3

Meeting the Productivity
Challenge

INTRODUCTION

3.1 Since the election, the Government has been developing a strategy to increase productivity in the UK to help meet its central economic objective of achieving high and stable levels of growth and employment. This strategy started from a recognition of the UK's productivity gap compared to other major economies, and an understanding of our key weaknesses: a lack of domestic competition, insufficient incentives and opportunities for enterprise and innovation, poor skills and a history of under-investment. The 1999 Pre-Budget Report (PBR) set out these issues, and outlined the Government's strategy for tackling the UK's productivity challenge. This Budget sees the implementation of a number of key components of that strategy and sets out the next steps in an ongoing programme of reform.

3.2 It is now more important than ever that the UK is equipped to respond to the new opportunities provided by rapid globalisation, the growth of new technologies, associated with the internet and e-commerce in particular, and a European economy that is recovering and reforming. The Government needs to ensure that it is creating the right climate and incentives for entrepreneurial individuals and firms to seize these opportunities.

3.3 The Government's strategy is to build on the macroeconomic stability that it has created through making the Bank of England independent and adhering to the Fiscal Rules (see Chapter 2). That platform of stability has provided the essential underpinning for a structural reform programme aimed at promoting competition, encouraging enterprise and innovation, raising the skills base, creating the best conditions for investment, and improving public sector productivity.

3.4 The Government is continuing to consult widely on what more could be done to improve the productivity of the UK economy. In the run up to Budget 2000, the Chancellor has undertaken an enterprise tour to hear views about how to improve enterprise and employment in the regions and communities of Britain. In July, the Chancellor will host a major conference in London, bringing together leading UK and US entrepreneurs to discuss how to improve enterprise in the UK economy, and how Government and business can work together to help areas of deprivation reach their full potential.

THE PRODUCTIVITY CHALLENGE

3.5 It is widely accepted that UK productivity performance has been poor (see box 3.1). This is because of several key historic weaknesses (see charts 3.1-3.4). These are that:

• despite the UK being open to international trade, it has suffered from a lack of strong domestically generated competition;
• a weak enterprise culture - the number of people involved in starting businesses in the UK is about half that of the US, although we compare well with most of Europe.
• the UK has a weak record on innovation, with the lowest rate of business R&D in the G5;
• insufficient skills - we compare poorly with Germany on intermediate skills, and have fewer highly-skilled people than the US;
• before 1999 the UK invested less of its national income than the G7 average every year since at least 1965, leaving us with a lower capital stock than our major competitors.

Box 3.1: Productivity ambition

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. The UK's productivity gap with countries such as the US, France and Germany is substantial. On the frequently used measure of output per worker or labour productivity, the UK has a gap of 36 per cent with the US, around 25 per cent with France and almost 15 per cent with Germany. Matching the US performance would mean that the UK was around £5,000 better off per person.

The Government aims to close this gap by creating the best economic environment for improving productivity in the UK. This is one: which is strongly competitive, so that businesses have to be innovative and entrepreneurial to stay ahead and markets are opened up for new entrants; which has a culture of enterprise with proper incentives for entrepreneurial, risk-taking individuals and businesses. This leads to innovation as new ideas and inventions are exploited successfully as new products and services; where all individuals have the skills to make the best use of new technologies that arise and can adapt in a fast-changing economy; where the resulting incentives promote more, and more productive, investment; and that is underpinned by improved public sector productivity delivered through better quality services and increased investment in infrastructure.

3.6 The Government's strategy to address these weaknesses recognises that they are all inter-linked (PBR 1999 set out these arguments in detail). For example, R&D alone will not create new products and new wealth without the spur of competition and the vision of entrepreneurs. Equally, firms have put off past investment not only due to macroeconomic instability, but also because they could not find workers with the right skills. It is therefore only by dealing with all these weaknesses together, that the Government will meet its productivity ambition.

COMPETITION

3.7 A competitive economy will drive up productivity by setting firms a sharp incentive to improve the efficiency with which they produce goods and services, keeping prices down and quality up. Firms will know that if they fail to do these things, they will lose business to existing competitors or new entrants. At the same time, firms will be encouraged to innovate to ensure that they maintain an advantage in a fiercely competitive market, boosting productivity further.

Improving competition in the UK economy

The Competition Act

3.8 The new Competition Act 1998 came into force on 1 March. 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 - up to 10 per cent of UK turnover for each year of the infringement up to a maximum of three years - and ensures that the OFT is able to identify and pursue cases of anti-competitive behaviour entirely independently of Ministers. The OFT will encourage whistle-blowers to come forward with information on cartels by implementing a leniency regime for companies that co-operate with them. This approach has been highly successful in the US.

3.9 To help ensure that the Act is implemented effectively, the OFT was awarded an extra £15.4 million over three years in the 1998 Comprehensive Spending Review. These funds have allowed the OFT to undertake an extensive programme to educate businesses in what the new Act means, and how it will be implemented. At the same time, the OFT has recruited additional experts to improve its capabilities, and organised additional training for its staff.

Review of competition in the professions

3.10 Certain professional rules are excluded from the prohibitions on anti-competitive agreements introduced by the Competition Act. The Chancellor announced in the PBR that the Director General for Fair Trading would provide advice to Ministers on the extent to which this can lead to distortions or restrictions in competition in the markets for professional services. These markets are worth over £25 billion.

3.11 The OFT has been considering how best to take forward this review. Its initial conclusions are that it should look at three generic types of restriction, between which there are likely to be significant interactions:

• rules which restrict entry to certain professions and legal restrictions on the ability of individuals who do not have specified qualifications from offering certain services;
• rules on the conduct of regulated professionals such as restrictions or prohibitions on advertising or price competition; and
• legal requirements which require third parties to use qualified professionals for certain transactions.

3.12 There may be linkages between the possible effects on competition of the way in which the professions are regulated and wider issues affecting these markets, such as the conduct of market participants. If so, the review will need to consider these as well.

3.13 The DGFT aims to put advice to Ministers later in the year. The Government will then need to balance any competition detriment identified by the review against other public policy objectives such as the protection of consumers from incompetent practitioners. In line with the recommendations made by Don Cruickshank last summer in his interim report on the regulation of the banking system, the Government will aim to ensure that any restrictions are proportionate and do not restrict competition more than is necessary. Following consideration by Ministers, the Government will consider whether the exclusion of certain professional rules from the Competition Act ought to be removed and whether other reforms to legislation are required, including to EC Single Market Directives.

3.14 In addition to improving the overall competition framework in the UK, the Government is:

• implementing the Utilities Bill, which will confer on the energy regulator a primary duty to advance the consumer interest through competition wherever possible and appropriate;
• planning to publish a Green Paper in the next month on competition in the water industry; and
• planning to publish a White Paper in the autumn on regulation of the communications industry.

Empowering consumers

3.15 To gain the full benefits of effective competition, individuals need to be well-informed consumers. This requires people to have access to easily understandable information comparing suppliers of similar products. This is why the Government is improving the information available to consumers on what are often complex products. For example, the FSA has set out proposals for publishing clear and helpful comparative information on products such as personal pensions, endowments, unit trust and ISA products (see Chapter 5). To meet its new remit to promote public understanding of the financial system, the FSA is also developing a customer focussed regime for regulating mortgages, majoring on disclosure.

ENTERPRISE AND INNOVATION

Enterprise

The ladder of opportunity for business

3.16 Enterprise is about using resources - knowledge, people and capital - to seize opportunities. Success depends on having access to resources and being aware of opportunities at every stage of the process of developing and growing a business. The Government's job is to create an environment in which enterprise can flourish. This requires an under-pinning of macroeconomic stability and vigorous competition. However, there is a positive role beyond this that the Government can play in encouraging an enterprise society. The aim of this Government is to help each firm raise and achieve its potential by creating a ladder of opportunity for business that starts before a firm is even created and stretches up to the largest companies in the country.

3.17 In practical terms, the Government has been working closely with business over the last eighteen months to identify the key barriers which can hold back enterprises from moving forward at each stage in their development: a lack of skills and ambition reducing the potential of start-ups; barriers and a lack of support when starting a business; and too few incentives to encourage existing businesses to aim for high-growth. The Government has designed and consulted on a large number of measures to help reduce these barriers, which will be introduced in this Finance Bill.

Pre start-up support

3.18 The Government's aim is to help create an environment which inspires and encourages entrepreneurial activity in all sections of society. To achieve this, it is important both to reduce cultural barriers which can stand in the way of individuals starting up or joining new enterprises, and to ensure that there is not an excessive fear of failure.

3.19 Raising the ambition and skills of young people will enable them to be successful in an enterprise economy, and is an important component in building an enterprise culture. From April, the Government will introduce measures announced in the 1999 PBR to boost enterprise skills in schools and to make young people more aware of business and the opportunities that it presents (see paragraph 3.72). The new National Curriculum will include a focus on enterprise and employment to improve the skills set of future entrepreneurs. This continues into higher education through the work of the Science Enterprise Centres.

3.20 Building on this, the Government is supporting the launch of the National Enterprise Campaign in May, spearheaded by the Confederation of British Industry, the British Chambers of Commerce and the Institute of Directors (see paragraph 3.73). The Campaign will include an initial focus on young people and boosting enterprise in high unemployment areas, including inner cities.

Reducing the fear of failure

3.21 Attitudes towards enterprise are affected by ability and the rewards for successful management and investment, and also by the penalties for not succeeding and the consequent fear of failure. 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 new enterprises, nor hinder further access to finance. At the personal level, bankruptcy can stigmatise those individuals whose businesses have failed despite their honest endeavours. The Secretary of State for Trade and Industry will shortly issue a consultation document containing proposals for possible reform of the law relating to personal bankruptcy.

3.22 A joint DTI/Treasury review is also currently underway into the corporate insolvency regime, with the assistance of a group of experts drawn from the private sector. The aim is to explore what more could be done to strengthen the "rescue culture" for businesses which may have longer term futures beyond their current financial difficulties. There will be further consultation on this issue in due course.

Starting in business

3.23 Starting in business requires access to resources including skills and finance. The Government's aim is to help all individuals gain access to the resources they need to turn their idea into a successful business. It is particularly important that no sections of society face unnecessary barriers to accessing any of this support.

Small Business Service

3.24 To give small firms easier access to the advice and support they need, the Government is setting up a new Small Business Service (SBS), which will be launched on 3 April. The SBS will act as a strong voice for small business at the heart of Government under the leadership of its Chief Executive David Irwin. The Chief Executive also has responsibility for ensuring that the SBS:

• simplifies and improves the quality and coherence of Government support for small businesses; and
• helps small firms deal with regulation and ensures 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.

Payroll support

3.25 The Payroll subgroup of the Better Regulation Taskforce recently published a report which looked at the costs to business, and in particular small business, of complying with their payroll obligations. Firms taking on their first employees assume responsibilities as employers for collecting income tax and National Insurance payments.

3.26 The Budget contains substantial new measures which will help small firms with these costs. A central recommendation of the taskforce report was that small businesses needed to be encouraged to use online payroll support services. The Budget contains new 100 per cent allowances for investment in information and communications technology (ICT) equipment, new discounts for e-filing and using internet payroll services, and new resources to inform small businesses of the benefits of internet services and provide training and support to them (See 3.57-3.61).

3.27 To give further help to minimise the cost of complying with payroll obligations, the Government has been developing a range of other forms of support for new and small employers. From April 2000 the Inland Revenue will expand the range of help available on payroll issues by building on the success of the New Enterprise Support Initiative (NESI). The Inland Revenue:

• has today published a payroll software standard which will reassure small employers that accredited software will meet their payroll commitments;
• will increase both the size and scope of the work carried out by the NESI helpline for new employers and more than double the size of the Inland Revenue Business Support Teams. These will offer new employers a detailed visit by Business Support Team to take them through various payroll issues; and
• will, from April 2000, extend the quarterly PAYE scheme to benefit an additional 80,000 employers. Following the £400 rise in the last Budget, the threshold for quarterly payments will be raised from £1,000 to £1,500 a month, saving employers up to £150 a year.

Enterprise open to all

3.28 To maximise the UK's enterprise potential, opportunities for growing businesses need to be available to everybody in the country. To ensure that enterprise is open to all and to encourage private investment in deprived, high unemployment areas the Government is supporting individuals and new businesses in such areas:

• the £30 million Phoenix Fund will establish a new network of 1,000 volunteer business mentors by April 2001; help to support new incubator workspaces; and support new and expanded loan funds;
• New Entrepreneur Scholarships will be offered to budding entrepreneurs in deprived areas from September 2001 to equip them with the management and business skills needed to turn their aspirations into successful businesses. Pilots will be run in London, Cornwall and Manchester later this year;
• the new Social Investment Taskforce - an initiative of the UK Social Investment Forum - chaired by Ronald Cohen of Apax Partners & Co., will consider a new strategic framework for social and community investment. This will include examining: tax incentives for investing in community development projects and social enterprises; a permanent investment fund to support a regular wave of new projects; and how to target more resources in venture capital funds at high unemployment areas;
• Kim Howells in the DTI has been appointed as Minister in charge of corporate social responsibility across Government. The Government sees corporate social responsibility as a key component of successful business strategies and is keen to see the practice become more widespread;
• the New Deal (see Chapter 4) will offer help for long term unemployed people to become self-employed and start their own business - for the over-50s, up to £3,000 each during their first year in business and in work; and
• the Government is looking at what lessons might be learned from the New Markets Initiative in the US, which is designed to stimulate major private investment in distressed areas.

Spreading ideas

3.29 In an enterprise economy, the rate of innovation will increase as people have the skills and incentives to turn ideas and technological developments into new products and services. Spreading ideas is key to encouraging new start up businesses in the economy and new production in existing firms. In this way innovation can act as a major source of growth in the economy.

3.30 The Government has a key role to play in ensuring that there are incentives to invest in R&D and to innovate as well as to exploit the results of that research. Encouraging both R&D and the commercial exploitation of intellectual property in the public sector and in universities will also support the formation of new businesses. To support these activities, the Government has:

• injected £1.4 billion in the 1998 Comprehensive Spending Review, including the £700 million Joint Infrastructure Fund endowed by the Government and the Wellcome Trust, towards ensuring the UK continues to generate leading-edge research;
• set up the £50 million University Challenge fund to provide seed funding for commercialising research;
• run the Science Enterprise Challenge. This provided £25 million for new centres to encourage enterprise in and around universities;
• committed up to £14 million a year on average from the Capital Modernisation Fund for the next five years towards the costs of establishing an Institute jointly between Cambridge University and Massachusetts Institute of Technology (MIT); and
• endorsed recommendations from the Baker Review to encourage the commercialisation of research from Public Sector Research Establishments.

Encouraging high growth

3.31 Too few businesses in the UK realise their growth potential. To do so, investment is crucial to capitalise on entrepreneurial talent and enable them to seize new opportunities for growth. This includes re-investment of the enterprise's own gains, external financial capital, and investment in building the enterprise's human capital through recruitment and training of skilled employees. The Government is introducing in this Finance Bill several measures to improve the fiscal incentives for companies and individuals to make this investment. Since 1997, the Government has cut the average corporation tax bill for small companies by nearly 25 per cent.

Capital allowances

3.32 To encourage all SMEs, manufacturing and services, companies and unincorporated, to invest from their own resources in capital stock, the Government introduced enhanced capital allowances for SMEs' plant and machinery investment in July 1997. This brings forward the tax relief for investing firms, providing a cashflow boost which is particularly helpful to smaller firms which are more reliant on cashflow to fund investment. The Government has maintained enhanced allowances at 40 per cent from July 1998 through to July 2000. In this Finance Bill, the Government will make these investment incentives permanent (see also paragraph 3.60 on capital allowances for ICT equipment).

3.33 SMEs' internal resources will often need to be supplemented by external finance and skills as the firm grows. The primary source of external finance for UK SMEs remains bank lending, and so it is important that this market is operating in as competitive and innovative a way as possible. This is one of the important aspects which the Banking Review chaired by Don Cruickshank examinined (see Box 3.2 above).

Capital gains tax

3.34 At early stages in their development, equity investments from individuals will often be a vital source of capital for SMEs. In recognition of this the Government introduced capital gains tax (CGT) taper relief in April 1998 to create incentives for long term investment in assets generating sustained growth, with particular support for entrepreneurial investment. The PBR in November stated that the Government was considering further change to the design of the business assets taper to ensure that the incentives it created had the maximum effect, and worked within the evolving risk capital market for smaller growth enterprises.

3.35 Following detailed consultation with business, the Government will shorten the business assets taper from ten to four years to bring the CGT incentives more into line with entrepreneurial investment patterns. The Government will also reduce the current percentage thresholds for equity shareholdings in trading companies to qualify for the lower rates from their current levels of 5 per cent for full-time employees and 25 per cent for others. In unquoted trading companies all shareholdings will qualify for the business assets taper. In quoted trading companies, all employee shareholdings will qualify as will other shareholdings above a 5 per cent threshold.

Chart 3.5: Existing and new tapers for business assets for higher rate tax payers

3.36 For the 3 million or so enterprises in the economy which are reliant on private risk capital rather than public equity markets to fund their growth, this will encourage all those involved in the success of the business, be they directors, employees, owners or outside shareholders, to invest in the future of the business. It will also promote wider share ownership generally among employees in all companies. This will help support the Government's aim for more companies and their employees to have common incentives towards enterprise growth, and complement other measures which the Government has been developing.

Employee share ownership

3.37 As announced in Budget 1999, the Government is introducing in this year's Finance Bill a new comprehensive all-employee share plan to support firms' own efforts to foster a more enterprising and 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 current schemes, to meet the needs of companies and employees.

Enterprise Management Incentives

3.38 Enterprises often need to expand their management team to deliver their growth potential, and need to provide sufficient rewards to offset the extra risk entailed for individuals investing their time in less established businesses. Share options are one means for companies to attract the key personnel they need. In this year's Finance Bill, the Government will introduce Enterprise Management Incentives (EMIs), which will help recruitment and retention by small higher-risk companies of key employees, by offering access to tax-advantaged share options. Under this incentive, such companies will be able to offer options over shares worth up to £100,000 (at time of option grant). The options will be taxed on sale of the shares, rather than taxed as income at exercise of the options. Following consultation, the Government has decided to increase the maximum number of employees that can benefit from EMIs from 10 to 15 per company.

Employer NICs

3.39 Many e-commerce and high-tech companies offer their employees substantial share options as part of their remuneration package. Where options are exercised outside an Inland Revenue approved scheme and the shares are readily convertible into cash, companies are liable for employers' National Insurance contributions (NICs) on the gain. For companies with volatile share prices this creates an exposure to an unpredictable NICs liability and can put at risk their investment strategies and damage future growth. The Government has received suggestions that employers' exposure to these difficulties could be resolved, for example, by allowing a voluntary agreement between employer and employee that all or part of the employer's NICs liability will be met by the employee. The Government is seeking views on these suggestions. It is attracted to improving flexibility in this area and is considering legislation as part of its support for the employees of companies with high growth potential.

3.40 It is also important that leading, larger companies are in a position to offer competitive remuneration packages to attract world-class directors that can help them succeed and thrive in the modern, global market place. However, companies and ultimately shareholders have a key interest in ensuring that directors' pay is linked closely to their performance. Following last year's consultation on this issue, the DTI will shortly announce the Government's proposals in this area.

Corporate venturing

3.41 Growing enterprises can often benefit from closer linkages with established businesses in their technology sector. Corporate venturing investment by the larger business can help cement these links. To encourage this form of financing and business support, this year's Finance Bill will introduce tax incentives to encourage companies to undertake corporate venturing. Companies will be able to claim corporation tax relief at 20 per cent on investments in small higher risk trading companies as well as a deferral relief where they sell shares and reinvest the gain under the scheme.

3.42 These incentives will provide a further stimulus to the work the DTI has already undertaken to promote corporate venturing. The conclusions of a major research study undertaken jointly with the CBI and Nat West published last year showed the benefits of venturing. Further initiatives are planned to help companies understand how corporate venturing works including joint Treasury/DTI work with large companies to promote venturing, a rolling programme of regional events throughout this year and a practical guide for companies interested in establishing a corporate venturing relationship. The DTI will also be working with the National Business Angel Network to encourage them to promote corporate venturing by matching corporate investors with smaller companies.

Regional venture capital funds

3.43 As enterprises progress, and their financing needs grow, access to venture capital finance can become more important. The Government is already working with the Regional Development Agencies (RDAs) to establish the first wave of new regional venture capital funds. These will be public private partnerships, with Government support (via the DTI's Enterprise Fund) to lever in private risk capital for investment in small scale venture capital across the English regions, helping to meet a demand which is currently under-served by the commercial market. Along with the proposed UK High Tech Fund and the DETR's Coalfields Enterprise Fund, the Government is currently aiming to stimulate the creation of venture capital funds totalling nearly £500 million.

3.44 To build on this, and widen and deepen the venture capital provision for smaller enterprises, the Government will concentrate its resources and skills to develop this programme in a new £1 billion target umbrella fund, operated by the SBS with a new Small Business Investment Taskforce working closely in partnership with the RDAs. This activity will be led by an experienced business finance expert. The umbrella fund will encompass the venture funds totalling nearly £500 million currently in the process of creation. In order to lever in new private finance, the Government will commit a further £100 million of new resources over the period 2001-04. The European Investment Bank has also agreed to support this enhanced programme by investing further in the additional venture funds to be created under the new umbrella fund (subject to detailed assessment of individual proposals).

3.45 In taking forward this programme, the Taskforce and the SBS will work in strategic partnership with the RDAs to help create an environment where all enterprises with growth potential, wherever they are located, can access the finance they need to realise their potential. As part of this strategy, the SBS and RDAs will co-decide on regional priorities - the criteria for the funds and the allocation of Government support - to narrow the equity gaps for small scale venture capital across the UK. For example, relative to their SME sectors, the North of England, South West and Wales have 50 per cent or less early stage venture capital compared to the UK as a whole. The £1 billion target umbrella fund should go a substantial way towards narrowing regional disparities and moving the market forward over the next 3-5 years. The programme will also address the need for specific risk capital funds to finance business growth in deprived areas of the country.

Clusters

3.46 Clusters are geographically concentrated groups of firms and research institutions that combine intense competition with collaboration to stimulate innovation and productivity. Strong empirical support exists for the spill-over effects between firms and between firms and universities in R&D, innovation and knowledge sharing. Alongside this, the clustering of specialist service providers such as legal and financial advice as well as venture capital providers, can provide a strong stimulus to growth.

3.47 The Government is continuing to develop a clusters strategy for the UK. The 1999 PBR announced a cross-departmental Ministerial Group chaired by Lord Sainsbury to consider how the Government can promote and facilitate the growth of clusters. The PBR also announced changes to the planning system to strengthen the support for the growth and development of clusters of firms and research institutions. In the future, regional plans will proactively identify cluster areas and plan for their expansion.

3.48 The Secretary of State for Trade and Industry will shortly announce the next phase in the development of clusters. This will be a fund to enable RDAs to provide co-financing for business incubators, for example allied to universities, and small scale infrastructure in partnership with the private sector.

R&D tax credit

3.49 There is significant evidence from US companies that higher R&D intensity leads to better growth prospects over the next five years. Small firms in particular are less well-placed than large firms to raise finance for R&D programmes and to capture the potential spill-over benefits from their own R&D. Hence, SMEs tend to under-invest in R&D relative to larger firms. To address these issues, the Government has put in place the new R&D tax credit which will be introduced from April 2000 and be targeted on all small and medium-sized companies. As set out in the 1999 PBR, this tax credit will increase the 100 per cent relief for current spending on 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' corporation tax rate.

3.50 This tax credit and the introduction of permanent enhanced capital allowances (see paragraph 3.32) will help all small companies. As major contributors to the UK's R&D effort and because of their reliance on physical investment, these measures will be particularly beneficial for manufacturers, giving them extra resources to help them carry out the necessary investment and R&D to keep ahead of their competition and reap the potential benefits of the new enterprise economy.

Intellectual property rights

3.51 Following consultation, the Government will also be considering changes to the taxation of intellectual property rights. The aim of the reforms is to replace the 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.

Competitiveness of the tax system

3.52 One of the Government's aims is to make the UK a more competitive environment for entrepreneurs, investors in business and businesses themselves. It is therefore important that the UK tax system is competitive in the global arena, ensuring that the UK is seen as a productive place for businesses to operate, and a favourable base from which to invest abroad. To help achieve this, the Government is:

• giving companies greater flexibility in how they structure their business. This will give them more freedom to organise themselves in ways that suit their business rather than in ways driven by the tax system;
• abolishing the witholding tax on international bond interest. This deregulatory measure will abolish from April 2001 the current tax rules for financial institutions which act as Paying and Collecting Agents of international bonds and foreign dividends. Instead the Inland Revenue will collect routine information about the savings income of all individuals;
• extending the scope of the review of the taxation of intellectual property to include the possibility of tax relief for the costs of purchasing goodwill and some other intangibles. This reflects the increasing importance that intangible assets have to business;
• consulting with a view to improving business efficiency by providing rollover relief for gains arising on disposals of substantial shareholdings held by companies; and
• ensuring that the double taxation regime provides relief for all forms of business operating in the UK and does so equally across direct and indirect business structures.

E-commerce

The challenge to the UK economy

3.53 E-commerce has the potential to be of significant benefit to the UK economy and to both businesses and consumers. The sharpest spur to productivity, innovation and enterprise is competition. The internet intensifies competition by lowering barriers to entry, and increasing price transparency. As a new medium, the internet has sparked innovation, creating whole new markets and producing synergies between existing goods and services. Firms can benefit from shorter supply chains and reduced inventory costs. Consumers benefit from increased price transparency as a result of lower search costs; the ability to buy products direct rather than through intermediaries; and from higher quality services, available 24 hours a day, 7 days a week.

3.54 To ensure the UK economy benefits from the opportunities that the internet offers, the Government has set itself the goal of making the UK the best place in which to trade electronically by 2002. There are some key challenges that need to be met in order to achieve this goal. In terms of connectivity large and medium-sized UK companies are, on average, performing well compared to other G7 countries. But small and micro firms are lagging behind. The Government aims to get 1¹/₂ million SMEs online by 2002; with 1 million actually trading online.

3.55 Another key challenge facing the UK today is to ensure that the internet does not result in a digital divide - a country of IT-haves and IT-have nots. The Government has set a goal of universal access to the internet by 2005.

3.56 Finally, Government itself must modernise so that it benefits from the opportunities presented by new technologies. The cross-cutting review of the knowledge economy being carried out as part of the 2000 Spending Review is looking at all aspects of Government and e-commerce. It is being headed by the Chief Secretary to the Treasury and Patricia Hewitt, the DTI minister for small firms and e-commerce.

Getting SMEs online

Discounts for e-filing

3.57 To encourage firms to take up the challenge to get online, the Chancellor announced on 16 February that firms will be eligible for discounts for electronic filing and payment of tax returns. During 2001-02 small businesses that file their VAT quarterly returns or PAYE end of year returns via the internet and pay the tax due electronically will receive a one-off discount of £50 (or £100 for both PAYE and VAT). Similarly, Self Assessment taxpayers who file their return over the internet and pay electronically will receive a one-off discount of £10. There will be an extra one-off discount of £50 for small employers who pay tax credits to employees and qualify for the £50 PAYE discount. The PAYE and tax credits discounts will also be available to small employers using an internet payroll service.

Support package for SMEs

3.58 The Government recognises that getting on-line means more than simply setting up a website. It is important that all firms, and especially SMEs, understand that new technology is crucial to their business. The Government is investing £60 million to help SMEs understand what getting online means for their business; to help SMEs get online; and to help them get the right services once they are online. This will include:

• £10 million for a major boost to awareness, advice and training for small firms on using IT, through an expansion of the DTI's Information Society Initiative;
• £20 million for a new call centre and web-based advice and information services, to help answer the basic questions people have when starting or running a small firm and give value-added support; and
• £30 million to build a comprehensive infrastructure for a secure electronic interface with government, businesses and citizens.

3.59 Key elements in this package of support will be delivered in the coming year. A lead role will be taken by the SBS, with regular enhancements to the SBS website and a fully functional information service up and running by the end of the year. It is crucial that the website and call-centre provide exactly what small businesses want and need, and so their help in designing it will be vital.

Capital allowances for ICT equipment

3.60 ICT equipment is at the heart of the new internet revolution. In the new knowledge economy, it is investment in ICT that will be a driver of future business success and productivity growth. E-commerce is opening up global markets to small firms that were once closed due to their size. The internet is not only radically reshaping relationships with consumers but also transforming relationships along the supply chain. Small firms cannot be left behind in this process which is as significant as the industrial revolution, so the Government needs to do even more to get UK small firms prepared for the new challenges of the knowledge economy.

3.61 For the UK to lead the knowledge economy, there needs to be a step change in the use of ICT technologies by small enterprises. This is why from April this year, the Government will introduce 100 per cent first year capital allowances for small enterprises investing in ICT equipment for the next three years, to help them gear up and succeed in the knowledge economy.

Promoting universal access

3.62 Everyone must have the opportunity to reap the benefits the internet offers. Transforming education and widening access will ensure the opportunities of new technologies are shared by everyone. To this end, the Government is:

• providing £1.7 billion for the national IT strategy;
• enabling employees to borrow computers from their companies as a tax-free benefit. About 300,000 people are expected to borrow computers in this way by 2002-03;
• developing a system under which poorer individuals - sometimes through local partnerships - will be able to lease or own recycled computers. Around 100,000 computers should be available by the end of 2001;
• linking all schools, libraries, colleges and universities via the internet through the National Grid for Learning by 2002; and
• establishing up to 1,000 ICT learning centres across the UK to improve access to ICT for all.

3.63 Using the internet must be affordable. One of the key inhibitors to greater use of the internet in the UK has been expensive local telephone charges. The telecoms regulator, OFTEL, has already taken a number of steps designed to increase competition in the telecoms market and drive down the cost of internet access. And the Chancellor has challenged the telecoms industry to reduce the cost of using the internet to US levels. The Government welcomes the recent developments in this area but there is a great deal still to be done. Our goal must be to see prices - for both traditional (narrowband) and high-speed (broadband) access - comparable with the lowest in the world.

SKILLS

3.64 To create and to benefit from an enterprise economy, the workforce has to have a high level of basic skills, and the ability to adapt to changing working practices. The lack of a sufficiently skilled workforce can prevent businesses from using new technologies and innovating, hence holding back their potential growth. Standards are now rising in both primary and secondary education, but the UK has further to go to deliver the levels of educational attainment that will support productivity growth and a more enterprising economy.

3.65 The Government has begun to address the numbers of people without basic skills both at primary and secondary stages, and through improving the facilities available for life-long learning (see box 5.2 on the Government's education ambition).

National Curriculum

3.66 In primary and secondary education, 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; and
• introduced 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.

Individual learning accounts

3.67 To allow members of the workforce to adapt their skills so that they can continue to fulfil their potential in a changing working environment, the Government is now implementing a national framework under which everybody 19 or over can apply for an individual learning account. People in England with an individual learning account 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 activities. (Scotland and Northern Ireland will decide their own priorities for what will be eligible for receipt of the discounts). These discounts will be available from September 2000 when vocational training relief will be withdrawn.

3.68 As announced in Budget 1999, a new relief will ensure that employees who hold individual learning accounts pay no tax or NICs on their employers' contributions towards their learning, provided the employers make available such help to their entire workforce on similar terms.

learndirect

3.69 UfI limited (the company taking forward the University for Industry concept) will also seek to drive up demand for learning through the development of its consumer brand learndirect. The learndirect helpline (0800 100 900) has already helped over a million people looking for impartial information about opportunities, including many who have been discouraged from taking part in education in the past. From Autumn 2000, learndirect will also provide a portfolio of high-quality, online learning materials. These will offer individuals the opportunity to acquire new skills and knowledge, at a pace that suits them, from their home, work or one of up to 1,000 learndirect centres in all regions of the country.

3.70 A further help for workers faced with the consequences of change is the Rapid Response Fund. It provides intensive support when a large scale redundancy is announced. RDAs bid for resources from this fund to promote fast retraining where there is no alternative provision available.

3.71 Addressing the basic skills of people in the UK will not be enough on its own. The Government also needs to ensure that young people have the mind-set to be successful in an enterprising economy, and that they are inspired and encouraged to do so. For example, young people need to understand and believe in self employment as a career option, and be ready to do several jobs in the course of their working lives.

Education business links

3.72 To begin to foster a spirit of enterprise among young people in the UK, the Government is providing £10 million to enhance education-business links from April 2000. As announced in the 1999 PBR, this money will:

• improve the quality of the existing infrastructure of education business link organisations;
• enhance teachers' professional development and improve the quality of work experience for pupils; and
• help to 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).

National Enterprise Campaign

3.73 The Government is also supporting the National Enterprise Campaign which will initially aim to encourage more entrepreneurial attitudes among young people by using entrepreneurial ambassadors as role models and mentors. Sir Alan Sugar and Sir Richard Branson will both add their weight to the Campaign alongside several other well-known entrepreneurs including Martha Lane Fox and James Dyson. To complement the work of the Campaign, the Chancellor will publish a book later this year showcasing successful entrepreneurs and containing examples of how they got started in business. Its aim will be to inspire young people to follow similar routes into business.

Management education

3.74 To make businesses successful, however, the UK requires a considerable pool of people with management expertise. Managers and management teams play a key role in whether a business will be a success or failure. The latest survey by the Society of Insolvency Practitioners showed that over half of all company failures in the UK are directly attributable to poor management and leadership.

3.75 To address these problems, and to help more companies survive and flourish, the Government aims to improve the quality of management education available. To this end:

• the Government will create the new Council for Excellence in Management and Leadership under the leadership of Sir Anthony Cleaver, Chairman of AEA Technology plc. The Council will develop a strategy for improving levels of leadership and management competence, reporting in March 2001; and
• the Business Schools Small Firms Advisory Group will shortly report to the Council identifying how Business Schools can more effectively meet the needs of SMEs and entrepreneurs.

Work permits

3.76 Although skills levels in the national population are rising, skills shortages are emerging in our increasingly tight labour market. Failing to fill these vacancies with skilled workers will retard productivity and growth and mean fewer employment opportunities in the longer term. Developing people in the UK through education and training is key in achieving this, but access to skilled people from overseas is also part of the answer. Equally important is to enhance the UK's image as an attractive location for talented overseas students and entrepreneurs.

3.77 Following the announcement in November's PBR the Government has carried out a thorough review of the work permits system. The UK has always benefited from a market-driven work permits system, so that employers can recruit skilled people from abroad without any artificial limits or quotas on the number of work permits that can be issued. This rationale will remain the same, but to enhance the effectiveness of the work permits rules, both to meet skills shortages and to attract more highly skilled workers and entrepreneurs from abroad who can benefit the UK economy, the Government has decided to:

• ensure that the work permit and immigration arrangements help attract overseas students to the UK, and enable employers to recruit talented foreign graduates by: providing a more transparent path for those students whose skills are needed to be able to switch to work permits without leaving the country; reviewing the Training and Work Experience Scheme; and exploring other ways of making it easier for students with valuable skills to get permission to work;
• make the shortage category list, which allows for streamlined applications, more responsive to emerging skills shortages by: implementing today new shortage categories for IT workers; and, for the future, by improving sectoral labour market analysis by the Overseas Labour Service (OLS) to more rapidly identify skills shortages;
• reduce the burdens on business by: eliminating the labour market test for extensions and changes of employment for work permit holders; eliminate the need for permits for supplementary work; increase the maximum period for a work permit to 5 years; and introduce season tickets for workers who enter for short periods on a regular basis and explore the scope for more permit-free categories;
• ensure the system reflects current UK and global labour markets by: revising the skills criteria for business and commercial work permits; reviewing the current Keyworker category for less skilled workers; and redesigning the arrangements for entertainers; and
• maximise the benefit to the UK economy of our flexible and modernised UK work permits system by: marketing it more effectively at home and abroad; introducing electronic filing of applications; and, improving the interface between the OLS and the Home Office, including providing a one-stop shop for applications and extensions from people already in the UK.

3.78 The Government will also run a number of pilots with appropriate safeguards to establish whether they offer genuine advantages:

• allowing multinational companies to self-certify entry clearance for intra-company transfers;
• enabling people of outstanding ability to gain entry clearance to seek work in the UK; and
• introducing a new category of "innovators", relaxing the capital requirements for entrepreneurs offering exceptional economic benefit, to come to the UK to set up high-tech businesses.

INVESTMENT

3.79 The Government's new macroeconomic framework (see Chapter 2) combined with the structural reforms designed to raise the productivity of the economy, together create the very best environment for investment. The sharper stimulus provided by the measures to create a more enterprising economy should help Britain to reduce its history of under-investment. The Government can also have a more direct influence on investment both through the tax system and through the institutional structures it creates.

3.80 There are early indications that greater macroeconomic stability, the Government's swift action to remove distortions and enhance incentives through the corporate tax system and confidence in the UK's future are beginning to have a beneficial effect. Business investment as a share of GDP has increased in recent years and should reach 14¹/₂ per cent for 1999. This is its highest share since at least 1965 and means that for the first time since that date it is on course to exceed the G7 average. As the Government's structural reforms take effect they will help to reinforce this investment performance, and help to reverse the UK's poor record.

The tax system

Corporation tax

3.81 The Government has cut corporation tax rates to 30, 20 and 10 per cent, their lowest ever levels, and the lowest among major industrialised countries. The 10 per cent rate will take effect in April 2000 and enable 270,000 small and growing companies to retain more of their profits for re-investment and growth. Moreover, the Government has provided added certainty for firms taking long-term investment decisions by committing to keep corporation tax rates at this level or lower for the rest of this Parliament.

3.82 To further boost investment in manufacturing and services, the Government will make permanent the current 40 per cent first year allowances for SME capital investment in plant and machinery. Moreover, the Government will be giving special priority to small business capital investment in computers and other e-commerce equipment. These small businesses will be able to write off in the first year all of the cost of investments in ICT equipment until 2003 (see paragraphs 3.32 and 3.60).

Capital markets

Institutional investors

3.83 The UK has long benefited from deep and sophisticated equity markets, enabling a wide range of companies to raise capital efficiently. Institutional investors - pension funds and life assurance companies - are key players in those markets, controlling around 45 per cent of quoted equity investments. The Government is concerned that there may be factors encouraging institutional investors to follow industry-standard investment patterns which focus overwhelmingly on quoted equities and gilts and avoid investing in SMEs and other smaller companies.

3.84 The Government has asked Paul Myners, Chairman of Gartmore Investment Management, to look at these issues. He will shortly be launching a consultation exercise, which will consider a number of issues in this area including:

• whether regulatory provisions have unintended effects on investment decision-making;
• how pension funds make their investment decisions, and the role of professional advisers;
• how institutional investors' results and charges are reported; and
• the incentive effects of the methods used to assess fund performance.

He will consider the implications of these and other issues and report back with recommendations by the next Budget.

3.85 The Financial Service and Markets Bill establishes the Financial Services Authority (FSA) as a single regulator to meet the challenges of evolving markets. Its aim 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.

PUBLIC SECTOR PRODUCTIVITY

3.86 As well as setting macroeconomic and microeconomic polices to create the right climate for productivity improvements, the Government is also a major agent in the economy in its own right. To improve productivity in the public sector, the Government is focussing on service delivery in the 2000 Spending Review, as well as continuing to make best use of its assets and creating partnerships with the private sector through both the Private Finance Initiative (PFI) and Public Private Partnerships (PPPs).

Improving public sector service delivery

Spending Review 2000

3.87 The Spending Review 2000 to be announced in July will produce spending plans that will ensure that Departments can deliver effective and responsive services, improve efficiency and manage their assets over the following three years. In setting the plans, the review is scrutinising departments' current performances in these areas against the targets that were set in Public Service Agreements following the Comprehensive Spending Review in 1998.

3.88 One of the key common themes of the Spending Review this year is productivity. Departments' plans for the review period are therefore being examined to assess how they will contribute to higher productivity and sustainable economic growth. This work will ensure that in delivering public services, the Government is encouraging productivity growth throughout the economy.

Public Services Productivity Panel

3.89 In its drive to improve productivity in the public sector the Government continues to be advised by the Public Services Productivity Panel, a small group of senior business people and public sector managers. The Panel, chaired by the Chief Secretary to the Treasury, was established for a year in the first instance. The Government is now renewing the Panel for a minimum of a further two years. The Panel's advice is based on the detailed studies that it carries out into different areas of government, working closely with the departments concerned. The studies are aimed at identifying and tackling key areas for improvement and at sharing good practice within the public sector.

3.90 Recent Panel studies have led to:

• proposals to reform incentives for the front-line office staff working in the Government's large office networks such as the Benefits Agency and the Inland Revenue;
• a comprehensive overhaul of arrangements for booking and managing NHS outpatient appointments to reduce waiting times; and
• an action plan for continuous improvement to customer service in the large transport agencies such as the Driver & Vehicle Licensing Agency and the Driving Standards Agency.

Partnerships

3.91 Partnerships between the public and private sectors are central to the Government's programme for modernising public services. By drawing on the best of both sectors, PPPs can help the public sector to deliver modern, high-quality public services.

3.92 The Government set out its approach to PPPs in a policy paper, "Public Private Partnerships: The Government's approach", launched on 15 March. This paper sets out in detail, for the first time, the Government's objectives for PPPs and the underlying principles which are central to the way in which Government goes about developing new partnerships with the private sector. It presents the opportunities associated with different types of partnership arrangements and demonstrates how PPPs will deliver real improvements to public services, for the benefit of customers, local communities and the country as a whole.

Partnerships UK and Office of Government Commerce

3.93 PPPs also bring with them new challenges for the public sector. It needs to learn to be a better and more effective partner, client and procurer of private sector services. Partnerships UK will be a new company jointly owned by the public and private sectors which will help the public sector build more effective, value for money partnerships with the private sector, continuing and building upon the work of the Treasury Taskforce. The development of Partnerships UK's business plan is now well advanced and the business will begin operations later in the spring.

3.94 The Government is also taking action to raise its game in the way it procures goods and services across the board. The creation of the Office of Government Commerce (OGC) is central to this agenda. By drawing together central government procurement agencies into a single organisation and providing a new drive to improve performance, OGC will help deliver a step change in public sector procurement practice. Peter Gershon has recently been appointed as Chief Executive to the OGC which will be up and running from April 2000.