3 Competition, Innovation and Investment

3.01 Achieving the Government's central economic objective of high and stable levels of growth and employment requires a partnership in the widest sense between government and business. That means ensuring that the respective roles, skills and experience that government and business can bring to bear complement each other across the economy. And it means ensuring that the world-class standards reached by many UK companies become the benchmark for all. The President of the Board of Trade has already launched a dialogue aimed at helping British business reach the standard of the world's best. The Government is committed to making a success of this model of partnership, as the means of meeting its objective of raising the trend rate of growth of the UK economy.

The historical legacy

3.02 In pursuing the objective of improved economic performance and growth, the Government and business must jointly tackle an overall record of poor performance. Although the causes of growth are only imperfectly understood, during the post-war period our record on growth and productivity has fallen behind those of broadly comparable economies.

3.03 During the post-war period up to the mid 1970s, sometimes described as a golden age of growth, the UK's growth rate, though high by historical standards, was significantly lower than that of the US, Japan, Germany and France (see Chart 3.1). In part, this gap arose because some of these economies were catching up with the UK, as post-war reconstruction gathered pace. From the 1970s, as this process of catching up came to an end, the gap between the growth rates of the UK and these economies narrowed but still persisted. Over the post-war period as a whole, many comparable economies not only caught up with the UK, but went on to overtake us.

CHART 3.1: GDP growth

Low productivity

3.04 Figures for GDP per head of the population help demonstrate the size of the gap that persists: since 1960, GDP per head in Japan, Germany and France has increased considerably, to levels well above those in the UK (see Chart 3.2). Most of the differences in GDP per head reflect relatively low levels of productivity (i.e.output per worker) in the UK, compared, for example, to other European economies.

CHART 3.2: Relative GDP per head

3.05 UK productivity is around 10 per cent behind the OECD average and up to 30 per cent behind that of the best (see Chart3.3). That means that we are failing to make best use of our skills and physical assets.

CHART 3.3: Productivity (GDP per worker) levels in 1996

Causes of poor performance

3.06 A number of factors appear to be important in explaining this relatively poor performance. For example:

the UK's track record of macro-economic instability has discouraged long-term planning and investment; the extremes of boom and bust have also meant that capacity and skills have been lost permanently to the economy during periods of recession;
the legal and regulatory framework has in some areas failed to do its job of protecting the public whilst encouraging competition;
in some areas of the economy we have been slow to exploit the commercial potential of new technologies;
a failure by business to measure performance against high standards and make use of best practice;
our record on investment has been poor by international standards;
the workforce has not had the skills necessary to adapt to changing economic conditions and to innovate.

Role of government

3.07 Reversing this legacy represents a significant challenge. The Government's role is not to pick winners, but to improve the conditions within which all businesses and employees operate. Under its new model of partnership with business, the Government is therefore acting to promote economic stability, improve the legal and regulatory framework, and promote innovation, high-quality investment and employment opportunity.

3.08 Chapter 2 describes the measures the Government is taking to ensure economic stability. The Government's other priority areas for action can be summarised as:

Setting the framework

putting in place a legal and regulatory framework which will promote fair and open competition whilst protecting the interests of consumers, employees and the environment;
taking the lead in promoting an open and competitive world economy.

Fostering innovation and entrepreneurship

removing obstacles in the economy which stand in the way of businesses becoming more innovative and enterprising, for example by reforming the tax system and improving access to finance;
where government action can add value, fostering networks between different sectors of the economy, promoting partnerships between the private and public sectors and facilitating the development of fast-growing, creative companies;
providing high-quality public services that provide individuals with the support and security which will help them develop their skills, take risks and innovate.

Encouraging best practice

encouraging the use of benchmarking with the aim of helping British business to reach the standards of our many world-class companies.

Promoting high quality investment

forming public-private partnerships to invest in a modern and efficient infrastructure;
investing in the skills of the workforce;
ensuring that the tax system promotes high quality business investment.

3.09 Chapter 4 describes the steps the Government is taking to provide employment opportunities in the modern labour market.

Setting the framework

Competition

3.10 Competitive markets are essential to a strong, wealth-creating economy. Competition keeps up the pressure on businesses to raise their game - thereby stimulating innovation and creating new business and employment opportunities. And competition brings benefits to consumers, reflected in prices, quality and choice.

3.11 The Government has a key role to play in setting a legal and regulatory framework which promotes competition. It has already acted in two areas.

Competition Bill

3.12 The Government has made reform of the UK's outdated competition law a top priority: in August, the President of the Board of Trade published proposals for a new legal framework; and a Bill was introduced into Parliament in October. The Government's intention is that the new law should come into effect in 1999.

3.13 The Bill will create a modern and effective framework for competition policy. It is based on a tougher and more rigorous approach to abuses, whilst increasing transparency and accountability.

3.14 The main provisions of the Bill involve:

introduction of a prohibition-based approach: certain types of anti-competitive behaviour will be prohibited and subject to penalties;
extending and strengthening the coverage of the law;
allowing action against abuses while an investigation proceeds;
making use of EU experience: the legislation will bring UK and EU competition law broadly into line;
special rules for small firms, to avoid unnecessary burdens;
strong incentives not to act in an anti-competitive manner: there will be new rights of appeal for third parties, enforcement powers and effective penalties.

3.15 The success of these new arrangements depends on effective implementation. The Government will therefore ensure that the Office of Fair Trading has the necessary resources and uses them effectively, focusing on those areas where its activity will generate the greatest economic return.

Utilities review

3.16 High quality utilities are a pre-requisite for business success. The Government has a central role to play in ensuring effective, independent regulation of the utilities in areas where competition cannot provide sufficient incentives. The windfall tax put right failures in the way the sector was privatised. To set the framework for the future, the President of the Board of Trade established a review of utility regulation in June.

3.17 The Government's main objective for the review is to ensure that the regulatory framework delivers improvements in customer service, value and choice through a greater emphasis on the interests of the consumer. Regulation at arm's length from government will be preserved within a framework set by Ministers. The issues which the review is addressing include:

increasing the effectiveness of consumers' input to the regulatory system;
improving the transparency, consistency and predictability of the regulatory regime, to help business make long-term judgements about investment;
providing incentives for managers to innovate and improve efficiency;
promoting investment which enhances quality of service.

There will be full consultation on proposals arising from the review.

Better regulation

3.18 Government regulation to protect the interests of consumers and employees underpins an efficient market economy. The Government is determined to improve the quality of regulation in the UK, so that it meets the objective of protecting the public while promoting business success. To take forward this work the Government has established an independent advisory task force, whose members are drawn from a wide range of backgrounds, including the small firms sector. Its initial work programme will cover employment law, consumer affairs, social services and the voluntary sector. It will publish its conclusions in these areas in September 1998.

3.19 The regulation of the financial services industry should promote well-regulated, efficient and honest markets which maintain confidence in the financial sector and protect consumers. The Financial Services Reform Bill will establish a new Financial Services Authority to do so. The new regulatory structure will also help ensure that the financial services industry can develop products and services for UK industries and entrench UK financial markets as world leaders.

Corporate governance

3.20 Improving the way in which firms take decisions can help improve the quality of their investments. The Government therefore attaches high priority to working with business and investors to bring about improvements in standards of corporate governance. It is primarily for businesses to improve the way they work. But government can promote best practice, for example by encouraging long-term investment decisions by companies and major institutional investors, promoting responsible policies for the pay of senior managers and fostering better communication between companies and shareholders, employees and the wider public.

3.21 The Government will judge the issues involved against the objectives of promoting growth and investment and improving transparency and accountability. It will set out its response to the final Hampel report in early 1998.

The international dimension

3.22 It has always been true of the UK that we depend on trade for our economic well-being: the UK today exports more goods and services as a proportion of GDP than any comparable country. As the process of economic globalisation gathers pace, our trading relations with the rest of the world are becoming more important than ever. Moreover, exports, imports and inward investment all have a central part to play in enhancing economic growth and allowing countries to catch up with the performance of others - for example through technology transfer and learning from best practice in other countries. Achieving increases in our economic prosperity therefore depends on others' prosperity and on the existence of an open world economy; in the long run, protectionism helps no-one. Chart 3.4 demonstrates the substantial benefits that more open trading systems can deliver, taking catch-up in GDP per head between the original six EEC member states as a case study.

CHART 3.4: Trade liberalisation and catch up

Twin EU and G7 presidencies

3.23 The Government is playing a leading role in arguing for improvements in the efficiency of the world economy, through reductions in barriers to the free flow of goods, services and investment. The UK's twin presidencies of the EU and G7 in 1998 will provide an opportunity for the Government to take the lead in pursuing these objectives.

3.24 As discussions on enlargement of the EU begin, the Government will argue vigorously for an approach based on the principle of openness: promoting trade both within the single market and with the rest of the world. Reform of the Common Agricultural Policy is a top priority.

3.25 The Government will also press for completion of the single market: the Single Market Action Plan identifies a number of areas in which further progress is needed.

3.26 The Government will work to ensure that the EU's position in the World Trade Organisation (WTO) reflects a commitment to reducing trade barriers and opening markets. An immediate priority is completion of discussions on financial services. Beyond that, the UK will press for progress on competition policy and agriculture and will push at a WTO ministerial meeting in May 1998 for multilateral liberalisation. The Government will pay special attention to the development of trade with developing countries.

3.27 The UK also plays a leading role in the work of international financial institutions. Priorities for the Birmingham G7 summit include a report on economic development in Africa, improving bilateral standards of financial regulation and combating international financial crime.

Tax treaties

3.28 The UK's tax treaties play an important part in opening markets for trade and investment, and are welcomed by business as a means of reducing tax-related barriers and providing certainty of treatment. The Inland Revenue continues to expand and modernise this network: earlier this year the UK passed the landmark of having tax treaties with one hundred countries, giving us the most extensive network of tax treaties in the world.

Innovation and entrepreneurship

3.29 The key to economic success in the global economy lies in responding to competitive pressures by identifying and developing commercial opportunities. If the UK is to raise its levels of income and productivity, we therefore need individuals and businesses to become more innovative and entrepreneurial. That depends in large part on their own efforts. But through its partnership with business, the Government can help remove obstacles to economic success.

Research and development

3.30 A key input to commercial success is research and development (R&D). Though the UK generates much world-class R&D, particularly in high-technology areas, our investment in R&D has been overtaken by that of our main competitors since the 1980s (see Chart 3.5).

CHART 3.5: Research and development

3.31 The Chancellor and President of the Board of Trade will be taking a wide-ranging look at ways of improving the UK's record on investment in R&D. As a first step the Paymaster General is sponsoring a new group looking at ways of improving access to finance for high-technology companies (see box below).

3.32 The President of the Board of Trade has established competitiveness working parties to identify barriers to investment and innovation: the investment working party will look at issues including the cost and availability of capital.

3.33 A steering group supported by DTI, the Treasury, the CBI and the Bank of England will oversee action to identify barriers to growth faced by small, high-technology businesses.

Access to finance: the McCullagh group
The Paymaster General is sponsoring a group examining the financing of high-technology companies, particularly in the start-up stage. The group aims to identify any barriers that may exist in that context to their growth; and make practical proposals within six months. A key focus will be providing the right environment for encouraging R&D. It will be chaired by Dr Keith McCullagh, Chief Executive of British Biotech plc, and include senior figures from high-technology companies, financial services and the venture capital sector.

Making better use of our science base

3.34 The UK also needs to do better at translating investment in R&D and other inputs into commercial success. We already have a world-class science base, which makes a very significant contribution to the economy. For example, business funding on a commercial basis of academic research is higher in the UK as a share of GDP than in most other OECD countries. But we need to do better still, through more emphasis on the development and marketing of high-quality commercial applications. The Government has launched a number of measures aimed at helping our scientists and businesses meet this challenge:

Foresight programme

a new ministerial group, chaired by a DTI Minister, will provide coordination for the Foresight Programme, which brings together business, scientists and government. And under the new Foresight Link Awards scheme the Government will provide �10 million for projects that make good commercial use of scientific research.

Business incubators

the Government is supporting the business incubators movement, which provides start-up help for small firms working in high-technology areas: the President of the Board of Trade announced challenge funding in May for the Centre for Business Incubation Policy.

Helping scientists go into business

the Treasury, DfEE and DTI, including the Office of Science and Technology, are examining ways of developing on a commercial basis the work of scientists in government research establishments and the universities.

Small firms

3.35 Small firms play a vital role in the UK economy: they account for almost half of non-government employment and are an important source of dynamism and innovation. Their size means that they are more vulnerable than larger firms to fluctuations in demand - they will therefore gain most from the Government's commitment to economic stability.

3.36 The Government is also taking direct measures to promote the interests of the sector. For example, the culture of late payment is a source of concern to many small businesses. In the light of a recent consultation exercise undertaken by the President of the Board of Trade, the Government will shortly introduce legislation creating a legal right to interest on late payment of commercial debt.

3.37 The Government is also examining ways of improving the services it provides to business through Business Links.

High-growth and innovative firms

3.38 High growth and R&D-based firms make a particularly important contribution to economic growth. Such firms face problems not encountered to the same extent by others, notably in gaining access to finance. The work the Government is doing on capital gains tax, which is discussed below, is looking at ways of increasing the incentives for investment in entrepreneurial firms.

3.39 The Government is looking at further ways of improving access to finance in the following areas:

the Small Firms Loan Guarantee Scheme is being reviewed with the aim of improving access to finance for technology-based firms;
in Europe, the UK was instrumental in securing agreement on the establishment of a new European Technology Facility (ETF), with a budget of 125 million ecu. The objective of the ETF is to help finance small firms involved in high-technology work, through investment in venture capital funds;
the Government is examining ways of achieving better targeting of equity investment by private individuals in high-growth firms. In this context, an announcement will be made by the end of this year on the current review of the Venture Capital Trust scheme and Enterprise Investment Scheme;
in the comprehensive spending review, the DTI is considering how to focus government activity more on helping business to innovate.

British creative industries
The creativity of the British people is one of our greatest strengths. This creativity has fostered industries which are, or have the potential to become, world leaders and which will increasingly contribute to employment. For example, the music industry has generated commercial successes across the musical spectrum.
The Government is now acting in partnership with the industry to identify ways of achieving greater commercial success. This work will be overseen by a Creative Industries Task Force, made up of Ministers and senior industry figures. It will be complemented by the establishment of the National Endowment for Science, Technology and the Arts (NESTA), with significant funding from the National Lottery. NESTA's objectives include turning British creativity into products which can be exploited in the global market.
As one element of this partnership, the Government is working with the UK film industry. A three year tax incentive announced in the last Budget will stimulate investment and further growth. There have also been substantial awards of National Lottery money to three groups of producers and distributors to assist with the process of industry restructuring.

Encouraging best practice: business in the competitive economy

Benchmarking

3.40 The test of these policies lies in how business responds. However, the Government can add value, working closely with business, by spreading best practice within and between commercial sectors. The President of the Board of Trade published a report this month entitled "A Benchmark for Business", which represents an important contribution to this work. The report shows that, although there are some world-class UK companies, the generality of firms perform less well on average than those in our major competitors. The purpose of the report is to increase business awareness of ways of making good these lags in performance. The President of the Board of Trade is consulting business through her Competitiveness Advisory Group on practical ways in which government can work with business on this agenda.

"A Benchmark for business": seven major sectors
The DTI's report on benchmarking reviews the performance of seven major sectors of the UK economy. It finds that in many sectors, such as chemicals and telecommunications, UK companies match the world's best. It also finds that in traditional sectors such as textiles, the intense pressures of globalisation have encouraged firms to become world class through innovation and investment in high quality, value added products. However it goes on to show that the productivity of many UK firms remains well below world-class standards.

Investment

3.41 A competitive economy will create incentives for improved investment performance. And an innovative, entrepreneurial culture will foster high-quality investment. Investment which releases the commercial potential of leading edge technologies has a particular importance: it can entrench a virtuous circle in the UK economy of innovation and entrepreneurship feeding through to sustained higher growth.

3.42 However, the UK's record on investment has been poor by international standards. UK total investment as a share of GDP has been consistently below the OECD average since at least 1960. Over the last international economic cycle, the other major industrial economies have invested significantly more per worker than the UK (see Appendix A).

3.43 Business and other non-residential investment is vital to the economy's productive potential. Appendix A shows that the UK's record in these areas is less clearly out of line with that of other major industrial economies, with the exception of Japan (see Appendix A). Nevertheless, there is evidence that the UK has a relatively low ratio of non-residential capital to GDP, reflecting a legacy of poor performance (see Chart 3.6). To catch up with the productivity levels of our competitors, we would need to invest more than them to make good the gap in capital stock.

3.44 Moreover, it is not simply the quantity of investment that counts - quality is also important. That is, outputs depend on the efficiency with which the inputs of capital and labour are used. To catch up with the best performing economies the UK needs not only to invest more, but to ensure that it maintains - and improves - the quality of its investment.

CHART 3.6: Ratio of non-residential capital stock to GDP, 1992

Public-private partnerships (PPPs)

3.45 Business investment by the private sector must be complemented by public sector investment to provide high quality infrastructure and public services. In the past, public investment has tended to fall victim to short-term public expenditure planning. The implementation of the golden rule of public borrowing described in Chapter 2 will help redress this problem: decisions on the Government's capital spending will be taken on the basis of the returns offered over the long term.

3.46 The process of improving infrastructure and public services is now under way, for example with the allocation of some of the proceeds of the windfall tax to improving the fabric of schools.

3.47 Investment in the nation's economic future requires partnerships between the public and private sectors, which will make best use of the skills and resources of each. PPPs unlock the possibility of higher quality projects and services, delivered more quickly, than would be possible if the public sector acted alone. The Government is now pursuing a range of initiatives to extend the range and quality of PPPs.

PFI

3.48 Within a week of taking office the Government announced its plans to reinvigorate the Private Finance Initiative (PFI). The findings of an external review led by Malcolm Bates are now being implemented. Action in hand includes the establishment of a new Treasury Taskforce to provide a focal point for PFI projects across government. The Taskforce will test all significant projects for commercial viability before they enter the market. And all government departments are now focusing on a manageable number of important projects.

3.49 The new approach is producing results. Since May, over half a billion pounds' worth of contracts have been signed, including for two major hospitals. More are in the pipeline: for example, the Paymaster General is coordinating work on developing private finance contracts which will deal with the repair and maintenance backlog in schools.

Maximising value from public assets

3.50 The Treasury is developing a new approach to commercial activity by government departments and agencies, designed to help maximise value from public assets. It is intended that larger and more complex projects should be taken forward in partnership with the private sector. Guidance on the new approach will be available shortly; the Government would welcome the input of the private sector in identifying and developing commercial opportunities in areas covered by it.

Removing legal obstacles

3.51 Recent legislation will remove legal obstacles to PPPs undertaken by local authorities and NHS trusts. Further legislation will be introduced to allow agencies constituted as trading funds to establish PPPs.

London Underground

3.52 Ministers are considering options for a PPP involving London Underground, which will improve the quality of service that can be provided for passengers and guarantee value for money for the taxpayer.

A Tax system that promotes high quality investment

Capital gains tax

3.53 In his Budget speech on 2 July, the Chancellor invited comments on reforms to capital gains tax which would reward long-term investment and be fair to all. The consultation process has now been completed and evaluation of the comments is continuing; the Government is grateful for the comments received. The Government remains committed to a system that rewards long-term investment, particularly by entrepreneurs. Ways by which the costs of any changes could be contained also need to be considered.

3.54 In the Spring 1998 Budget, the Chancellor will respond to the comments received and bring forward measures to achieve these objectives.

Corporation tax

3.55 In the July Budget, the Chancellor also made changes to corporation tax to help create the right environment for long-term investment by companies. Corporation tax rates were cut by 2 per cent and payments of tax credits were abolished to remove the distortion that encouraged companies to pay out dividends rather than reinvest their profits.

3.56 Advance corporation tax (ACT) currently distorts the tax system because, for some companies, surplus ACT results in double taxation of their overseas profits. Many companies have told the Government they would like to see ACT abolished in favour of payment by instalments for larger companies.

3.57 In the light of these concerns the Chancellor is proposing further significant changes to corporation tax, to improve the tax system for companies and UK investment funds. The Chancellor is acting now to set out his intentions, to remove uncertainty:

abolition of advance corporation tax (ACT). In the next Budget the Chancellor intends to abolish ACT from 1999. Abolition of ACT will solve the problem of surplus ACT for the future and reduce the complexity of the current system;
a fair deal for existing surplus ACT. The Chancellor intends to preserve substantially companies' current expectations for using surplus ACT;
quarterly payments of corporation tax for larger companies. To replace ACT, the Chancellor intends to introduce a system of quarterly payments for corporation tax. Instalments would be phased in over four years, beginning in 1999. Small companies would remain subject to the same tax treatment as at present. Once the four-year transition is completed, medium-sized companies would pay half of their corporation tax through instalments starting in month seven of their accounting periods and the rest subsequently. Large companies would pay all their corporation tax by instalments, with 50 per cent due in-year (beginning in month seven) and the rest subsequently;
a 1per cent cut in the main rate of corporation tax. As part of this package, in the next Budget the Chancellor will cut the main rate of corporation tax to 30 per cent from April 1999. This will ease the transition to quarterly payments of corporation tax by larger companies.

3.58 The Inland Revenue will consult business on the details of how the system of quarterly payments will work; it is today issuing a consultative document[1] to inform this process.

Individual savings accounts

3.59 Chapter 5 describes the Government's intentions for consulting on the introduction of the individual savings account. By encouraging individuals to save, the ISA will help underpin long-term investment.

(1) The consultative document, "A modern system for corporation tax payments", is available from the Inland Revenue Information Centre, 0171 438 6420/6425.back

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Prepared 25 November 1997