firms. Enterprising attitudes are necessary in both, and will be assisted by an entrepreneurial culture which reflects the attitudes across society to risk, reward, failure, and wealth generation.

3.29  The UK has traditionally seen itself as an enterprising economy in comparison with many other European countries. Recent evidence3 suggests that the UK does compare well with much of Europe, but lags behind some of its other leading competitors in providing the right environment and culture to support entrepreneurial activity:

• entrepreneurial activity in the UK (starting up businesses and investing directly in such enterprises) is around half that of the most entrepreneurial country ­ the US. Increasing Britain's level of entrepreneurial activity towards that in the US would be expected to have a significantly positive effect on productivity growth;
• the UK has a risk-averse culture, with respect for entrepreneurs in the UK lower than in any other G7 country except Japan. Moreover, only 16 per cent of people in the UK think that good entrepreneurial opportunities exist, compared to 57 per cent in the US; and
• Britain has low levels of entrepreneurial activity among women ­ 2 per cent of women are trying to start a business, compared to 5 per cent of men. In the US, the proportion of women trying to start a business is around 7 per cent, compared to nearly 10 per cent for men.

3.30  As well as increased individual entrepreneurship, the UK economy would benefit if more firms were more ambitious. Currently less than one quarter of SMEs in the UK have an objective to grow substantially over the next three years.⁴ Lower ambitions translate into lower performance, which can diminish the key role played by small firms in the economy, both as net job-creators and as the source of new ideas and stronger competition.

3.31  The Government is determined to address the UK's enterprise deficit. It is working with partners across business and education to foster a shift in understanding of, and support for, a more entrepreneurial culture. The Government also has an important role in helping ensure that incentives attract people and capital towards entrepreneurial activity. Finally, there needs to be a rigorous appraisal of the barriers to enterprise and how the Government can reduce them and support businesses in overcoming them.

Lord Trotman's review of small business

3.32  It is vital that the importance of small firms is recognised and that they are given the best possible chance of maximising their potential for growth. The Chancellor has asked Lord Trotman to review the policy environment that the Government has put in place for small business in areas such as tax and business support. Lord Trotman will be reporting in time for his recommendations to be considered in the run up to Budget 2000.

The National Campaign for Enterprise

3.33  Strengthening the UK's enterprise culture is a long-term challenge, requiring partnership between Government, business and educators. The Government is currently working with the British Chambers of Commerce on developing the National Campaign for Enterprise, due to be launched in Spring 2000 (more details are set out in 3.96 below).

Incentives to enterprise

3.34  Enterprise is a scarce resource in the economy. If the UK is to develop a successful enterprise culture, it is important that the financial and cultural incentives are strong enough to encourage those with entrepreneurial talent to use it.

Capital Gains Tax

3.35  In April 1998, the Government introduced Capital Gains Tax (CGT) taper relief in order to create incentives for investment in assets generating sustained growth, with particular support for entrepreneurial investment. Capital markets are evolving rapidly, and the competitive imperative to achieve substantial growth is intensifying (particularly for smaller enterprises in the e-commerce field). This in turn is making it more important for smaller enterprises to access the risk capital they need to deliver their growth potential. Equity investment from "business angels" and other individuals is typically the first level of venture capital for such companies. So the supply and price of such finance can be affected directly by the CGT regime, as can the incentives for reinvestment of entrepreneurial gains in subsequent ventures.

3.36  To ensure that it is doing the most it can in this area, the Government will consider the impact of the current design of the CGT business assets taper, with decisions announced in Budget 2000. In particular, and subject to detailed consultation, the Government will shorten the business assets taper from 10 years to 5 years in order to bring the timing of CGT incentives more into line with entrepreneurial investment patterns. It will also assess the case for widening the scope of CGT incentives towards entrepreneurial investment by reducing substantially the percentage thresholds for qualifying business asset shareholdings (from their current levels of 5 per cent for full time employees and 25 per cent for others).

Enterprise Fund

3.37  Stronger incentives for entrepreneurial venture capital investment are also being created through the establishment of DTI's Enterprise Fund that was announced in the
DTI's 1998 Competitiveness White Paper, 'Our competitive future: building the knowledge driven economy' (Cm 4176). This will combine public support and private finance in two innovative new channels for equity investment:

• a national high-tech venture capital fund, combining a £20 million government investment with private finance to raise a total of up to £100 million for investment in venture funds specialising in backing early-stage, high-tech companies; and
• a network of regional venture capital funds of at least £10 million each across the English regions aimed at small scale, equity gap investment, again using Government finance to bring in private finance, while maintaining a strong commercial incentive on the funds to achieve long-term returns.

3.38  The Secretary of State for Trade and Industry will also be announcing details of the new Enterprise Grant shortly. This grant scheme for small firms will, alongside the assistance provided by the Enterprise Fund, ensure a coherent package of financial support for small business.

Corporate Venturing Tax Incentive

3.39  Corporate venturing offers advantages to both new and established firms. Developing technology businesses need to have both the finance and the know-how to make the leap from being promising start-ups to being successful world class companies. Corporate venturing allows smaller companies to access the finance, management, technical and marketing skills of larger firms. For large companies it enables them to access the technologies they themselves cannot always create.

3.40  Following consultation after Budget 1999 the Government will be introducing a tax incentive in next year's Finance Bill to provide incentives for UK companies to undertake corporate venturing. Companies that undertake corporate venturing will receive an up-front corporation tax relief at 20 per cent on investments in small higher risk trading companies as well as a deferral relief where companies sell shares and reinvest the gain in corporate venturing. Further details and enhancements of the corporate venturing tax relief will be announced by the Secretary of State for Trade and Industry tomorrow.

Employee Share Ownership

3.41  Aligning more closely the incentives of employees, managers and investors will help to deliver a stronger entrepreneurial performance. The Government recognises that employee share ownership can contribute to this. Research has shown that over time employees with a stake in the business in which they work will tend to contribute more actively to its development. As more employees have such an incentive, the effects are reinforced.

3.42  As announced in Budget 1999 the Government is introducing a comprehensive all-employee share ownership scheme from April 2000 to support companies own efforts to foster a more productive relationship with their employees. This will be the most tax-advantaged all-employee share scheme ever introduced in the UK. It will also provide greater flexibility than in the current scheme to meet the needs of companies and employees. The Secretary of State for Trade and Industry will announce further details tomorrow.

Box 3.3: Electronic commerce The Government's aim is to make the UK the best place to carry out electronic trading by 2002. It will create competitive markets, transform education, widen access to computers, and modernise its own use of technology. The Government is reviewing every barrier to competition in emerging e-commerce markets and the Government's Competition Act (see paragraph 3.20 above) puts in place a tough new competition regime. Transforming education and widening access will ensure that the opportunities of new technologies are shared by everyone. The Government aims to give everybody in Britain the chance to gain the skills and access to make the best use of the Internet. It is: providing £1.7 billion for the national IT strategy; enabling employees to borrow computers from their companies as a tax-free benefit. Over 300,000 people are expected to borrow computers in this way; developing a system under which poorer individuals ­ sometimes through local partnerships - will be able to lease computers. 100,000 computers should be on loan by the end of 2001; linking all schools, libraries, colleges and universities via the Internet through the National Grid for Learning; and establishing up to 1000 ICT learning centres across the UK to improve access to ICT for all. Modernising Government, especially its use of technology will refocus activities on the customer. The Government: intends to offer a discount on tax returns filed over the internet as announced in Budget 1999. Further details will be announced in Budget 2000; is providing £1.1 million from the Capital Modernisation Fund to develop electronic procurement systems across government, which could save over £10 million a year; and is using £230 million from the Invest to Save Budget to fund new innovative ways of delivering government services ­ many exploiting the potential of the Internet.

Enterprise Management Incentives

3.43  Smaller, higher-risk companies face particular challenges in remunerating the high calibre managers and other key employees they need to realise the company's growth potential. Strengthening of a company's skill base in this way is often a pre-condition for obtaining external risk capital. So it is important to ensure that there are sufficient incentives to encourage talented individuals to take a risk and invest their energy in growing smaller enterprises. The Government is therefore introducing a new Enterprise Management Incentives (EMI) scheme in the next Finance Bill. EMIs will encourage key employees to join small higher-risk companies, by offering access to tax-advantaged share options. Under this scheme, such companies will be able to offer up to 10 key employees options over shares worth up to £100,000 (at time of option grant). Further details will be set out by the Secretary of State for Trade and Industry tomorrow.

Review of Corporate Insolvency regime

3.44  Incentives to enterprise are affected not only by the rewards to successful management and investment, but also by the penalties for not succeeding. Business failures are inevitable in a vibrant enterprise economy, but it is important to ensure that the process of failure does not unnecessarily deter the creation of enterprises, nor hinder their access to finance. The Treasury is undertaking a joint review with the DTI into the corporate insolvency regime. The aim is to create a culture in the UK more favourable towards corporate rescue which avoids unnecessary losses in economic value.

3.45  At the personal level, bankruptcy can also stigmatise those individuals whose businesses have failed despite their honest endeavours. The DTI is undertaking a parallel review of the legislation in this area. One of the measures being considered is a reduction in time, from three years to six months, before which some bankrupts are discharged from bankruptcy. Other measures are also being considered to reduce the fear of failure.

Enterprise open to all

3.46  It is important to set incentives for people to be entrepreneurial, but enterprise should not be confined to narrow sections of society. Businesses need to make opportunities open to all; and the Government must also ensure that incentives are available to everyone in the country. This will allow Britain to benefit fully from the entrepreneurial potential of people and businesses whatever their background and wherever they are.

3.47  Established businesses have an important role to play in helping deprived areas and disadvantaged groups reach their full potential. Modern companies are increasingly aware that corporate social responsibility is a key component of a successful business strategy. Hence many companies are actively supporting local communities. The Government is keen to see this practice become more widespread.

3.48  The Policy Action Team (PAT14) that has been looking at access to financial services, concluded that banks in particular have a major task ahead of them in extending services to low-income households and developing delivery channels accessible to people in deprived neighbourhoods. Part of the answer may well involve e-commerce. The Government believes banks and other providers of financial services should be transparent about their involvement with community development and ensure that opportunities that are profitable for them as well as beneficial for the community are not overlooked. It will monitor progress carefully.

Stimulating enterprise in deprived areas

3.49  It is clear that many enterprises in deprived areas currently face acute problems in obtaining access to suitable support, advice, and finance from mainstream commercial providers and through traditional delivery channels. Groups such as women, ethnic minorities and disabled people have not been given enough opportunity to start businesses. To help stimulate better delivery of such services, particularly through locally-rooted partnerships between the public and private sectors, the Government will be taking forward a £30 million programme to promote better access to finance and business support, including:

• a new development fund to promote innovative ways of supporting enterprise in deprived areas, such as business incubator units;
• a new challenge fund to help resource Community Finance Initiatives, local intermediaries serving locally-based SMEs;
• Loan Guarantees to help co-finance commercial lending to Community Finance Initiatives; and
• a national network of mentors to business start-ups, through a new Business Volunteer Mentoring Association.

3.50  These measures address many of the issues raised in the report of the Treasury-led Policy Action Team 3 (PAT3) on enterprise and social exclusion in deprived areas, published on 2 November. The report sets an agenda for the Government (especially the SBS), Regional Development Agencies (RDAs) and local authorities to follow through. It also identifies potentially profitable opportunities for banks and other major businesses to contribute to economic regeneration through enterprise creation and growth. The programme includes £20 million of additional funding from the windfall tax.

3.51  Anyone with a good idea and ambition should have the opportunity to turn this into a successful business. Uncertainty over future levels of income, in particular during the start-up phase of the business, can be a significant disincentive to an unemployed person moving into self-employment. The Government is considering the case for a start-up grant, to act as an income bridge between benefits and business, as recommended by PAT3.

3.52  The Government will also consider creating scholarships specifically targeted at entrepreneurs from deprived areas. These scholarships will give individuals the skills they need to turn their ideas into thriving businesses by offering them access to advanced management and business training.

Reducing the barriers to enterprise

3.53  To give small firms greater recognition, the Government is setting up a new Small Business Service (SBS). Ministers will be announcing the outcome of the DTI's recent consultation shortly, and recruitment of the Chief Executive is underway. The new SBS will have three main tasks:

• to help small firms deal with regulation and ensure small firms' interests are properly considered in future regulation. This will involve working with regulators and other Departments to minimise burdens on small business and ensure that clear guidance is available;
• to simplify and improve the quality and coherence of Government support for small businesses. This will include an early review of all Government support available to small business; and
• to act as a strong voice for small business at the heart of Government. The Chief Executive of the Small Business Service will have direct access to Ministers.

3.54  To enhance a competitive and entrepreneurial economy, a careful balance needs to be struck with regulation. It is important that regulations with good intentions do not frustrate competition and enterprise, and that unnecessary regulations are investigated and removed. The Regulatory Impact Unit in the Cabinet Office and the Better Regulation Taskforce led by Lord Haskins are tasked with ensuring that new legislation is devised only following a regulatory impact assessment, and that unnecessary regulations are removed. Last month they announced they were reviewing payroll regulations against their principles of good regulation.

3.55  The Government recognises that small firms have problems dealing with payroll regulations. In response to this the Inland Revenue will significantly expand the amount of support it offers to new employers. More details will be announced shortly by the DTI and the Inland Revenue. The Inland Revenue will also publish a new national standard for payroll software early next year.

3.56  Employers often suggest that the differences in the detailed rules for pay-as-you-earn (PAYE) income tax and national insurance contributions (NICs) and their application cause difficulties when dealing with payroll. By bringing policy responsibility for tax and NICs together in the Inland Revenue the Government has now provided a single focus for employers' representatives to discuss improvements in legislation and processes across both PAYE and national insurance. The Inland Revenue will work with employers' representatives and others on options to reduce technical differences, while having due regard to individuals' benefit entitlement.

Planning

3.57  The planning system has a key role to play in promoting sustainable development and must be attuned to the needs of business and enterprise. Important changes are being made to ensure that the planning system helps promote clusters (see 3.74-77 below). In addition the Government has a comprehensive agenda to modernise the planning system so that it supports competition and innovation, does not provide a barrier to the growth of either new and existing companies, and offers certainty, efficiency and transparency in decision making.

3.58  To ensure that the planning system encourages competition and innovation and is efficient:

• regional plans will have to support competition, and will be subject to a Sustainability Appraisal, which will assess how the plans, among other objectives, have promoted competition;
• councils which have demonstrated a track record in streamlining planning decisions for business will gain Beacon Council status. These business-friendly councils will be offered grants to spread good practice to others and raise standards generally. The first Beacon Councils will be announced in December;
• DETR have issued proposals to streamline decisions on major projects of national significance, such as large infrastructure projects. The object is to reduce unnecessary and costly delays, whilst ensuring the public rights to comment on developments are respected;
• regional planning bodies are expected to work closely with the RDAs ­ the innovative, business-led organisations to take forward regional policies ­ and other business interests in drawing up regional plans. The notion is that successful planning must be based on an effective working partnership between all stakeholders. These principles are reflected in the planning concordat between the DETR and local government. A further concordat between local government, business and the voluntary sector is also being put in place;
• demanding new targets have been set for the Planning Inspectorate to speed up planning enquiries. In the years covered by the Comprehensive Spending Review there will be a 46 per cent improvement in inquiry appeal handling times, cutting the cost to business of unnecessary delays. This will complement the steps being taken to improve local authority planning performance through the introduction of Best Value and other streamlining processes; and
• a consultation on the reform of planning obligations, often known as Section 106 agreements, is to be launched next year. The current system has been criticised for lacking transparency, for delays and for the creation of uncertainty and burdens for business. Equally there may be scope for more flexible use of these agreements for developers and local authorities to negotiate imaginative ways to offer benefits to local residents affected by a development. The consultation document will address all these concerns.

Innovation

3.59  A dynamic enterprise culture is the key to increasing the rate of innovation in the economy. It ensures that people have both the incentives and the skills to turn new ideas and inventions into wealth-creating businesses, products, services. Too often in the past the UK has been strong on invention and weak on innovation, precisely because we lacked the essential pre-condition of an enterprise culture.

3.60  Innovation ­ the successful exploitation of new ideas ­ has always been a major source of growth in the economy. And it is becoming more important, as the rate of technological progress accelerates and global competition becomes more intense. In order to succeed, countries need to ensure not only that their knowledge base continues to expand, but also that they exploit it ever more effectively.

3.61  The Government has a key role to play in ensuring that the scope for innovation is maximised and that there are incentives for pursuing new technologies. Firstly, the Government is a major investor in R&D ­ a key driver of innovation ­ through public sector research laboratories and through its funding of university research. Secondly, there can be pervasive spillover effects from innovation ­ since unlike the consumption of goods the fact that one person is exploiting a new idea does not prevent others from exploiting it too. This means that firms may under-invest in R&D.

3.62  To encourage innovation the Government needs firstly, to ensure that the science base in the country is doing leading-edge research; secondly, to encourage technology transfer from research that is carried out; and thirdly to improve the incentives for business to conduct research.

3.63  The Comprehensive Spending Review included a £1.4 billion injection of funds to ensure that the UK continues to be world-beating at generating research. At the heart of this programme is a £700 million Joint Infrastructure Fund endowed by the Government and the Wellcome Trust, for new university equipment and buildings.

3.64  Many UK universities help to create prosperity and jobs through successful commercialisation of their research, creating new spin-out companies, licenses, or other forms of commercial or research collaboration with business. By certain measures some UK universities are even more successful than their US counterparts ­ for example in terms of spin-outs, patents or royalty income per unit of research income. But in terms of realising the broader wealth creation potential, many universities will need to learn from the best and significantly improve the commercialisation of their research if they are to catch up with the US ­ the world leader in this area.

3.65  In the US, more than 200 universities are engaged in technology transfer, which adds $21 billion to the US economy each year. If UK universities can improve their technology transfer efforts and foster more entrepreneurship in their staff, then the gains to the economy could be great. This is why the Government:

• set up the University Challenge fund. The £50 million fund was announced in last year's PBR and the first round winners have been selected. The Budget announced a further £15 million of funds for the scheme, which will have a second round; and
• ran the Science Enterprise Challenge. This provided £25 million for eight centres of enterprise around the country. The winners were announced on
  14 September and are now implementing their plans.

3.66  To add to the national network of eight enterprise centres at UK universities, the Chancellor announced yesterday that Massachusetts Institute of Technology (MIT) will jointly establish an Institute with Cambridge University. The Government will contribute about £14 million a year on average from the Capital Modernisation Fund for the next five years towards the costs of establishing the Institute. Funding for the Cambridge University Enterprise Centre from the Science Enterprise Challenge Fund will be released following this agreement. An announcement will be made in due course about its allocation. Among other things the Institute will:

• stimulate the development of technology based business out of the academic base;
• develop a research programme in fields likely to have a substantial impact on the future evolution of technology; and
• undertake education and research designed to improve the UK's entrepreneurship, productivity and competitiveness.

3.67  Successfully commercialising university research depends not only on the university identifying and marketing its research with commercial potential, but also on the willingness and ability of companies to recognise and take up the new technologies. The technology transfer process relies not only on "university push", but also on "industry pull". The Government needs to ensure that businesses play a role in these initiatives to promote technology transfer. But businesses also need to engage with the science base more generally. They should actively seek out research with applications relevant to their business and see it developed ­ through a collaborative process ­ into successful products and services. Businesses with a strategy for R&D that looks to their long-term competitiveness should see the value of engaging more actively with research establishments.

3.68  Evidence from US companies shows a clear association between a company's higher R&D intensity and their growth prospects over the next five years. However, even companies that fully recognise the benefits to themselves of R&D cannot take account of the benefits to other companies and the wider economy. This provides a rationale for the Government to intervene to improve companies' incentives to undertake R&D.

3.69  This rationale is particularly strong in relation to small firms who are less well-placed than large firms to capture the spillovers that often result from businesses' R&D programmes, and who also find it harder to raise finance for R&D than do larger firms. Small and medium-sized businesses under invest in R&D to a greater degree than large companies. Not only does the UK have the lowest ratio of industry-funded business enterprise R&D to GDP in the G5, but our smaller companies' R&D to gross value-added ratio is significantly less than for large companies.

R&D tax credit

3.70  For these reasons, the Government will introduce a R&D tax credit targeted on small and medium-sized enterprises from April 2000. As stated in Budget 1999, this tax credit will increase the 100 per cent relief for R&D to 150 per cent. So when added to the existing relief, the cost of R&D will be reduced by 30 per cent for a company benefiting from the small companies rate.

3.71  The credit will also be available to companies not yet in taxable profit, recognising the greater cash constraints that such early-stage, innovative companies face and the extra assistance they need. If these companies take the relief up-front, their cash cost of doing R&D will be reduced by 24 per cent. Following consultation, the Secretary of State for Trade and Industry will announce further details and enhancements tomorrow.

3.72  The Government has received positive responses to proposals for reforming the taxation of intellectual property rights, following the Inland Revenue's Technical Note published in March 1999. Subject to the results of further consultation with business on a number of technical issues, the Government plans to introduce legislative changes in Finance Bill 2001.

Box 3.4 The Baker report: exploiting public sector research Government spends £2.2 billion of its £6.75 billion total research spend in its own laboratories ­ the public sector research establishments or PSREs ­ which have led to such diverse advances as liquid crystal display technology and Dolly the cloned sheep. More is needed to increase the generation of jobs and prosperity from these important investments. That is why the Government asked John Baker, chairman of Medeva plc, to make recommendations for improving the exploitation of PSRE research. His report "Creating knowledge: creating wealth" was published on 27 August 1999. The Government fully endorses the principles in the report, and will: ensure a much stronger drive to exploit PSRE research ­ with more freedoms for PSREs; make changes to civil service conduct rules to allow Government scientists new incentives and rewards, subject to safeguards, for participating fully in exploitation; tackle the risk avoidance culture in PSREs; with the Government encouraging well managed risk-taking. The Government welcomes the statement issued today affirming that the National Audit Office will adopt an open-minded and supportive approach to commercialisation by PSREs, focusing on their commitment to exploitation, the quality of their risk management, and the lessons that can be learned for PSREs as a whole. address the need of PSREs for advice to help them commercialise their discoveries and inventions; the Government will consult on options, including a role for Partnerships UK ­ the new public private partnership which the Government is creating to assist the public sector in being a better client of privately-financed services. The Government welcomes the Baker report and the broad thrust of its recommendations. Many of these will need to be taken forward by the departments and Research Councils that sponsor PSREs and the Government will announce how this will be done in the new year.

3.73  The aim of the reforms is to replace the current separate and often out-dated tax rules with a new and simpler treatment of intellectual property rights (IPR) transactions, based more closely on accounting practice. There may also be scope to simplify the rules for deducting income tax at source when royalties are paid to owners of IPR (eg payments for use of patent or copyright). These reforms should help reduce compliance costs, and thereby remove one of the barriers to innovation.

Clusters

3.74  In an era of globalisation and the growth of the Internet, a firm's location still matters. There is strong empirical support that the returns to R&D, and the spillover of knowledge between firms and research institutes are enhanced by co-location. The networking and interaction between firms and research institutes, and the clustering of specialist service providers of legal and financial advice and venture capital, provide a powerful stimulus to productivity growth.

3.75  Lord Sainsbury's report into Biotechnology Clusters, published in August 1999, represented an important step in developing understanding of clusters and the appropriate policy response.

3.76  One element of the Government's clusters strategy is to reform the planning system. The Deputy Prime Minister will today be announcing further changes to the planning system to strengthen the support for the growth and development of clusters of firms. Building on changes that have already been announced, these will mean:

• regional plans should proactively identify cluster areas and plan for their expansion;
• regional plans will identify innovative cluster areas and recognise the importance of business to business links for cluster development as well as links between business and the science and research base;
• guidance from DETR on the importance of clusters in Planning Guidance on regional plans (PPG11), will also be put into planning guidance on local plans (PPG12); and
• DETR will produce a detailed explanatory guide on how to implement a clusters planning policy.

3.77  Planning reform is not the only issue. Following discussion of clusters in EA(PC) ­ the Cabinet Committee on Productivity and Competitiveness chaired by the Chancellor ­ the next steps in the Government's strategy will be announced by Lord Sainsbury on the 18 November. He will announce a cross-departmental Ministerial group to drive forward work on clusters. One of the tasks of this group will be to consider in greater detail the issues raised by the RDA economic strategies published on 26 October. These included business incubators, networking activity among firms and links between firms and universities in course design and research.

3.78  Lord Sainsbury's report into clusters also highlighted the importance for growing firms of the availability of high quality premises on flexible terms. Once research into the impact of its 1992 Code of Practice on the commercial property market has been completed, the Government will be considering if anything further is required to accelerate recent trends towards greater flexibility and transparency in the operation of the market.

3.79  The Government can also support innovative and firms creating high value added products and services in the way it uses its own funds to promote investment in assisted areas. The Government's Regional Selective Assistance (RSA) is worth £120 million per annum in England. Following consideration by EA(PC), this flagship scheme for promoting investment in assisted areas will be refocused on high-value projects making the maximum contribution to the country's long-term competitiveness. The Secretary of State for Trade and Industry will announce details shortly.

SKILLS

3.80  The enterprise economy that the Government is seeking to create requires a workforce with a high standard of basic skills and the ability to adapt continuously to new technologies and changing working environments. The Government needs to ensure that those in work or seeking work ­ of all ages, abilities and backgrounds ­ have good opportunities to improve their employability.

3.81  Although standards are rising in primary and secondary schools, the education service has further to go to deliver high levels of general educational attainment and people with sufficiently adaptable skills. Britain's under-performance in skills reduces the capacity for innovation and enterprise, and constrains productivity as the less skilled cannot make the best use of the technologies and opportunities available.

3.82  In the UK, fewer young adults stay on in education compared to other countries; some seven million adults lack literacy skills, and even more struggle with basic arithmetic. These failings inhibit a large proportion of the workforce from keeping pace with the changes in working practices at a time when it is ever less likely that people will be able to hold just one job throughout their career.

3.83  As a long-term economic ambition for the next decade, school and college leavers will gain the highest possible qualifications they can, with the majority going on to higher education for the first time.

3.84  The Government's response to the numbers of people without basic skills includes:

• the implementation of literacy and numeracy strategies in primary schools: those aged 11 who meet the required standard in English and mathematics rose five and ten percentage points respectively in 1999 compared to 1998;
• the introduction of more classroom assistants and the National Grid for Learning in primary and secondary schools;
• proposals for strengthening school leadership and rewarding teachers for high performance, as set out in 'teachers: meeting the challenge of change' (Cm 4164).

3.85  As well as increasing the basic skills of those in school, the UK needs to provide training to people who are already in the workforce. Life-long learning is vital to improving the skills of the workforce to help them move with the changing technologies and continue to fulfil their potential.

3.86  Since April this year people have been able to open individual learning accounts at their local TECs in England and Wales by paying £25 to receive £150 towards the cost of appropriate learning. There are also pilot projects in Scotland. From next year the Government will be putting in place a national framework under which people who open individual learning accounts will be eligible for:

• 80 per cent discounts on computer literacy courses and some other specific types of learning; or 20 per cent discounts on a wide range of other eligible learning activities. (Scotland and Northern Ireland will decide their own priorities for what will be eligible for receipt of the discounts).

3.87  On current plans the discounts will first become available from next September and, accordingly, as announced in Budget 1999, Vocational Training Relief is to be withdrawn at the end of August 2000. In making the proposals work to their best effect, the Government sees a role for trades unions in encouraging their members to open learning accounts and in exploring with employers the scope for them jointly investing in their employees' accounts. Employers will be encouraged to contribute towards the learning of all their employees free of tax and NICs.

3.88  The University for Industry (UfI) will offer on-line and supported learning to individuals and business, with a particular focus on SMEs. It is soon to announce its first development centres. Up to 70 of these centres will test UfI services and learning materials in the run up to launch next autumn. The centres will be in easily accessible locations such as shopping centres, community centres and churches. Learners will be able to choose from a range of test course materials including information technology and business and management skills. This is an important step in the establishment of the UfI, which is a key element in the Government's commitment to life-long learning.

3.89  A productive workforce requires not only high levels of basic skills such as literacy and numeracy, but also a large pool of people with good management skills. All businesses rely heavily on the expertise and judgement of their management teams. And poor management can have a damaging effect on a company: last year's report by the Society of Practitioners of Insolvency found that 22 per cent of business failures were directly attributable to poor management.

3.90  Recent years have seen a significant rise in the number of UK business schools offering MBA-based training. However, despite this rise in numbers, the UK only has three schools ranked amongst the world's top 505. Equally, the majority of business schools do not provide training directly tailored for SME managers and entrepreneurs.

Management Education

3.91  The Government's strategy for tackling these issues includes:

• ensuring that the Department for Education and Employment, the SBS and the University for Industry work together to develop a coherent approach for SME management development;
• working with Investors in People (IiP) UK to review the IiP standard to ensure that it is SME friendly. A new SME standard has been produced and is currently being piloted. This new standard will be fully implemented in April 2000; and
• launching, with the National Federation for Enterprise Agencies, an initiative to increase the number of business mentors by 1,000 in the next two years.

3.92  In addition, the Government is:

• setting up the Council for Excellence in Management and Leadership, a small group of industrialists and entrepreneurs, under the leadership of Sir Anthony Cleaver, Chairman of AEA Technology plc, to develop a strategy for improving the levels of leadership and management competence in the UK; and
• creating the Business School Small Firms Advisory Group to identify best practice in relation to business school provision of management training specifically designed for SMEs and entrepreneurs. This group will report to the Council for Excellence in Management and Leadership by March 2000.

3.93  The workforce also needs the right attitudes and the mind-set to have a successful career in a more enterprising economy. It is important that young people receive positive messages about enterprise throughout their education, and acquire more entrepreneurial skills. For example, young people need to understand the viability of self-employment as a career option, and the skills needed to succeed in working lives that are more likely to involve a broader range of different jobs than before. The curriculum and primary and secondary education in the past have not paid enough attention to ensuring that people leave school with such skills and outlooks.

National Curriculum

3.94  To address this, the Government has revised the National Curriculum to include a new focus on enterprise skills at both primary and secondary level. From September 2000, the National Curriculum will make more explicit the links between education, employment and enterprise; and it will also include financial literacy and consumer education. Guidance, schemes of work and materials for schools are now being developed in time for September 2000.

Education Business Links

3.95  The Government wants to involve as many schools and businesses as possible in developing a new spirit of enterprise among young people. However, the current scale and quality of enterprise education is inadequate. That is why the Government is announcing a £10 million package to boost enterprise skills in schools, particularly those in disadvantaged areas. The money will come from within the Departmental Expenditure Limit of the DfEE. Starting in April 2000, this package will provide:

• £5 million to improve the quality of the existing infrastructure of school-enterprise bodies;
• £3 million to enhance teachers' professional development and improve the quality of work experience for students; and
• £2 million to help double the scale of enterprise programmes with a proven track-record of success, such as those provided by Understanding Industry and Young Enterprise (including Junior Achievement in primary schools).

3.96  The National Campaign for Enterprise (see paragraph 3.33 above) aims to create a more entrepreneurial culture in the UK by transforming attitudes, developing skills and encouraging the formation of new businesses. The Campaign, which will initially focus on young people, will be spearheaded by a network of entrepreneurial Ambassadors who will act as role models and mentors. Alan Sugar, who for the last two years has toured schools and universities speaking about the importance of enterprise to young people, will add his weight to the Campaign, as will Richard Branson, who is to launch the new Virgin Business School in the new year. Other Ambassadors will include Reuben Singh, Simon Woodroffe, Prue Leith and Dr Chris Evans.

3.97  The Campaign will help to develop the enterprise skills of young people in the UK. It will promote the existing range of enterprise programmes aimed at young people, such as Young Enterprise and Understanding Industry, helping them to raise their profile and reach a wider audience. The Campaign will launch a book in the new year showcasing successful entrepreneurs. It will be aimed at inspiring young people to go into business, and contain examples of how established and young entrepreneurs got started.

Work permits

3.98  The UK also needs to attract the most skilled and most enterprising people from abroad to add to the skills pool of resident workers. This will increase the quality of the UK's human capital and will allow greater economic activity and more employment opportunities for all in the longer term. Skilled foreign workers will help the UK address skill gaps, both where there are transient shortages in particular areas, for example amongst IT workers, or where skills shortages persist.

3.99  The Government is therefore making it easier for skilled foreign workers in key areas to come and work in the UK, where they have the skills and attitudes to help generate an enterprise economy. The Government is:

• adding relevant categories of IT workers to the list of work permit shortage occupations as recommended by the IT, Communications and Electronics Skills Strategy Group report;
• undertaking a fundamental policy review of work permit arrangements. This will aim to simplify the process for employers and provide criteria which better reflect the global labour market;
• considering recommendations from the report into immigration following the DTI's Competitiveness White Paper to make the processes in the Immigration and Nationality Directorate more business friendly; and
• investigating ways to make it easier for foreign entrepreneurs and small investors to come and start businesses in the UK.

INVESTMENT

3.100  The Government's new macro-economic framework, combined with the structural reforms designed to raise the productivity of the economy, together create the very best environment for investment.

3.101  The Government has put in place a platform of macro-economic stability for the long term, built around explicit objectives for low and stable inflation and sound public finances. This provides individuals and businesses in the UK with the confidence to invest, and it attracts internationally mobile capital flows in greater volume and at lower cost.

3.102  But against this benign backdrop, Britain needs to provide a sharper stimulus, to reverse a history of under-investment. This stimulus comes from the Government's structural reforms designed to raise productivity:

• more vigorous competition means that firms have rapidly to adopt new technologies, through physical investment, if they want to succeed;
• an enterprise culture open to all drives both the creation of new businesses and growth in existing businesses, and so raises investment;
• innovation improves the production possibilities of the economy and generates the new commercial opportunities that encourage people to invest; and
• a modern skills base ensures the most productive use is made of new physical capital, without which firms will lack the incentive to invest.

3.103  In all these ways the Government's productivity agenda will help to encourage a higher quality and quantity of investment. But the Government also influences investment through the institutional structures it creates and, very importantly, through the tax system.

Changing the tax system

3.104  The Government has cut corporation tax rates to 30, 20 and 10 per cent, their lowest ever level, and the lowest amongst our major competitors. In introducing the 10 per cent rate, the Government has enabled 270,000 small and growing companies to retain more of their profits for re-investment and growth. Moreover, it has provided added certainty for firms taking long-term investment decisions by committing not to raise corporation tax rates this Parliament.

3.105  In addition, the Government has:

• reformed the corporate tax system to modernise and simplify it, removing advance corporation tax (ACT) which acted as a major distortion. It now provides a more neutral environment for financing decisions and supports an improved climate for quality and long-term investment; and
• extended 40 per cent first year capital allowances until 1 July 2000 meaning that small and medium-sized companies have, for the past three years, enjoyed a significant reduction in the costs of investment.

3.106  There are early indications that the combination of greater macro-economic stability, and the Government's swift action to remove distortions and enhance incentives through the corporate tax system, are beginning to have a beneficial effect. Business investment as a share of GDP has increased in recent years. In 1999 it is projected to reach 14 per cent, its highest level since at least 1965. As the Government's structural reforms take effect they will help to reinforce this recovery in investment, and help to reverse the UK's poor record.

Capital markets

3.107  The UK has long benefited from deep and sophisticated equity markets, enabling a wide range of companies to raise capital in an efficient manner. But it is important to ensure that the relationships and remits throughout the investment chain ­ from investors, particularly institutional investors, through fund managers, to companies themselves ­ support long-term investment decisions and engender innovation, both in the products available on the capital markets and in the companies themselves. In particular, the Government needs to ensure that smaller, higher-growth, often more innovative companies are well-served by the capital markets.

3.108  The Financial Service and Markets Bill establishes the Financial Services Authority (FSA) as a single regulator to meet the challenges of evolving markets. Its motto is regulation that has a light touch where possible, and provides protection where necessary. Under the Bill, the competent authority for listing will be transferred from the London Stock Exchange to the FSA to avoid any conflicts of interest and to facilitate competition.

3.109  The Government is keen to see an increase in the amount of funds from institutional investors directed towards venture capital. In the US it is estimated that around 5 per cent of institutional assets are invested in venture capital, whereas in the UK that figure is closer to
1 per cent. There is a concern that this important sector of the economy, with significant growth potential, could be missing out on a valuable source of funds.

3.110  Following the Prime Minister's speech to the British Venture Capital Association in July 1999, three of the leading actuaries published a statement that the time was now right for institutional investors to invest a higher allocation of their funds in unquoted securities. This was an important development and the Government will continue to take an interest in the industry's response.

3.111  Increased transparency and accountability between companies and their shareholders is also essential if the market for institutional investment is to operate as efficiently as possible. To this end the National Association of Pension Funds published a report in July suggesting ways of increasing levels of UK shareholder vote execution. The DTI is currently considering the results of its consultation on how increased transparency could be introduced into the setting of Directors' remuneration to ensure that it is both accountable and adequately linked to performance.

3.112  Positive steps have also been made on improving access to public markets for high-tech, growth companies. Techmark, the London Stock Exchange's new index for technology companies, was launched by the Chancellor of the Exchequer on 3 November. Following that launch, the US technologies market NASDAQ announced plans to launch its European operations in the UK, reinforcing London's position as the EU's financial centre. This launch will bring NASDAQ's skills and experience in supporting early stage, high-tech companies to the UK. Together with the launch of Techmark, this represents a significant step forward in helping such companies join the main market, with the access to institutional funding which that brings.

3.113  Small and growing firms seeking investment are not usually in a position to look to public equity markets and may not yet have profits to reinvest. Finance for small and growing firms comes from a wide range of other sources including: banks, other firms, and private investors. The Government is acting to improve access to finance in all these areas.

3.114  The Banking Review (see 3.24 above) is examining the levels of innovation, competition and efficiency of the banking sector and considering how it could better serve SMEs.

3.115  The measures to encourage venture capital, including the corporate venturing tax relief (set out in paragraphs 3.39­40), will also improve the access to finance for small firms and help to raise investment.

3.116  The Financial Services and Markets Bill will reduce the time and cost involved in raising capital from private investors. It will exempt communications from companies to a defined class of high net worth or sophisticated individual investors from the normal financial promotion rules. This is likely to be of most benefit to smaller firms seeking to raise equity from "business angel" investors.

3.117  The Government is also encouraging saving, through ISAs, stakeholder pensions and Pooled Pension Investments (PPIs). Saving by individuals is an important source of capital formation, as well as providing security for the people concerned.

3.118  The measures above, combined with the rest of the Governments strategy to improve the microeconomic environment for enterprise in the economy, will lead to higher private sector investment. But the Government is also reversing the legacy of under-investment in the public sector.

PUBLIC SECTOR PRODUCTIVITY

3.119  The biggest contribution that Government can make towards increasing the UK's productivity is to establish macroeconomic and microeconomic policies which encourage enterprise. But it is also important to recognise that the Government is directly responsible for a significant proportion of the economy.

3.120  The Government is focusing on concrete improvements and service delivery, and has set over 600 output and efficiency targets through Public Services Agreements (PSAs). These targets are being closely monitored to ensure that public services become more modern, efficient, and responsive, bringing all areas up to the level of the best. The Government will report on progress against these targets in spring 2000.

3.121  The Government's emphasis on improving outputs from public services is demonstrated by significantly increased provision for renewal, reform and modernisation of the UK's infrastructure. The £2.5 billion Capital Modernisation Fund has been set up to support innovative capital projects which will further improve the quality of public service delivery.

3.122  The Government also believes in using both private and public sector expertise to raise public sector productivity. The Public Sector Productivity Panel ­ consisting of private sector experts and senior business people ­ is working with government departments to identify and tackle key areas for improvement. To encourage ideas from within public services for increasing efficiency and improving service delivery, the Invest to Save Budget allows services to bid for funds to support innovative projects.

3.123  The public sector is the largest buyer of goods and services in the country. But up to now it has had a fragmented system in which 180 departments and agencies have separate dealings, often with the same supplier. Following the report by Peter Gershon, the Managing Director of Marconi Electronic Systems Ltd, into public procurement, that was announced in last year's PBR, the Government is streamlining its procurement processes by creating the Office of Government Commerce (OGC). The OGC should deliver over £1 billion of efficiency savings over the next three years, while also cutting project delays and overruns.

3.124  The final part of the Government's strategy to raise investment is to reverse the legacy of under-investment in the public sector. This is important not only for its direct effect on the level of investment, but because it is a necessary complement to higher private sector investment. Public investment, for example in high quality infrastructure and public services, provides the foundations for a successful private investment.

3.125  The Government's aim is to renew and improve Britain's infrastructure and public sector services. The Comprehensive Spending Review announced an almost doubling in net public investment over the period of 1998­99 to 2000­01.

3.126  The Government is using partnerships with the private sector to add to and complement this additional public sector investment, in cases where they provide better value compared to investment by the public sector. Under public private partnerships (PPPs), the public sector specifies the outputs required, but the responsibility for the underlying investment, and many of the risks associated with delivering those outputs, is transferred to the private sector partner. This will offer better services, delivered more efficiently and providing better value for money for the taxpayer than public sector investment, provided the outputs can be clearly specified from the outset, and that all parties understand the risks they are taking on.

3.127  Since May 1997, the PPP programme has developed rapidly. The Government's reforms to the private finance initiative (PFI) have led to an increase in the flow of deals. The PFI is expected to generate some £11 billion worth of new private sector investment to deliver improved public services over the period 1999-00 to 2001-02. In July 1999, and following the recommendations of the second report into PFI by Sir Malcolm Bates, Chairman of the Pearl Group, the Government announced plans to build on this success further, with the establishment of Partnerships UK (PUK) ­ a private sector company with a public sector mission. PUK will provide the public sector with the key commercial skills to forge more and better partnerships with the private sector on equal terms, and will act as a project manager for PFI deals, providing public sector organisations with expert advisory and implementation skills.

3.128  The Government is also using PPPs in a number of state-owned industries, to introduce private sector management and ownership disciplines, so as to help these businesses fund and better manage their investment programmes and operate efficiently. This will help improve the services they provide, as well as enhancing their own chances of long-term commercial success and the value of these businesses to the taxpayer.

3.129  Similarly, PPPs are contributing to the Government's drive to use publicly-owned assets more effectively and efficiently. The National Asset Register (NAR), published in 1997, identified the assets that the Government owns. Since then, departments have been encouraged to sell off the assets that they do not require, and to make best use of irreducible assets that they do not use to full capacity, often in partnership with the private sector. To ensure that departments have made progress in these aims since 1997, the Government will be publishing an update of the NAR next year which will detail their activities in these areas.

¹Higher skills: degree or above. Intermediate skills: vocational qualification above high school but below degree level. [Back]

²"Decomposition of Industry-level Productivity Growth: A micro-macro link" OECD 1997. [Back]

³The Global Entrepreneurship Monitor, 1999 UK Executive Report published by London Business School. [Back]

⁴Enterprise Britain 1998, Centre for Business Research, Cambridge University. [Back]

5Financial Times Survey on Business Education, 25 January 1999. [Back]