Meeting the productivity challenge
THE PRODUCTIVITY CHALLENGE
Raising UK productivity
3.1 Raising productivity is one of the central conditions for meeting the Government's objective of high and stable levels of growth and employment and delivering sustained increases in living standards. This chapter sets out how and why the Government is working to increase productivity, the challenges that it faces and the environment that it is seeking to create.
3.2 Over the past three years, the Government has secured a platform of stability which provides the basis for raising productivity. The challenge for business, unions, educationalists and other organisations across the regions is together to tackle the productivity issue. Meeting this challenge offers the prospect of higher growth and increased employment opportunities with low inflation and low interest rates. The Government is determined not to pass up this opportunity.
3.3 The Government's strategy for productivity growth1 is based around macroeconomic stability and microeconomic reform. It is an agenda for Government, management and employees across the economy to raise their performance and take the opportunity for sustainable higher growth.
UK productivity performance
3.4 Productivity can be defined in a number of ways. Labour productivity can be measured as output per worker or output per hour worked. Total factor productivity measures the combined productivity of capital and labour in the economy. Whatever measures are used, the UK has long displayed lower productivity levels than its major competitor nations, and continues to do so (see Chart 3.1).2
3.5 Increasing productivity growth and starting to close the productivity gap should increase trend output growth, and so deliver greater economic and employment opportunities, and better living standards. The Government set a long-term ambition in the 1999 Pre-Budget Report: that the UK will have a faster rise in productivity than its main competitors over the next decade. To further this aim, the DTI and the Treasury have a joint Public Service Agreement (PSA) target to 'improve UK competitiveness by narrowing the productivity gap with the US, France, Germany and Japan over the economic cycle'. The DTI is preparing jointly with the DfEE a paper setting out their strategy to help achieve this.
Meeting the challenge
3.6 Closing the productivity gap cannot be achieved without a broader drive from workforces and managers across the country. In October the Chancellor therefore invited the TUC and the CBI to work together on an agenda for improving UK productivity. Six particular areas were identified for joint working:
3.7 Together with educationalists and other organisations, the Chancellor invited the TUC and CBI to identify case studies of strong and poor performance. They have been asked to seek proposals from individual employers and unions for concrete improvements and to highlight issues for the Government to address. This will provide a starting point from which everyone can play a full role in raising UK productivity growth.
3.8 The first part of the Government's contribution to meeting the productivity challenge is to provide a platform of macroeconomic stability. Economic instability makes it difficult for individuals and firms to plan, save and invest all of which are essential for productivity growth.
3.9 As Chapter 2 sets out, implementation of the Government's fiscal and monetary frameworks has provided low inflation, significantly reduced volatility in output growth and a more favourable environment for long-term investment.
3.10 UK productivity growth, slow throughout most of the 1990s, has shown recent signs of improvement (see Chart 3.2). But growth still trails that of the United States, which has seen an extraordinary acceleration in recent years (as discussed in Box 3.1).
3.11 The Government's microeconomic reforms are focused around the five drivers of productivity growth: competition, enterprise and innovation, investment, skills and
3.12 Competition drives better use of inputs. It motivates firms and individuals to improve their productivity, rewarding those who perform better and sorting them from those who
3.13 Achieving these improvements requires enterprise and innovation. Entrepreneurs who are able to spot opportunities and to take on the necessary risks to achieve them are an energising force for productivity improvement. Equally, new ideas form the basis of many of these opportunities, whether innovations in processes or products.
3.14 The Government can assist the development of a more entrepreneurial culture by reducing the fear of failure and promoting the benefits of success. This intervention can be particularly effective in cities and disadvantaged areas, where barriers to entrepreneurship can be especially severe. Further, it can encourage innovation across the economy by providing incentives for companies to carry out more research and helping them to extract the best from innovations developed elsewhere.
3.15 The quality and quantity of inputs are both important. Sufficient investment needs to be available and it needs to be used productively. The UK is fortunate to have highly- developed capital markets. However, it has also suffered from prolonged under-investment in many areas. Despite strong growth in business investment, a cumulative investment gap with our competitors persists. The Government is working to improve this situation through ensuring that the tax framework is favourable, by promoting efficient financial markets, and by reversing a long trend of under-investment in the public sector.
3.16 Both the quality and quantity of skills available affect productivity. Addressing the barriers that keep people from developing their full potential in the labour market is not only vital to address deprivation, it is key to driving economic growth. The Government is providing new opportunities for individuals to improve their skills and for companies to make the most of their human capital. It has invested in modernising education, providing lifelong learning and addressing skills shortages to close the gap between the UK skills base and those of our major competitors.
3.17 Improvements in inputs will benefit public sector productivity as well as private sector productivity. Government has different mechanisms, however, at its disposal to motivate improvements in how these inputs are used. Achieving such improvements not only ensures better use of public money, but also increases productivity across the economy as a whole.
3.18 These five drivers are inter-related in principle: competition, for instance, not only drives improvements in the use of inputs but can also improve inputs (for instance competition between training providers). They are also inter-related in practice: policies to motivate entrepreneurship can strengthen competition, for example.
3.19 Since 1997, the Government has worked to reform and improve aspects of all five drivers (see Table 3.1).
Table 3.1: The Government's productivity reforms
The role of regional policy
3.20 The building blocks for productivity growth are grounded in the strengths of regions, and the rural areas and cities within them. The Government is committed to a regional policy that exploits these strengths, not through top-down initiatives but through regional and local initiatives enabled by a national Government that provides the necessary flexibility and resources.
3.21 Through establishing Regional Development Agencies (RDAs), the Government has enabled regions to take a lead in developing productivity and delivering national and regional policies. The Pre-Budget Report gives RDAs more flexibility to make the most of their role as strategic leaders of regional and local economic development (see paragraphs 3.643.67).
3.22 To promote enterprise in our communities the RDAs will work closely with Local Strategic Partnerships (LSPs). LSPs will bring together the local authority, all service providers (such as the police, schools and health and social services), local businesses and community groups in a single coalition for a community. By developing Community Strategies they will play a key role in maximising local strengths and addressing local problems.
The European dimension
3.23 The Government is committed to pursuing economic reform within the European Union, and the goal of raising productivity is shared by all EU member states. At the Lisbon summit in March 2000, EU Heads of Government established a new strategic goal for the new decade for Europe, "to become the most competitive and dynamic knowledge-based economy in the world". To achieve this, the Lisbon and Feira summits agreed concrete action plans and deadlines in a range of areas, including venture capital, electronic commerce, financial services and telecoms liberalisation.
3.24 By monitoring performance through the use of agreed Europe-wide structural indicators, Member States are able to learn from each other and to share best practice. At the Stockholm Council in March 2001, the Government will look to build on the progress made since Lisbon.
3.25 The Government has begun to make the changes necessary to meet the productivity challenge by ensuring that markets are able to operate efficiently and providing the incentives for businesses to grow. It has established a platform of macroeconomic stability from which microeconomic reform can proceed. Now it is necessary to build on this start and to seize the opportunity. This will ensure that increases in productivity performance are sustained, securing higher prosperity for all.
The importance of competition
3.26 The Government has placed competition policy at the heart of its strategy to close the productivity gap. A competitive environment plays a central role in driving productivity growth in an economy. It encourages firms to innovate by reducing slack, putting downward pressure on costs and providing incentives for the efficient organisation of production. It also reorganises market structure, by reallocating resources away from inefficient firms.
3.27 In this way, competition creates an environment within which productive firms flourish. When more productive firms gain market share and less productive firms shrink and exit the market, the overall level of productivity rises. Attempts to quantify this effect in the US and UK have led to broadly similar results, attributing 30 to 50 per cent of manufacturing productivity growth to the sorting of productive and unproductive plants.3
Creating a framework for competition
3.28 The Government has introduced a range of measures to improve competition in the economy as a whole. It has modernised the legal and institutional framework in order to ensure that market discipline acts across the economy to motivate productivity improvements and to sort the more and less productive firms.
3.29 The Office of Fair Trading (OFT) has greatly enhanced powers to tackle anti-competitive practices, due to the Competition Act 1998, and to scrutinise the competition effects of financial services regulation, in light of the Financial Services and Markets Act. The Utilities Act, now in place, enhances the competition duty for the energy regulator.
3.30 It is also important to ensure that the competition authorities have the resources and structures to use these powers effectively. The OFT received an additional £10.2 million over three years in the 2000 Spending Review, and has a new Director General in John Vickers, former Chief Economist at the Bank of England.
3.31 The regime put in place by the Competition Act 1998 is already making an impact on competition in the UK:
3.32 The Government is also consulting on the creation of a new board structure for the OFT. The Government believes that in view of the increased responsibilities and powers under the Competition Act it is no longer appropriate for all the body's powers to be vested in one individual. This should depersonalise regulation and broaden the basis of the decision making that informs it.
3.33 The Government has announced how it plans to reform the process for controlling mergers to deliver the objective of depoliticising decisions and making competition the sole focus of assessment in the vast majority of cases. These changes require primary legislation to be implemented fully, but as a first step towards delivering these objectives, the Secretary of State for Trade and Industry has already committed himself to accepting the Director General of Fair Trading's (DGFT) advice on whether a merger should be referred to the Competition Commission, other than in exceptional circumstances.
Ensuring competition in particular markets
3.34 The new legal and institutional framework provides a powerful basis for ensuring effective competition. In key markets where competition has broader benefits for the economy as a whole (such as telecoms and banking), or where repeated questions about competitive pressure have been raised (such as the new car market), the Government has gone further to stimulate competitive intensity.
3.35 In Budget 2000, the Chancellor announced that the Government would act upon the recommendations of Don Cruickshank's report to improve competition and services to customers in the banking industry. The Government's immediate response included:
3.36 In August 2000, the Government and the Financial Services Authority published their detailed responses to the Cruickshank review. The Government announced a number of new measures, including:
3.37 Following the Competition Commission's investigation into the new car market, the Government has introduced measures to increase competition in the supply and sales of new cars. As a result, consumers have seen significant reductions in the new car prices on offer from major manufacturers.
3.38 In its recent report on supermarkets, the Competition Commission found the industry to be broadly competitive. However, it raised a concern about the relationship between supermarket chains and their suppliers. The Commission made a number of recommendations which would put relations between supermarkets and their suppliers on a clearer and more predictable basis, including a Code of Practice. The Secretary of State for Trade and Industry has accepted their recommendations, and has asked the DGFT to seek appropriate undertakings from the leading supermarkets. The DGFT is due to report back at the end of the year.
3.39 As the Department of the Environment, Transport and the Regions has recently announced, the Government is committed to ensuring that water consumers also benefit from the improvements in price, quality of service and choice which competition can deliver. The Government is now carrying out further work, involving the industry regulator Ofwat, on how best to implement this commitment while protecting environmental and public health standards. Options being examined include licensing new entrants for common carriage, separate licensing of different parts of the industry and how to ensure new entrants have access on reasonable terms to water resources. A full statement of conclusions will be made.
Competition in the professions
3.40 The OFT is also conducting a review of the state of competition in the professions. This is focusing on whether statutory or self-regulation unnecessarily restricts or distorts competition in key markets such as accountancy and legal services and the associated conduct of the businesses active in these sectors. The OFT issued a consultation document in May which elicited a wide range of representations. Consultants were appointed in early July to carry out a detailed study, taking into account the points raised. They have since spoken to a range of organisations, including representatives of consumer interests as well as practitioners and their regulators.
3.41 The DGFT will submit a report to Ministers on the findings of the review at the turn of the year. The Government will then need to consider what reforms may be appropriate, balancing any detrimental effects on competition with other public policy objectives, and ensuring that any restrictions on competition are both proportionate and do not go further than is necessary to deliver policy objectives.
3.42 The Deputy Prime Minister has been conducting a review of competition in the airport sector. The conclusions of this review will be announced shortly. The Government will work actively in Europe for a new slot allocation regulation that promotes competition and efficient use of capacity.
3.43 The Government is to publish a Communications White Paper later in the year on its vision and objectives for communications in the twenty-first century, including its regulation in the age of convergence of broadcasting and telecommunications. In parallel, the UK is working with its European partners to modernise and make more flexible European Union telecommunications regulation, ensuring that competition and the consumer are centre stage.
ENTERPRISE AND INNOVATION
3.44 A dynamic environment with opportunities for enterprise and innovation is vital to improving economic performance. The Government wants to make the UK the most attractive environment for business in Europe, removing obstacles to entrepreneurship and promoting the development and spread of new ideas. Productivity improvements thrive in a climate of new ideas, new businesses and new opportunities.
3.45 The Government is particularly concerned that these opportunities are open to everyone. If entrepreneurship is confined to a narrow segment of society, not only are many people denied the chance to succeed, but also the economy wastes a valuable resource for fulfiling its potential.
Improving the tax system
3.46 To provide the right incentives for enterprise, the Government has undertaken radical reforms of the tax framework for businesses, including:
3.47 In this Pre-Budget Report, the Government is announcing further initiatives to make the UK the best possible environment in which to do business. Building on announcements made in Budget 2000, it is:
3.48 The right tax framework can make a critical contribution to achieving an environment in which enterprise and innovation flourish. The Government will continuously review the tax system to ensure that it is meeting this goal. But there is more that the Government can and has done to improve the situation for business.
Reforming insolvency and business rescue
3.49 The fear of failure can act as a powerful disincentive to potential entrepreneurs considering starting their own businesses. Inefficient or inappropriate treatment of businesses in difficulty may stifle entrepreneurs who could otherwise have turned their situation around. The Government is examining the possibilities for reforming corporate rescue and insolvency and the report of a review group on this subject was published on 2 November.
3.50 The report recommends that the Inland Revenue and Customs and Excise should adopt a more commercial approach. In response, a new Inland Revenue/Customs and Excise unit is being set up to consider proposed rescue plans put forward by businesses. The unit will ensure that from April 2001 rescue proposals put forward by businesses (so-called Voluntary Arrangements) receive individual consideration. The unit will consider proposals in the same way as commercial creditors considering the full range of discretion available, and recognising that helping a business through a difficult period is often the best way to secure repayment of debts. New and strict timetables for dealing with vulnerable businesses will be published and adhered to.
3.51 A consultation is now under way in relation to a number of other recommendations and options for change. These include:
Limited Liability Partnerships
3.52 The Government has modernised the legal framework for business in the UK by introducing Limited Liability Partnerships (LLPs). Designed to appeal particularly to the professional business community, this arrangement allows members to limit their liabilities but structure their activities as a partnership. LLPs will be available from 6 April 2001.
3.53 In order to ensure that the commercial choice between using an LLP or a partnership is not distorted, the LLP will be treated for tax purposes as a partnership. The Government is concerned to ensure that the new structure is not used to create an unfair advantage through tax avoidance and the Inland Revenue is publishing alongside this Pre-Budget Report its proposed way forward and inviting comments.
Encouraging employees to share in success
3.54 Employee share ownership can help to align the incentives of all those in an enterprise. In order to encourage employees to take a stake in the success of their companies, the All-Employee Share Ownership Plan (AESOP) was introduced in Finance Act 2000. Over 160 companies have applied to set up a new AESOP, with 20 company schemes (covering more than 30,000 employees) already approved. By 2005, half a million more employees are expected to have shares in their companies through schemes of this type, bringing the total number who have a stake to over 2.5 million.
3.55 To encourage further employee shareholding and foster a more enterprising and productive relationship between firms and their employees, the Government extended in Finance Act 2000 the more generous business assets rate of capital gains tax taper relief to all disposals of shares held by employees in their companies where the companies were wholly (or almost wholly) trading. So that more companies and employees can benefit and to reduce their compliance costs, the Government is proposing to extend the benefit of the business assets taper to include employees of a range of non-trading companies from 6 April 2000. The Government will consult regarding the appropriate level of revenue protection.
3.56 Since 6 April 1999 National Insurance Contributions (NICs) have been payable by both the employer and employee on the gains arising when share options are exercised outside an Inland Revenue approved scheme, if the shares are readily convertible into cash. The rapid growth in the stock market since April 1999 has led to concerns by companies with volatile share prices that their exposure to an unpredictable NICs liability could endanger their investment strategies and damage their future growth by deterring investors.
3.57 The Government announced on 19 May 2000 that it was introducing legislation in the Child Support, Pensions and Social Security Act to allow the employer's NICs to be recovered or transferred to the employee, following agreement between companies and their employees. This will solve the accounting problem and help smaller start-up companies with limited cash flow.
3.58 Having addressed the concern over share options issued after 19 May 2000, new legislation will be introduced to cover share options issued between 6 April 1999 and 19 May 2000. Under these rules, companies will have the option of removing all uncertainty through settling their NICs liabilities on those options based on market values at the time of this Pre-Budget Report. This will remove future growth from the charge to employer's National Insurance. Together with the option of transferring liability to the employee, this will solve the difficulties for those high growth firms.
Encouraging SME financing and growth
3.59 A thriving small and medium sized business sector is important to driving productivity growth. In particular, the creation and growth of new firms promotes the exploitation of new ideas and opportunities, and sharpens competition.
3.60 Smaller, high risk companies often experience problems recruiting and remunerating key employees, and, in acknowledgement of this, the Government introduced in Budget 2000 tax-favoured Enterprise Management Incentives. This allowed the individual company to issue up to £100,000 of tax-favoured share options to up to 15 key employees. This has proved popular and, since the launch in July, over 100 companies have notified the Inland Revenue that they have granted options to a total of over 500 people, and it is estimated that 2,500 companies will use EMIs over the next three years.
3.61 However some companies have commented that they would like more flexibility, including the opportunity to issue these options to all their employees. The Government will therefore consult on replacing the limit on the number of employees with a total amount of tax-favoured options that the company can allocate in the way best suited to its business. In addition, rather than keeping the limit at the current level of £1.5 million, the Government will consult on raising the limit to £2.5 million. These two changes will increase the benefits of EMIs and make them available to more employees.
3.62 The Government has introduced a wide range of measures designed to boost the supply of risk capital finance to SMEs with growth potential, which might otherwise be under-supplied by the market. In particular, to improve the supply of equity to smaller, higher-risk companies, the Government has improved the Enterprise Investment Scheme (EIS) and Venture Capital Trust (VCT) scheme. Total investment to date is around £750 million for EIS and £1 billion for VCT. Encouraging a different source of capital for smaller companies, the Government has introduced a corporate venturing tax relief scheme from April 2000. This is designed to promote mutually beneficial investment by corporates in smaller higher risk trading companies.
3.63 To take advantage of this increased supply, more SMEs with growth potential need greater understanding of venture capital and specialist advice on how to structure business plans to secure external equity finance, to make themselves 'investment ready'. There is evidence of a gap in this market, akin to the classic 'equity gap'. The Government has therefore asked the SBS, working with the Regional Development Agencies and in consultation with the Small Business Investment Taskforce and market practitioners, to make early progress in identifying measures to bridge this gap, with a view to harnessing the expertise of the private sector as rapidly as possible.
Regional Development Agencies
3.64 Regional Development Agencies (RDAs) are at the heart of the Government's agenda for promoting sustainable regional economic growth, enterprise and regeneration. They provide a key element in the delivery of the Government's strategy for improving UK productivity.
3.65 In the 2000 Spending Review the Government announced that RDAs would have a strengthened role as strategic leaders of economic development, with a key role in promoting innovation and enterprise in their regions. They are to have a substantial increase in resources and a significant increase in flexibility on how to use those resources. The RDAs' overall budgets will rise from £1.2 billion this year to £1.7 billion in 200304. Within this overall sum, RDAs will be subject to the same rules as other government programmes. From April 2002 the separate budgets from DETR, DfEE and DTI will be brought together in a cross-departmental Single Budget.
3.66 The Government welcomes the RDAs' enthusiasm in developing the Single Budget and has decided to take a major step towards this with significantly increased freedom from next year:
3.67 As part of this increased flexibility, through consultation RDAs will be asked to provide stretching outcome and output targets to ensure their activities deliver their strategic goals, matching flexibility with greater accountability. These measures give RDAs increased flexibility to spend where they can have the greatest impact in delivering national and regional policies next year, promoting enterprise, innovation and growth. Increased flexibility next year will ensure a smooth transition to the Single Budget the year after.
The Social Investment Taskforce
3.68 The Social Investment Taskforce (SIT), led by leading venture capitalist Ronald Cohen of Apax Partners & Co, reported to the Chancellor in October. Its report, Enterprising Communities: Wealth Beyond Welfare, recommended a five-point programme of action aimed at stimulating enterprise, investment and wealth creation in under-invested communities.
3.69 The report's five main recommendations were:
3.70 The Government welcomes this innovative report and endorses its central conclusion, that enterprise and wealth creation are vital to building sustainable communities. The Government is already supporting the growth of community development finance for businesses in under-invested areas. In response to the SIT report, the Government will now do more:
Promoting an enterprise culture
3.71 Positive attitudes to enterprise, business and risk-taking are fundamental to an entrepreneurial economy. Often, the UK has been compared unfavourably with some of its rivals on this score4. The Government is addressing the need for a more pro-enterprise climate.
3.72 The Government is supporting 'Enterprise Insight', which was launched by the Prime Minister in May 2000. The campaign, led by Chief Executive Oonagh Mary Harpur, aims to create over the next 5 to 10 years a more enterprising culture across the UK, by:
3.73 The campaign will be spearheaded by the Ambassador Programme, where hundreds of entrepreneurs and business people will take part in a range of nationwide enterprise activities, including discussion forums with young people and mentoring young entrepreneurs.
3.74 The Government is helping to foster a spirit of enterprise among young people by providing £10 million this year to boost enterprise activities in schools. This money is being used to:
3.75 In Budget 2000, the Government announced the New Entrepreneur Scholarships to provide budding entrepreneurs in disadvantaged areas with the management and business skills they need to turn their business ideas into reality. Three pilot schemes in Manchester, Greenwich and Plymouth have been launched, with more than 30 participants.
3.76 The successful exploitation of new ideas is a crucial component for productivity growth. The UK needs world-class research in universities and the private sector, and the ability to capitalise upon the innovations it produces. But it has not always performed to its full potential in this field. Research and development intensity in the UK, for instance, is lower than in the US, France, Germany or Japan. Since 1997, the Government has reinforced the innovation base and worked to ensure that the economy makes the most of good ideas. Analysis for the pharmaceutical task force has shown that the UK pharmaceutical industry is the most productive in the world, as measured by patents per amount invested.
3.77 To encourage research and development by SMEs, the R&D tax credit has been introduced. This raises the tax relief for qualifying current R&D spending by SMEs from 100 per cent to 150 per cent. The enhanced relief will reduce the cash cost of research and development by 30 per cent where the company pays the small companies rate of corporation tax. Firms not yet in profit can take the relief as a (discounted) cash payment, reducing their costs by 24 per cent.
3.78 The Government will be evaluating the efficacy of the R&D Tax Credit for SMEs once sufficient information on its take-up becomes available. The Government will also be examining the case for complementary measures aimed at boosting R&D across business, drawing on existing analyses and on the research of the CBI, the Engineering Employers Federation, and other interested parties.
3.79 The Small Business Research Initiative (SBRI), announced in the Science White Paper, will encourage more high-tech small firms to start up, or to develop new research capacity. It will open up to SMEs R&D procurement programmes from departments and Research Councils worth up to £1 billion. It has the target of procuring £50 million of research under these programmes from small firms. Each participating department will aim to procure at least 2.5 per cent of their R&D from small firms, with Research Councils moving to meet the target over time.
Making the most of the radio spectrum
3.80 The radio spectrum is an essential raw material for many of the UK's most promising industries of the future. But the amount of spectrum available is finite and ensuring that it is used efficiently is essential if the growth of these industries is not to be impeded.
3.81 The Government has taken steps in recent years to improve the UK's spectrum management regime to provide that spectrum users face the right incentives to use it efficiently. It has introduced administrative pricing and auctions as spectrum
3.82 The auction of spectrum for third generation mobile services earlier this year demonstrated the importance of spectrum to commercial operators. It also demonstrated that auctions are a very effective way of ensuring that spectrum is assigned to those who value it most.
3.83 The next decade will see significant growth and innovation in wireless communications. The UK has been successful in making spectrum available for new services but it is essential that the framework for spectrum management keeps up with the pace of change if the UK is to remain at the forefront of the information revolution. To help it move forward in this area, the Government will commission an independent review of spectrum management, to report to the Chancellor and to the Secretary of State for Trade and Industry. The review will advise Government on the principles which should govern spectrum management and what more needs to be done to ensure that all users, including non-commercial users, are focused on using their spectrum in the most efficient way possible. In doing so, it will consider the use of spectrum management tools such as spectrum valuation, pricing and trading.
Taking advantage of ICT
3.84 The Government is acting to ensure that the UK takes advantage of the possibilities offered by ICT (see Box 3.1). It is encouraging investment in ICT, access to and use of the internet, and the development of ICT. Initiatives to date include:
3.85 The Government has set targets for the UK to be the best place to do e-commerce by 2002, and, by 2005, for everyone who wants it to have internet access and all government services to be online. It has already beaten its target to have 1.5 million SMEs online by
3.86 But getting business online is only the first challenge. Ensuring e-commerce brings real business benefits is the next step. A recent DTI study found that businesses representing 27 per cent of UK employment are trading online, putting the UK on a par with the US and Canada and ahead of Germany and Sweden. The Government is aiming to increase from 450,000 to 1 million the number of SMEs trading online by 2002.
3.87 The DTI study concluded that the last year had seen good progress by small and micro businesses but that more is required in some respects before they can be considered up with the best in the world. For example, the UK is fifth on the measure of micro businesses trading online with 14 per cent, compared with Germany the best performer at 21 per cent.
Making the most of UK universities
3.88 UK universities are a vital economic resource, nationally and regionally. If they are to play a full part in improving the UK's economic performance the universities need the resources to sustain a world-class science base and the incentives and framework to encourage greater interaction with business. Since 1997, the Government has introduced a number of initiatives to improve universities' contribution to closing the productivity gap.
3.89 The Higher Education Innovation Fund, announced in the Science and Innovation White Paper, is designed to build on universities' potential as drivers of growth in the knowledge economy. Worth £140 million over three years, it seeks to encourage knowledge transfer and help universities in their efforts to promote productivity and competitiveness in small firms. It incorporates the existing Higher Education Reach Out to Business and the Community (HEROBC) fund, tripling existing funding by the third year. The last round of HEROBC funding, in August, allocated £22 million to 50 bids from universities and colleges.
3.90 The University Challenge Fund enables commercial initiatives to be developed from university research to a point where they can raise venture capital. So far, 37 institutions have been involved and 80 projects have received investment from the fund. The first round of funding totalled £45 million, and there will be a second round of funding worth £15 million.
3.91 The Science Enterprise Challenge provides funding to teach science, engineering and technology graduates entrepreneurial skills. In addition to the £29 million already allocated, the 2000 Spending Review added £15 million to its funding. 40,000 students will benefit from the scheme by 2004.
3.92 The Joint Infrastructure Fund, announced in the 1998 Comprehensive Spending Review, allocated £750 million to start reversing years of underinvestment in the science infrastructure. The Wellcome Trust provided £300 million of this money.
3.93 The Science Research Investment Fund, announced in July, continues this partnership with the Trust and will invest a further £1 billion in 200203 and 200304. The Wellcome Trust will contribute £225 million.
3.94 The potential of public sector research establishments, which have produced innovations such as the liquid crystal display, has often not been fully exploited. A report commissioned from John Baker recommended a range of measures. In response the Government has established a £10 million fund for commercialisation of public sector research. It has made changes to civil service rules to give government scientists better incentives and rewards, and Partnerships UK will be advising research establishments on the exploitation of their research.
Investment in the UK
3.95 The UK has, historically, suffered from problems of under-investment. The greater economic stability now being achieved will promote investment. Low and stable inflation and sound public finances provide individuals and businesses in the UK with the confidence to invest, and attract internationally mobile capital flows in greater volumes and at lower cost. UK long-term interest rates, and hence the cost of capital, have fallen. Business investment, as a proportion of GDP, reached record levels in 1999 which are being maintained this year.
3.96 To encourage investment, the Government has reformed the tax system by:
3.97 A stable macroeconomic climate and the right tax framework are vital. But it is also necessary to ensure that funding for investment is available to those who need it and can best use it. This means making sure that capital markets are able to work efficiently in allocating investment across the economy.
The Myners review
3.98 In Budget 2000, the Government asked Paul Myners to conduct a review of UK institutional investment. As part of his ongoing review, he has written a letter to the Chancellor and the Secretary of State for Social Security outlining two proposals. These are summarised in Box 3.6.
Business angels and financial promotion
3.99 Individual investors in smaller growing companies ("business angels") provide a key link in the financing chain, helping enterprises to become 'investment ready' for subsequent venture capital funding. Business angels can also bring additional finance and industry expertise to venture capital funds.
3.100 To reduce the time and cost involved for both SMEs and venture funds in raising capital from private investors, the new Financial Services and Markets Act will exempt communications to a defined class of high net worth or sophisticated individual investors from the normal financial promotion rules. The draft Financial Promotion Order, which should come into effect by July 2001, proposes to define high net worth investors as those with annual income above £100,000 or net financial assets above £250,000.
3.101 Since labour (alongside capital) is one of the key inputs to production, the quantity and quality of skills are crucial to raising productivity. Yet skill levels in the UK are lower than in many of our main competitors. For example, a lower proportion of people in the UK have intermediate skills than in France or Germany. When international adult literacy was last surveyed between 1995 and 1997, the UK came tenth out of twelve countries, lagging behind the US, Canada and Germany. One in five of the UK adult population continues to suffer from very low skills in literacy and numeracy.
3.102 In November 1997, the Secretary of State for Education and Employment announced his intention to establish a National Skills Task Force. The Task Force reported earlier this year, and identified three core components to a National Skills Agenda:
3.103 The Government is considering its full response to these findings. It has already endorsed this conception of the National Skills Agenda, and outlined its strategy for addressing this agenda. The key elements of this are:
3.104 The level of basic skills and the ability of and opportunity for members of the workforce to adapt to changing technology and working practices are all important. The Government has pledged to reduce the number of adults with literacy or numeracy problems by 750,000 by 2004. Significant extra resources were allocated in the 2000 Spending Review towards this aim, increasing spending from around £240 million in 200001 to over £400 million in 200304.
3.105 Ensuring that Britain's young people enter the workforce with a high level of skills is essential to raising Britain's long-term productivity performance. This means starting from an early age to increase levels of educational attainment and encourage young people to realise their full potential. Chapter 5 explains how education is an important influence on children's life chances. The Government is working to reverse the record of under-investment and under-achievement in Britain's schools, and provide all children with the skills they need to succeed in the modern economy. It has:
Raising the UK skills base
3.106 In addition to raising standards in primary and secondary education and ensuring that young people leave school with a foundation of essential skills, the Government intends that by the end of the decade 50 per cent of the UK's young people will have the opportunity to benefit from higher education by the time they are 30. There they can gain the professional, technical and managerial skills on which a strong and successful economy relies. The 2000 Spending Review provides funding for more places in higher education, including:
Investing in lifelong learning
3.107 The dynamic and ever changing nature of the modern economy means that lifelong learning must be at the forefront of education policy both providing opportunities for adults who have missed the chance to develop basic skills earlier in life, and providing the opportunity and encouragement to individuals and firms to adapt existing skills and gain new ones. This has the potential to produce dramatic benefits for both the individual in terms of greater flexibility and adaptability and the opportunity for higher earnings, and for employers and the wider economy in terms of higher levels of productivity.
3.108 This autumn, learndirect (the brand name for the UfI) is rolling out its ICT-based learning portal and services nationally, opening up a new avenue through which adults can add to basic skills or build on higher skills. This is enabling training to reach further to groups of people unable to take advantage of more formal training opportunities. Users can learn at home, in the workplace or in one of over 700 learndirect centres which are now up and running across the country. A total of 38,000 users have so far registered on an average of two courses each. Early signs are that as many as 40 per cent of learndirect users have not engaged in learning in the past three years.
3.109 In addition, over 600 new ICT learning centres were announced in September 2000, with more to follow in the spring and autumn of 2001. These centres, located across the country, will enable people with low or no skills to acquire basic ICT skills. As well as significantly improving employment prospects, this will open the way to the acquisition of other skills, often through progression to the UfI. Through the inclusion also of ICT access points in libraries, there will be 6,000 UK online centres by 2004.
3.110 As part of its goal to create a highly skilled and adaptable workforce, the Government has also launched a national system of Individual Learning Accounts (ILAs). In England ILAs are available to all people aged 19 or over, but are being particularly targetted at those between 19 and 30, those returning to work, the self-employed, and non-teaching school staff. Learners can benefit from a package of incentives including £150 for the first million account holders to book eligible learning, provided they contribute £25. With almost 400,000 accounts opened so far, the Government is well on course to meet its target of 1 million account holders by March 2002.
3.111 To examine some of the key ongoing issues related to workforce training (see Box 3.7), the Performance and Innovation Unit in the Cabinet Office, working with stakeholders inside and outside government, will shortly start a project to identify the extent, nature and causes of under-investment in workforce development. In the light of this analysis, it will make proposals for solutions.
Improving management skills
3.112 High quality management and leadership skills are an important element of raising the productivity of the UK economy. The Skills Task Force found evidence of both skills shortages and skills deficiencies in UK management and leadership. To examine how management and leadership can be improved, the Government has established the Council for Excellence in Management and Leadership under the chairmanship of Sir Anthony Cleaver. The Council is due to report its interim findings in April 2001. The Government will consider the Council's conclusions and recommendations.
Tackling skills shortages
3.113 The Government is committed to ensuring that the UK competes for the best skilled workers in the world market. The arrangements for work permits have therefore been reviewed and the commitments made in Budget 2000 are being delivered.
3.114 The 'innovators' scheme was launched in September to attract budding entrepreneurs (especially those who plan to set up high-tech companies) to the UK. A range of IT jobs have been included in the shortage category list to make it easier for employers to obtain work permits for such workers.
3.115 It is now far easier for those overseas students whose skills are needed to obtain permission to work on graduation. The Overseas Labour Service has revised the definition of skilled workers to include all those with degrees allowing employers to obtain work permits for graduate recruits. The Home Office has recently changed its procedures so that prospective university students will not be denied student visas on the basis that they wish to switch into work permit employment on completion of their studies and applications from students to switch their immigration category will be normally be approved. The Government will be publicising these new measures widely to universities and employers.
3.116 Burdens on business have been reduced, with work permits now running for up to five years rather than four, and extensions and changes of employment are no longer subject to a labour market test.
3.117 Processing times for work permits have already gone down significantly and by April 2001, the Overseas Labour Service aims to process 80 per cent of completed applications within a week. Employers will soon benefit from electronic application forms which will be introduced in December 2000 and the Government is already piloting a scheme to allow employers to issue their own work permits.
3.118 At the turn of the year, the Government will launch a pilot scheme to attract people of outstanding ability from around the world. The scheme, which will seek applicants initially for up to six months, will allow particularly skilled individuals to enter the UK to seek work in their field of specialism. In order to gain entry, applicants will need to satisfy three of the following four criteria:
Within a year of entry, each applicant will need to show evidence of employment at a level warranted by their skills base
PUBLIC SECTOR PRODUCTIVITY
The role of the public sector
3.119 The Government is working to provide the best framework and the right incentives for businesses to close the productivity gap with our international competitors. But it is also changing the way it works itself, ensuring similar disciplines are in place so that the public sector works to improve its own productivity5.
3.120 The Government is seeking to bring this about in three complementary ways: by defining clearly the key outcome targets for each department and who is accountable for their delivery; by improving performance management based on clear strategies for delivery; and through a major investment for change programme supported by the right incentive structures and increasing managers' flexibility to innovate.
3.121 The Public Service Agreements (PSAs), first published after the 1998 Comprehensive Spending Review, and updated and improved as part of the 2000 Spending Review, are the single most ambitious attempt internationally to set targets for policy outcomes and service improvements that the Government is committed to. The new set, published in July, have been slimmed down to bring out more clearly the single-sentence aim, high-level objectives, and concrete targets that each main department and cross-departmental programme is working to. The 160 targets that result are an understandable, precise and accountable statement of the Government's priorities. Clear commitments have been made on key issues of concern. For example the Government will:
3.122 Many of these improvements can only be achieved by co-ordinated action by several parts of government. A feature of the 2000 Spending Review was the 15 cross-departmental reviews. As a result around 30 of the PSA targets are held jointly by more than one government department and they are jointly accountable for their delivery.
3.123 Setting clear priorities is only the first step towards delivery of improved services. The new Service Delivery Agreements (SDAs), published earlier this month, make clear the programmes and actions that departments will be working on in order to deliver the high level targets including the specific contributions departments are making to deliver joint targets. The SDAs also provide a guide to management priorities and value-for-money reforms in government departments. Parliament and the public will be kept informed regularly and in detail about performance against the targets, in departmental Annual Reports. The next reports are due in spring 2001. In addition the Government is preparing to provide more regular progress reports on PSA target delivery on the internet. The detailed public reporting provides a strong incentive to deliver the commitments contained in the PSAs, and the Cabinet Committee on Public Services and Public Expenditure (PSX), supported by the Treasury, rigorously monitors departmental performance, assessing progress against agreed milestones.
3.124 PSAs underpin the approach to clarifying accountabilities throughout public sector organisations. Being clear about expectations and putting the emphasis on results rather than procedures gives a sound foundation on which to build effective systems of public sector performance management. By targeting appreciable improvements in key services that the public value, the real enthusiasm of individuals within public sector organisations to serve the public can be tapped and engaged. In this way each individual can accept realistic but challenging objectives and be held accountable for them.
3.125 The Public Services Productivity Panel, a team of top private and public sector change management experts including chief executives and trade unionists, is a central part of the Government's strategy to improve public sector performance. One its first outputs was a new framework for performance management which has been adopted as the new business planning structure for the whole of central government as part of the Civil Service Reform programme. All departments are now required to establish independent quality assurance for their planning systems on a three year cycle.
3.126 The Government is committed to significantly improving the public sector's capital stock as an integral part of improvements to public services. The 2000 Spending Review allocated £43 billion of additional funding to deliver significant improvements in key public services an investment for change underpinned by clear targets and a process of modernisation and reform. As part of this, net public investment is set to double to £18 billion a year by 200304. High quality capital investment in public services will make a valuable contribution to raising their productivity.
3.127 To ensure best use of this significant increase in investment, the Government has introduced a series of incentives to increase the productivity of the existing public sector asset base and new investment. The National Asset Register brings accountability to existing asset holdings. The Government has introduced resource accounting and budgeting, which ensures financial planning takes account of the annual cost of holding public assets, not just the purchase price. Departmental Investment Strategies, to be published shortly, set out how departments will deliver value for money in their investments. In addition, departments are allowed to recycle receipts from the sale of redundant assets to fund assets that are needed. As part of the Government's commitment to improve productivity in new capital investment, the Capital Modernisation Fund is a source of finance for innovative capital projects that look at new ways to enhance public service delivery such as delivering services on-line.
3.128 The public sector has not always been quick to innovate in the past, with the consequence that productivity is held back as systems fail to adapt sufficiently to changed circumstances. With clear accountabilities for outcomes and results, there is a case for reviewing inhibiting rules on systems and procedures. Under Modernising Government, steps are being taken to encourage innovation by increasing managers' flexibility to act. These include a requirement for all initiatives to undergo a regulatory impact assessment to minimise the level of bureaucracy experienced in implementation, greater 'bottom up' input into policy making through a regional co-ordination unit, over £230 million allocated for the first three rounds of the Invest to Save Budget allowing local managers to identify new ways of improving productivity, and a pilot of local PSAs (see Chapter 5) enabling central and local government to agree new freedoms and flexibilities to achieve new stretching targets in specific areas.
3.129 Accountabilities will be effective only if tangible consequences are associated with success and with under-achievement. Opportunities to innovate will only be taken up if there is a genuine entrepreneurial culture, where rewards are not reserved for those who play safe. Setting the right incentives is therefore the third interlocking piece of the Government's strategy.
3.130 The Government is committed to modernising public sector pay to ensure that it provides appropriate incentives for the delivery of PSAs, including a much greater use of performance-related pay. The four large national networks (the DSS, Inland Revenue, Customs and Excise and Employment Service), are preparing for the introduction of team-based performance awards directly linked to the delivery of PSA targets, a major recommendation of the Public Sector Productivity Panel in its report Incentives for Change. All other departments will review by April 2002 their current pay systems to determine how best to ensure that in future they underpin more effective service delivery and greater productivity.
3.131 The Public Sector Productivity Panel has, in its first year, recommended a wide range of ways to help deliver better services including improved team-based performance incentives, a new approach to the comparative measurement of police efficiency, ways to achieve greater customer focus in the delivery of services and a number of practical steps to improve NHS services. The Panel's joint report, Public Services Productivity: Meeting the Challenge, published in August 2000 stressed that a good performance management system embedded in the culture of an organisation is essential to deliver consistent top class performance.
3.132 The Panel has recently been expanded, and is currently developing its programme for the coming year. The Panel intends to focus its work on helping secure better ownership for the delivery of services through improved accountabilities, incentives and motivation of staff. As before, the Panel will be working on the ground to help the public sector deliver real change to improve the productivity and performance of public services for all users.
3.133 Public-Private Partnerships (PPPs) are a cornerstone of the Government's policy to modernise and improve the quality of public services. But PPPs bring with them new challenges which require specialist skills and expertise.
3.134 Partnerships UK has been established as successor to the Treasury taskforce. By combining private sector skills and disciplines with a strong public sector mission it will help the public sector to get the best deal from Private Finance (PFI) and PPP transactions.
Reforming government procurement
3.135 The Government is a major purchaser of goods and services. Making sure that it is a good purchaser not only improves value for money, but also encourages best practice amongst its suppliers.
3.136 To this end, the Government established the Office of Government Commerce (OGC), bringing together procurement from across Government. Following recommendations from a review of public procurement, the OGC is on track to save £1 billion across departments within three years through modernisation, skilling, e-tendering and strategic partnerships. All government procurement will be sent and received electronically by 2002.
1 The Government has published alongside this Pre-Budget Report a separate paper setting out its strategy for raising UK productivity: Productivity in the UK: the Evidence and the Government's Approach, HM Treasury, November 2000.
2Comparative data on national productivity performance are collated by the Organisation for Economic Cooperation and Development, and adjusted by the Department of Trade and Industry to take account of the latest figures for the UK and US. Due to the introduction of the System of National Accounts there have been revisions to the GDP estimates for several countries, hence the data used in this Report are updates of those incorporated in Budget 2000.
3For the US see 'Aggregate Productivity Growth: Lessons from Microeconomic Evidence', L Foster, J Haltiwanger and CJ Krizan , NBER Working Paper 6803, 1998; and for the UK 'Productivity in the 1990s: Evidence from British Plants', J Haskel and M Barnes, Department of Economics, Queen Mary, University of London, Draft Working Paper, 2000 available at http://www.qmw.ac.uk/~ugte153.
4For instance Executive Report, Global Entrepreneurship Monitor, 1999.
5The Government will be publishing a separate paper in due course on public sector productivity, to complement the week's paper on productivity in the wider economy published alongside the Pre-Budget Report.