THE PRODUCTIVITY CHALLENGE

The Challenge

3.1  Productivity - the quantity of output each of us on average produces - is a fundamental yardstick of economic performance. No economy can grow sustainably unless its productivity improves. And poor productivity condemns a nation to be held back.

3.2  This is precisely the position in the United Kingdom. We are not as productive as our major trading partners, and the extent of the under-performance is very substantial. This shortfall holds back our living standards and our potential. Tackling it must be a central national priority.

3.3  The UK has a productivity gap with the United States of around 40 per cent and around 20 per cent with France and Germany. In most sectors of the economy the UK is far short of the best in the world. For instance, even though our best automotive plants are amongst the best in the world, average automotive productivity is still only just over half that of Japan.

3.4  Moreover, the productivity gaps are deep-seated. The UK has lagged behind our major competitors for decades. Beginning in the last century the UK was overtaken, first in manufacturing and then in service sector productivity, by its major competitors. Chart 3.1 shows the extent of the gaps they have opened up on the UK.

CHART 3.1 HERE

3.5  Closing these gaps amounts to a formidable challenge. However, the productivity gap is also a productivity opportunity. There is no intrinsic reason why UK productivity could not be world-class; indeed in some areas - such as software services - it is. Such a prospect, long-term as it might be, would be one of dramatically increased opportunities and living standards for all.

3.6  It is to this prospect that the Government wishes to lift the nation's sights. Even comparatively small progress would be worth a great deal. For example if just ¼ per cent could be added to the UK trend rate of growth - itself an ambitious goal - this would add around £30 billion to GDP in five years.

The Government's Approach

3.7  The Government has already begun laying the foundations on which better productivity performance can be built:

• first, stability has been key to the Government's economic strategy, as Chapter 1 sets out;
• second, the changes made to the tax system in the Government's first two Budgets will help encourage investment for the long term and reward successful entrepreneurs;
• third, the Comprehensive Spending Review (CSR) delivered an additional
  £19 billion investment in education that will help deliver improved skills for both those in education and those already in the workforce;
• fourth, the CSR delivered an additional £1.4 billion in funding for science, including a unique partnership with the Wellcome Foundation, that will help generate high quality research and innovation across the economy;
• finally, the doubling of net public investment over the next three years, including substantial investments in education and transport, will help to provide infrastructure fit for a world-class economy.

3.8  However, the Government believes there is more that can be done.

The productivity seminars

3.9  Earlier this year the Chancellor of the Exchequer and the Secretary of State for Trade and Industry jointly launched a series of seminars. The aim of these seminars was to examine some of the underlying causes of the UK's poor productivity performance and to explore options for improvement. These were fora for business people, financiers, union leaders, teachers and academics to suggest and discuss ideas and policies that might help tackle this central economic challenge. The seminars have examined specific issues such as finance, skills, management and entrepreneurship. Other seminars looked at case studies of specific industries such as the software and automotive sectors. A number of seminars began with detailed presentations from McKinsey, whose independent analysis of the underlying causes of the productivity gap was published on 30 October.

3.10  There has been wide agreement at the seminars that there are very substantial and damaging productivity gaps and that this a key economic challenge for the Government to tackle in partnership with business.

3.11   The key theme to emerge from the seminars is this: Britain still lacks a widespread culture of enterprise and ambition. Participants were concerned that British competitive pressures were often too weak. Although Britain has some world-class companies and managers, management can sometimes be unambitious in the face of the grind of continuous improvement or of the challenges of a strategy based on innovation in products, working methods and investment.

3.12  Ultimately, these are challenges for businesses. The Government therefore particularly welcomes the business-led 'Fit for the Future' campaign, spearheaded by the CBI and supported by the DTI. This aims to promote the transfer of best practice across every industry sector in the economy. The Government urges all businesses to take advantage of it.

3.13  Later this year the Department of Trade and Industry will explore further in a White Paper how its principles of modernisation and fairness apply to competitiveness. This will set out more of the Government's thinking on economic reforms. It will focus in particular on the increasing importance of knowledge and information in creating and sustaining economic activity throughout the economy.

The next steps

3.14  The Pre-Budget Report aims to begin to build on the steps the Government has already taken to tackle the productivity problem. The strategy is built round tackling four of the UK's historic weaknesses:

• innovation and enterprise
• investment
• competition
• skills

3.15  These weaknesses are not independent; they are closely interrelated. For instance, a poor record of innovation and making a success of new businesses leads to limited competitive challenge; barriers to competitive entry hold back innovation and potential entrepreneurs; a poor skills base holds back both investment and innovation. And the shortfalls in some areas of management, which were much highlighted at the productivity seminars, are both a root cause and a product of all four.

3.16  Set out below, for consultation, is an analysis of how each of the weaknesses the Government has identified contributes to the productivity gap and how the Government proposes to begin to tackle these problems. These first steps will be developed further in the 1999 Budget.

Enterprise and Innovation

The problem

3.17  Innovation and enterprise are key driving forces in improving productivity. The introduction and exploitation of new ideas, and the creation and growth of new enterprises, not only drive growth directly but are also prime sources of improvement and competitive challenge throughout the economy.

CHART 3.2 HERE

3.18  The Government strongly believes the UK needs to do more to encourage entrepreneurship. It needs new businesses which grow, and provide an engine of innovation and job creation. This view was strongly echoed in the productivity seminars. In particular:

• there is a widespread perception that cultural factors - risk aversion, a stigma associated with failure - are a significant barrier to the entrepreneurial spirit;
• problems in getting firms to grow are as large, if not greater, than those of establishing the firms in the first place.

3.19  In addition:

• there is evidence that large UK companies are much less effective and imaginative than those in the US at stimulating the small firm sector through acting as expert investors in start-ups ('corporate venturers'). By 1994 large firms in the US were investing some $500 million in small firms in the computer, biotechnology, engineering and other industries. The UK has nothing remotely comparable;
• there is also a particular difficulty in getting good people out of mature companies into growing businesses;
• there was a strong impression in the seminars that sometimes UK universities contrast unfavourably with the entrepreneurialism - and close involvement with the business world - of their US counterparts;
• UK entrepreneurs seem much more likely to experience financing difficulties than in the US possibly because, although the UK venture capital sector is reasonably strong, it is heavily biased towards investing in management buy outs (MBOs) rather than new start ups and the liquidity of equity markets for smaller companies is less than in the US.

3.20  Innovation - the exploitation of ideas and products that entrepreneurs and others can exploit and grow - is a further part of the story. Critical for the economy as a whole, new products, production methods and organisational changes can create substantial improvements in productivity.

3.21   The UK has a good record in producing ideas. The science base continues to produce research that is respected throughout the world. Nevertheless the UK also needs to improve its record of exploiting these ideas to create new products and then bring them to market, generating new businesses and growth:

• British universities could do more to focus on exploiting the commercial potential of their research and there is much that businesses could do to pull this through. UK business also needs to focus on improving its own research and development and the exploitation that follows;
• as Chart 3.2 shows, over the past decade the aggregate amount of R&D conducted by UK firms has continued to lag our international competitors. Aggregate R&D spending by small and medium-sized enterprises in particular is low.

Policy Approach

Innovation and Science

3.22  The UK needs to enhance a first-rate science base, putting proper systems in place for exploiting the commercial value of research, and getting scientists and business to take a much closer interest in each other.

3.23  The Government has begun by taking vital first steps to enhance the science base and maximise the economic value derived from it:

• the Comprehensive Spending Review set out an additional £1.4 billion injection of funds to ensure that the UK continues to be world-beating at generating research knowledge. At the centre of the DTI's programme is a £600 million infrastructure fund, endowed equally by Government and the Wellcome Trust, for new equipment and buildings. Bids for the first round were invited in October, with an initial deadline of 4 December, they will be considered by an expert committee shortly after. There has been a high level of interest from universities;
• the University Challenge scheme, also jointly funded by the Wellcome and Gatsby Trusts, to help pull ideas with commercial potential out of the laboratory. This scheme will provide £50 million in early-stage seed funding to help exploit the commercial potential of university research. By the deadline of 15 October, 44 bids had been received by the DTI, involving a total of 73 universities.

3.24  The Government will begin by ensuring that the substantial capital renewal provided by the joint Government/Wellcome infrastructure fund is used to underpin research in leading research areas - particularly those, like biosciences, that offer the opportunity for levering in further private funding and for commercial exploitation.

3.25  The Government also proposes to build on the potential of University Challenge to further strengthen exploitation of the science base by creating a £25 million Science Enterprise Challenge that will invite universities to compete for funds to endow up to eight new Institutes for Enterprise. These Institutes will bring the teaching of entrepreneurship and business skills into the science curriculum, helping to inspire and equip scientists and engineers to commercialise their knowledge. They will also be centres of excellence for the technology transfer process, bringing together specialist teams to organise science commercialisation effectively. The Institutes will be expected to draw on best international practice, and to match world-class standards. Details of the competition for Science Enterprise Challenge will be announced at the time of the DTI's forthcoming White Paper. Universities will be expected to bring forward proposals that involve significant funding from other sources.

3.26  The Government is also determined to ensure that the Government's own research institutes and other public sector research establishments are fully engaged in efforts to commercialise their research, where possible in collaboration with universities.

3.27  To complement this drive to push research into the market, the Government is examining proposals aimed at enhancing the incentives for businesses to draw on these ideas, as well as investing in their own home-grown R&D.

3.28  The Government published, in this year's Budget, a joint DTI and Treasury consultation paper - 'Innovating for the Future' - exploring how best to remove barriers to R&D investment.

3.29  The Government has looked at a number of ideas for incentives to encourage R&D investment. These included:

• a research and development corporation tax credit open to all firms based on the incremental increase in R&D spending;
• a tax credit based on the volume of R&D spending for small and medium enterprises (SMEs). One method of ensuring that firms not yet in profit, and hence not paying corporation tax, would still be able to gain immediate benefit from this type of incentive would be to make the credit payable directly to these companies.

3.30  The Government believes the case for extra incentives is strongest in the SME sector so it will consult with business further during the pre-Budget period on the feasibility and effectiveness of a volume-based R&D tax credit for SMEs. This work will also look at ways of encouraging R&D spending by companies not yet in taxable profit.

3.31  As a first step in working towards a potential new tax incentive, and also to assist the operation of the existing Scientific Research Allowance scheme, the Inland Revenue and the DTI will review the definition of business research and development for fiscal use, and consult business further on proposed new clearer guidelines on the Government's interpretation of that definition.

3.32  Establishing a rational and less complex system for the taxation of intellectual property (IP) was the second central conclusion to emerge from the 'Innovating for the Future' consultation exercise. Intellectual property is one of the key outputs of firms' innovation and R&D investment.

3.33  The Government will consult by the next Budget on two possible measures to reduce tax compliance costs and distortions on business decisions affecting intellectual property transactions:

• moving towards a simpler system of IP taxation, essentially following the accounting treatment for relieving expenditure on IP purchases and taxing proceeds; and
• simplifying the taxation of royalty payments which accrue to the owners of intellectual property rights. In place of the variable treatment at present, the aim would be to allow as many payments as possible to flow gross, consistent with maintaining effective UK taxing rights. In addition, if the definition of 'royalty' income for tax purposes were to be aligned with the simpler and more rational OECD model, the remaining deduction of tax at source rules would be more recognisably tied to the terms of a relevant double-taxation treaty - thus simplifying their application by business.

3.34  These potential tax measures for intellectual property reform are complex and need further work and consultation. But the Government hopes that a broadly revenue-neutral package, based on the ideas set out in paragraph 3.33, can be found which brings worthwhile simplification for consideration by the 2000 Budget.

3.35  As well as these tax issues, the consultation exercise has also highlighted the importance of measuring and reporting the value of innovation if firms are to manage their R&D activities effectively. The Government encourages companies to use the framework provided by current accounting standards as a means to inform their own R&D investment decisions and to disseminate information about their R&D activities to the market as a whole. The DTI's forthcoming White Paper will set out an initiative to be carried forward with the Accounting Standards Board and others on intangible assets more generally.

3.36  Finally, the review confirmed the importance of a balanced IP rights system, with sufficient protection to encourage investment, and efficient means of disseminating information to widen the process of innovation. The consultation highlighted the need to ensure that the IP system is kept up to date and readily accessible to smaller enterprises. Again, the DTI will be addressing this aspect of the environment for innovation in its forthcoming White Paper.

Enterprise

3.37  The Government has already acted in the March 1998 Budget to encourage enterprise in small and medium sized firms through a package of tax reforms, including the introduction of the Capital Gains Tax taper.

3.38  The Government is examining how best to build on those steps to develop an environment which encourages investment and growth in enterprising small and medium sized businesses. That work includes reviewing the case for continuing with enhanced first year capital allowances and other issues such as the effective rates of tax borne by small businesses, for decision in the next Budget.

CHART 3.3 HERE

3.39  In November 1997 the Paymaster General commissioned an independent group to examine the financing of high technology companies. The group, chaired by Sir Peter Williams of Oxford Instruments, looked at areas including investor incentives, support for R&D, and information about investment opportunities. The Government will consider the group's tax and regulatory suggestions in developing proposals for coming Budgets and in work on the proposed Financial Services and Markets Bill.

3.40  The Government is particularly keen to ensure that the tax system not only encourages long-term investment but also incentivises successful entrepreneurs. This year's Budget introduced a new Capital Gains Tax (CGT) paper to encourage long-term investment. The Enterprise Investment Scheme (EIS) and CGT reinvestment relief were unified in a new more generous EIS, with improved targeting to provide more effective support for smaller higher risk ventures. The Government will examine further how these two aspects of the tax system can together encourage entrepreneurs and other investors to make serial investments in smaller growing companies, so that as these enterprises graduate to new sources of equity funding the original investors will be better able to reinvest their funds into other similar ventures.

3.41  In the March 1998 Budget, comments were invited on changes to the taxation of capital gains of companies. The Government is grateful to those who commented and will be considering the issues with the possibility of bringing forward changes in future Budgets.

3.42  Smaller quoted companies (SQCs) are another vital component of the UK's business sector. Earlier this year, the Paymaster General commissioned an independent group to report to the Treasury on the barriers to growth faced by SQCs. The group focused on improving equity markets through incentives for individual investors, better information flows, and more support for smaller firms. The group has made a number of recommendations which the Government will consider in work on coming Budgets and on the proposed Financial Services and Markets Bill.

3.43  A thriving small and medium sized business sector need not be supported by conventional financial institutions alone. There is also a role for corporate venturing: large companies providing support and investment in smaller businesses. This can make powerful commercial and economic sense because:

• corporate investors can be better placed to judge investments in firms in their industries - particularly in high-technology areas - than generalist venture capitalists. Thus corporate venturing can be a more efficient form of capital for smaller firms;
• it can also create synergy, combining the dynamism and creativity of smaller firms and the capacity and market reach of larger corporates. Cross-fertilisation between the two can be of strong mutual benefit.

3.44  Corporate venturing has been one of the driving forces behind the emergence of Silicon Valley. But it is much less common in the UK: the 'Cambridge phenomenon', for instance, comes as close as any UK experience to Silicon Valley, yet recent research has suggested that overseas corporate venturers have made twice the number of investments in Cambridge as venture capitalists and three times as many as UK corporations.

3.45  The Government believes there may be a case, subject to affordability and feasibility, for incentivising corporate venturing in various ways, including potentially through the tax system. The Government will be consulting on this possibility, but in the meantime would welcome views on corporate venturing more generally.

3.46  Finally, businesses cannot grow without taking sensible commercial risks which often take time to pay off. The temporary financial problems which this can create for growth-oriented businesses should not be confused with business failure. Businesses facing short-term difficulty need the opportunity to overcome their problems and to grow and flourish.

3.47  The Government is therefore concerned to keep to a minimum the number of unnecessary corporate failures as well as to shift the traditional British attitude to business risk more generally. Britain needs to move away from an undue stigma associated with failure. The DTI will be announcing, in its forthcoming White Paper, plans for reviews of corporate rescue procedures and a separate review of how insolvency and bankruptcy law might be changed to reduce the stigma of financial failure.

3.48  Meanwhile, business people themselves can help to generate and renew a culture that values entrepreneurs. The forthcoming launch of an entrepreneurship campaign by the British Chambers of Commerce, CBI, IOD, and Federation of Small Businesses should be a major step forward. This campaign will create entrepreneurship ambassadors to champion enterprise in schools and universities, provide mentors for new businesses, and facilitate improved understanding between banks and small businesses. The Government will also continue to support efforts to make more use of business incubation techniques, including through its support for UK Business Incubation.

INVESTMENT

The problem

3.49  The Government believes that at the root of much of the productivity problem in the UK lies a long history of under-investment. Investment is fundamental to growth and the creation of wealth. New investment underpins the introduction of new techniques and innovations. Without adequate investment the UK will fail to make the best use of its resources today, and it will fail to seize new opportunities for growth in the future.

3.50  For decades, the UK has invested less than our major competitors. As Chart 3.3 shows, the UK has a much lower level of capital stock per worker - a key determinant ofproductivity.

3.51  The reasons for under-investment are complex. And of course there can be bad investment as well as good. Nevertheless, lack of investment can be a critical productivity constraint if human input is not backed by the investment necessary to make the most of it. Better productivity performance must be about both the quality and quantity of investment; investment which helps us work smarter, not simply harder. And it must recognise that investment in capital is not a substitute for investment in skills - they must complement each other.

3.52  The Government has already begun to act to improve investment in the UK by establishing a more stable macroeconomic framework, implementing tax changes to promote investment and establishing the new Regional Development Agencies. And it has radically improved the framework for public investments as will be set out in the forthcoming paper 'Fiscal Policy: A New Framework for Public Investment'.

3.53  However the Government does not believe this is all that can be done. The UK needs to look also at its markets and institutional structures to ensure they are working to their full potential. Strong and open capital markets are essential preconditions to businesses obtaining the investment they need to grow. The UK's financial markets are generally perceived to be one of its strengths, yet under-investment persists - on the face of it, a curious mismatch.

3.54  There are various factors that could be at work here:

• communications between companies and shareholders may not be as transparent or effective as they could be. Many seminar participants perceived UK businesses to be less effective than US firms at explaining and justifying their long-term investment plans to their shareholders or using employee share-ownership to build commitment from the workforce;
• some seminar participants believed the UK banking sector might not be as vibrant as elsewhere;
• other potential inefficiencies in the capital markets, in particular sometimes a perceived focus on the part of institutional investors on shorter-term at the expense of longer-term returns;
• problems in valuing businesses effectively. Increasingly the value of a company's brand, R&D, knowledge and its people substantially outweighs the value of a firm's physical assets. Yet information on the former can be scant; companies might do more to provide it and investors more to demand it.
• promote widespread employee share ownership - in small firms as well as large;
• improve long-term company performance;
• encourage high-quality managers to share in the risks and rewards of running SMEs, particularly early stage high-technology companies, by supporting equity-based remuneration.

3.55  Britain's vibrant capital markets remain one of its strengths. But to keep them so, openness, transparency and effective competition are essential. Set out below are four areas where the Government believes there may be room for improvement: employee share ownership, the banking system, the equity market, and the market for savings products.

Employee Share Ownership

3.56  The Government wants to encourage more employees to take a stake in their companies and to maximise the contribution of share ownership schemes to productivity. The Government's objectives are to:

• promote long-term shareholding by employees to build a stronger sense of partnership in industry and increase productivity;

3.57  Evidence, particularly from the US experience, clearly indicates the benefits which can accrue to firms using schemes involving a wide range of employees, especially when these are combined with other forms of worker participation in their companies.

3.58  There are already several tax-advantaged schemes designed to promote employee share ownership. Currently around one million employees are given shares and a similar number are granted share options each year through these schemes.

3.59  But the Government wants to examine what more could be done to promote a long-term partnership between employees as shareholders and the company. For example, only around a third of SAYE Sharesave participants appear to hold on to company shares. Retention of shares under the Approved Profit Sharing scheme appears higher, and employees have the same rights as other shareholders while the shares are held in the trust, including receiving dividends and exercising voting rights. The Government is looking at ways in which this scheme might be redesigned to provide stronger incentives for long-term shareholding by all employees.

3.60  Sir Peter Williams in his group's report on the financing of high technology business, the Smaller Quoted Companies group and the DTI Competitiveness Working Party on Investment have all suggested that special tax-advantaged share incentive schemes might help encourage more high calibre managers to join and stay with smaller companies, particularly early stage high-technology companies, which in turn could enhance their growth prospects.

3.61  Given the benefits for the economy as a whole of creating the right environment for dynamic and innovative smaller firms to grow, it is worth considering whether tax incentives might tilt the risk-reward balance to encourage entrepreneurial ambition and focus the incentives where they can be most effective. Limiting any incentives to key managers in a targeted group of smaller companies could avoid problems of earlier executive share option schemes which were indiscriminate in the tax advantages they provided, and were often unrelated to the risk taken on by managers benefiting from the options.

3.62  The Treasury will issue a consultation document seeking views on the current tax-advantaged employee share schemes and possible alternatives, both for all employee schemes and a targeted incentive for managers in smaller, dynamic enterprises such as early stage high technology companies. The conclusions of the review will be announced in the 1999 Budget.

Banking

3.63  The Government believes that the banking sector plays a central role in the UK economy - the investment it finances is a key driver of growth and productivity. High levels of innovation, competition and efficiency are vital to an effective banking industry - and are essential to meeting the productivity challenge. So too, in particular, is an effective partnership between the banks and growing businesses.

3.64  The Government very much welcomes increasing competition in some parts of the retail banking sector, with the entry of supermarket and telephone banking, and the newly-converted building societies. There are also some welcome signs of improving SME lending techniques, based on the use of more sophisticated methods of risk assessment.

3.65  The Government also welcomes the improving relationship between the banks and the SME sector, including the broader range of lending techniques that have been developed. Given the overriding importance of this sector, the Government nevertheless believes it would be valuable to review the current levels of innovation, competition, and efficiency in the banking industry and the services it provides and to establish whether there is more that the banks could be doing in cooperation with the SME sector. The Government has therefore asked the banks to work with Don Cruickshank, who will lead the review. This will:

• examine the banking industry in the UK, excluding investment banking;
• examine the levels of innovation, competition and efficiency in various sub-markets, including relationships with SMEs;
• look at how these levels compare with international standards; and
• consider whether there are any options for change which the industry or the Government should consider.

3.66  The review will aim to report within a year. This will be a genuinely open-minded review. Everyone - the banks, their customers and potential competitors - will have a proper chance to put forward their views.

Equity markets

3.67  Britain's equity markets are widely regarded as one of its strengths. In recent years there has been useful progress in improving the clarity and effectiveness of dialogue between companies and their shareholders, enhancing the markets' role in directing capital towards its most efficient uses.

3.68  However, this is just one aspect of a broader system, not all of which always operates as well as it might. Just as the Government has an interest in effective communications and accountability between companies and their shareholders, for instance, it also has an interest in similarly effective relationships higher up the chain - between institutional investors and their clients, notably pension and life funds. It is through these relationships that fund managers' incentives are set, and their behaviour and attitudes determined.

3.69  The Government believes there could be room for improvement here. An effective market structure, in the UK context, could be one in which:

• fund managers were expected to set out, to their clients and publicly, their objectives, how they assess investment performance and the basis on which key staff are remunerated;
• they were also expected actively to vote their shares, and to explain their voting (or abstaining); and in addition building on, for instance, the existing requirements of pensions legislation:
• fund managers' institutional clients' boards and/or trustees were expected to set out, again publicly, their objectives and how they assess the performance of their investments;
• including, in particular, their attitude towards venture capital investments and how they evaluate them;
• as well as how, and over what time period, they assess the performance of fund managers, and basis on which they remunerate them.

3.70  These are expectations that would support, and go with the grain of, rational commercial decision-making. The Government is keen to see progress in this area and would welcome views from industry in the coming months as to how improvements could be established.

Savings

3.71  Although there is no necessary link between national savings and investment, in practice they tend to be closely correlated. The Government believes saving is an important priority, one which it has already begun to address through the introduction of ISAs and the development of CAT standards.

3.72  However there is clearly further to go before the UK can credibly claim to have developed a portfolio of savings products which provide the optimum efficiency and transparency which is necessary to build consumer trust. This is a key concern for the new Financial Services Authority (FSA). In particular the FSA will work with the thrust of the overall productivity agenda, to:

• develop a better understanding of the competitiveness of UK financial services, and the ways in which regulation impacts upon it. The FSA will have a specific duty to have regard to the desirability of maintaining the competitiveness of the UK's financial services;
• promote customer understanding of the risks and benefits of investing in different financial products and services, thereby sharpening competitive pressures in the industry;
• do more to promote disclosure.

3.73  There are two intertwined objectives here. One is competitiveness and productivity in the financial services industry itself. The other is a more competitive, innovative and trusted savings market, providing a healthy flow of finance for investment. These aims are mutually supporting and both are important components of the broader productivity agenda.

COMPETITION AND REGULATION

The problem

3.74  The Government believes that businesses deliver world-class innovative performance only when they are exposed to tough, open and fair competition. It is competition which drives companies to invest in people and machinery, to match the best in management and marketing, and to innovate in process and products. It also gives consumers a better deal.

3.75  Competitiveness abroad begins with competition at home. This means:

• tackling vested interests;
• exposing management to international best practice; and
• bringing down unnecessary market barriers to new entrants and new ideas.

3.76  Rigorous competition is also about giving consumers a better deal - academic research suggests the costs to UK consumers of lack of competition are considerable (see Box 3·3).

3.77  In addition, some seminar participants were concerned that there were signs that competitive pressures in the UK were not always sufficient to encourage businesses to tackle weaknesses in a determined and effective way. As the seminars showed, the scope for gains in UK productivity from matching best practice - both internally and through the supply chain - is perceived by managers themselves to be very considerable.

3.78  The Government therefore particularly welcomes the contribution the CBI's best practice campaign should have towards disseminating the benefits of benchmarking throughout industry. However it is competitive pressures which are potentially the most powerful driver of improvements; it is essential that these pressures are not artificially subdued.

3.79  One way in which they sometimes can be is through regulation. Regulation, although often for desirable social or environmental reasons, can reduce competition by making it expensive for businesses to join a market, or restricting innovation in products or processes.

Policy Approach

3.80  The Government has already implemented measures to begin to ensure that UK markets are as open and as competitive as possible. The Competition Bill models UK law on the competition provisions of EC law. It combines a tough approach to preventing abuse without placing undue compliance burdens on businesses. Special rules will help small firms avoid unnecessary costs.

3.81  Under the Bill the OFT will have new powers building on its existing important role in policing competition policy. It has, for instance, recently decided to review the profitability of supermarkets in the grocery trade and pricing in the car industry, both markets of key concern to consumers.

3.82  However tough competition regulation is only possible if it is underpinned by sufficient resources. In recognition of the central priority the Government places on open and competitive markets, the Office of Fair Trading will receive new resources worth more than 20 cent of its current budget. At the same time the OFT is carrying out a thorough going review of its own strategy and structure designed to give the organisation a sharper focus.

3.83  There is also an important international dimension to competition. Open international markets in trade and investment increase competition. The Government is playing a leading role in fighting for reductions in barriers to the free flow of goods, services and investment. It is pursuing open markets through all possible channels:

• multilaterally - for example, by strongly supporting a new round of World Trade Organisation (WTO) trade negotiations;
• bilaterally - for example, through active support for the EU's Transatlantic Economic Partnership with the US; and
• unilaterally - for example, to help promote competition in the car sector the Government is consulting on removing the ceiling on Single Vehicle Approvals (SVAs), which if removed would allow volume import of cars from non-EU countries direct into the UK.

3.84  In addition, the Voluntary Export Restraints agreement which currently restricts the number of car imports from Japan to the UK will expire at the end of 1999. Thereafter the EU will become an open market for car imports which should result in increased competition and lower prices for consumers. The expiry is required by WTO rules and is fully supported by the Government.

3.85  Better regulation is an important factor for international business too. Barriers to trade, such as differing or burdensome standards between countries, add costs to trade and discourage its growth. The UK is working to identify these problems and negotiate with our trading partners to eliminate them. One example is the Transatlantic Economic Partnership between the EU and the US, which have the world's biggest bilateral trading relationship. This is seeking ways mutually to recognise each others' standards so a product that already meets EU standards will meet US ones too.

3.86  The Government is also committed to ensuring that other forms of regulation strike the best balance between protecting the consumer and environment and encouraging prosperity and jobs. These can be difficult balances to strike. That is why the Government established the Better Regulation Task Force, chaired by Lord Haskins, to ensure that Government as a whole takes the best and most effective approach to regulation matters. As part of its work the Better Regulation Task Force will undertake a review looking at the role of regulation in relation to productivity, with a view to identifying a possible range of specific areas for further Task Force scrutiny. The Task Force will review McKinsey's concerns in this area, looking for instance, at the points McKinsey have raised about building control regulations.

3.87  More generally, the Government does not believe there is room for complacency, either in relation to the level of competitive intensity in UK markets or to the regulatory regime. A key part of the Government's productivity strategy must be to ensure that robust competition in product markets thrives, over time driving productivity improvements towards world-class levels, and that there is a sufficiently strong competition regime to ensure that it does.

3.88  Businesses also need to be able to expand and modernise. International experience suggests there can be an additional premium from locating clusters of similar businesses in the same area. But parts of the UK are already amongst the most built up and densely populated regions of the world. It is clear that the planning system has a key role to play in delivering sustainable growth.

3.89  Planning regulations can in some cases act as an obstacle to economic expansion. At the same time, there is widespread support amongst businesses for using the planning system as a positive tool for wealth creation and sustainable development.

3.90  The Government has been undertaking a root and branch overhaul of the planning system to see where planning regulations can be made more attuned to the needs of enterprise and business start-ups while still meeting the Government's wider environmental objectives. Following publication of 'Modernising Planning' last January, the Government has already started a major campaign to reduce planning delays and remove inconsistencies. It has introduced a programme of measures which will provide for a more efficient process for major projects, a more strategic role for regional planning, speedier local and unitary development plans and quicker resolution of local planning applications. But much remains to be done to deliver a more efficient, streamlined and integrated approach to planning that can improve business competitiveness without devaluing the quality of decision-making or public accountability.

3.91  The Government will be examining in detail how the planning system can best help promote business competitiveness and in particular clusters of similar businesses.

SKILLS

The problem

3.92  Skills are critical to productivity and investment. Yet there is much evidence that skills in the UK do not compare well with our leading international competitors.

3.93  Of those joining the work force for the first time, in 1995 only 54 per cent of those aged 18 had stayed on in education in the UK, compared with 84 per cent in France and Germany. Even in areas where the UK does perform well, such as in higher education, there was a strong perception amongst seminar participants that the skills that are taught do not always match the needs of the economy.

3.94  In the existing workforce, there is a major skills deficiency in intermediate level vocational skills (Levels 2 and 3) compared to our main European competitors, particularly Germany.

3.95  Many people find it difficult to develop and upgrade skills because of their lack of basic literacy and numeracy skills. 22 per cent of adults in the UK have very poor literacy skills, compared to 14 per cent in Germany. This severely restricts the range of jobs they can do and diminishes their ability to re-train - as they must in a modern economy - for new jobs and new ways of working.

Policy Approach

3.96  The Government's strategy is to give:

• new entrants to the workforce (school and college leavers) the skills they and businesses need to succeed; and
• give the existing workforce lifelong learning opportunities to obtain new skills, to adapt to new industries and new economic challenges

  Skills for new entrants to the workforce

3.97  The Government's drive for higher standards in schools will raise attainment; and closer links between business and schools will make clear the opportunities available to those with the right skills. Both policies will help motivate young adults to gain more from a longer period in education.

3.98  The Department for Education and Employment (DfEE) published on 15 October a consultation paper “Schools and Business - Sustaining Partnerships” to seek views on how these can work more effectively.

3.99  The Government also intends to provide a further incentive for businesses to engage with schools, by reintroducing tax relief on the salaries of staff seconded from business to educational establishments.

3.100  The Government believes that an understanding of the world of work and of the economic realities of adult life is central to future employability and should be reflected in the school curriculum. The Government is already undertaking a number of measures to prepare young people for work. In addition, the Qualifications and Curriculum Authority's Preparation for Adult Life Group will be considering a number of options for the revised National Curriculum, which is to be in place from 2000.

3.101  On 28 October the Secretary of State for Education and Employment announced a new set of National Learning Targets for England, reflecting the proposals of the National Advisory Council for Education and Training Targets (NACETT). By 31 December 2002:

• at least half of 16 year olds should have a qualification at level 2 (five GCSEs at grade C or above, an Intermediate GNVQ or an NVQ level 2), compared to 46 per cent in summer 1998;
• 95 per cent should have one GCSE at grade G or an equivalent qualification, reducing by between a quarter and a third the proportion that leave school with no qualifications at all;
• 85 per cent of 19 year olds should be qualified to level 2 compared to 73 per cent in summer 1998;
• 60 per cent of 21 year olds should be qualified to level 3 (two A levels, an Advanced GNVQ or an NVQ level 3) compared to 50 per cent in summer 1998.

3.102  In support of these targets, and those below for adults, there will be a significant expansion in Government supported education and training. There will be more than 500,000 extra students in HE and FE by 2002. There will also be an expansion in skills training in the workplace by way of National Traineeships and Modern Apprenticeships. The Government has recently introduced legislation which will give young people in jobs the right to time off for study or training. And it will also pilot an Educational Maintenance Allowance for those aged 16 to 18 to raise the rate at which those from lower household incomes stay on in education.

3.103  Given the substantial public investment in university students, it is particularly important that they find productive work after graduation. Better information is crucial to achievement of this aim. Work is already in progress on improving performance indicators for Higher Education (HE) Institutions that will better inform the choice of prospective students. Those relating to the key issue of employment outcomes will take effect in 2000.

3.104  In addition, the quality assurance system is being adapted to emphasise the clear specification of programme content and outcomes, making it easier to judge what skills a graduate will bring to the work place. This will include the key skills required by employers. Trials of the new quality framework will begin next year, with a view to implementation in September 2000. The Government will look further at ways in which Higher Education Institutions should work to improve their graduates' employability. As part of the employability agenda, a new 'reach out' fund will, from 1999, support HE institutions in building links with business and meeting employer needs. This will be complementary to the Science Enterprise Challenge initiative described above.

Lifelong learning

3.105  The Government is committed to a step change in the participation of adults in lifelong learning. For adults, the Secretary of State for Education and Employment has announced the following targets:

• 50 per cent to reach Level 3 by 2002, compared with 44 per cent in summer 1998;
• 28 per cent to reach Level 4 (degree level) compared with 25 per cent in summer 1998.

3.106  On 21 October, the Secretary of State announced the £40 million budget for the University for Industry (UfI) for 1999-2000. The UfI will help individuals and businesses identify the learning they need and to gain access to it.

3.107  Work continues on the arrangements for Individual Learning Accounts, through which many adults will be encouraged to take responsibility for their own learning. Twelve development projects are already under way. These will inform the arrangements for the first 100,000 'starter' accounts to be opened in 1999-2000. The priority groups for this first phase of ILAs will include people with no qualifications and in low skill jobs; people working in small firms and those seeking to return to work. There will be a national framework for ILAs in place from 2000 for a sustainable system of ILAs, setting out incentives for participation.

3.108  The Secretary of State for Education and Employment has already announced a number of initiatives on skills:

• in March this year, the Government set up the Skills Task Force to advise on the development of a National Skills Agenda which will deliver the skills needed for the UK's economic success. The Task Force is currently considering issues such as employability and key skills and learning in the workplace;
• a group led by Sir Claus Moser is advising the Government on how best to achieve its target of doubling the help available to adults to address their literacy and numeracy skills so that over 500,000 adults a year are being helped by 2002. It will report later this year;
• 20 Centres of Excellence for IT and High Technology training together with new training facilities to tackle other skill shortage areas are to be set up. They will be operational by March 1999;
• £6 million over three years for the Union Learning Fund to support trade unions to do innovative work to promote and provide lifelong learning for their members. 45 successful bids were announced in September 1998.

3.109  Although the Government has a key part to play, the UK's productivity over the coming years will depend largely on the effects of employers to 'upskill' their work forces. The trend is in the right direction: 82 per cent of employers with 25 or more staff funded or arranged off-the-job training in 1997, compared with 76 per cent in 1991.

3.110  Investors in People' was launched in 1991, setting a standard for organisations in the training and development of employees. 33 per cent of organisations with 200 or more staff are now recognised as meeting this standard. The Government has set new targets for organisations: 45 per cent of organisations employing 50 or more staff, and 10,000 organisations with between 10 and 49 staff to be recognised as Investors in People by 2002.

PRODUCTIVITY IN THE PUBLIC SECTOR

3.111  The Government can also play a further direct role by improving productivity in the public sector. Public services account for about a fifth of the real resources of the economy. It is crucial that these are well targeted and that they are provided in the most efficient and effective way possible. Many government policies also directly impact on businesses in ways which can affect their performance.

3.112  Earlier this year the Government published its spending plans for the next three years as a result of the Comprehensive Spending Review (CSR). It committed itself to a wide-ranging programme of reform in the public sector, with:

• tough efficiency targets - 3 per cent a year for the NHS; 2 per cent a year for the police - and reforms to modernise and improve key public services;
• a new Best Value regime for local authorities to force them to compare performance between similar authorities;
• reforms to tackle absenteeism in the public sector, with a target of reducing sick absence by 20 per cent over the next three years;
•  

  a crackdown on fraud which is estimated to cost the country £2 to £7 billion a year;

  • a new Invest to Save budget which will encourage different parts of the public sector to work together to improve service delivery and cut costs;

  • innovative ways of improving management in the public sector, including a new Centre for Management and Policy Studies in the Cabinet Office, drawing on best practice and new approaches to management.

  3.113  To ensure that these and other reforms are delivered, the Government is committed to publishing Public Service Agreements (PSAs), setting out key targets for improving delivery. These will be published in a White Paper later this year. Departments will also produce Departmental Investment Strategies (DISs), which will demonstrate that capital investment is being efficiently and effectively used. Summaries will be published next spring.

  3.114  Progress against the PSAs will be overseen by a Cabinet Committee (PSX) chaired by the Chancellor of the Exchequer. A Public Services Productivity Panel will bring in outside experts, senior business people and public sector managers to advise the Government on ways of improving the productivity and efficiency of government departments and other public sectors bodies. The Chairman will be the Paymaster General, the vice-chairman will be Byron Grote of BP-Amoco.

  3.115  The Government will also set up a new Productivity and Competitiveness Cabinet Committee, also chaired by the Chancellor, which is being created to scrutinise those policies and regulations which may erect barriers to the productivity of the private sector and the level of competition in the economy.

  Procurement

  3.116  Central Government civil procurement costs £12 billion a year. Its proper management and coordination is essential. The Government has commissioned a review, to be led by Peter Gershon of GEC-Marconi, which will examine current arrangements for civil procurement. The review will recommend any changes that would support the Government's efficiency, modernisation and competitiveness objectives and ensure the success of the Government's drive for improved productivity through the better management of relationships with suppliers.

  Private Finance Initiative

  3.117  By the beginning of October 1998, around £11 billion worth of PFI projects had been agreed. The Government wants to build on the success of the Private Finance Initiative and ensure it continues to thrive when the existing Treasury Task Force is wound up. The Government has therefore decided to establish a second review - under Sir Malcolm Bates - to consider what institutional arrangements should be made following the expiry of the Task Force's mandate. He will be guided by the Government's objectives of introducing the best of private sector skills and practices into public sector procurement, and ensuring that a steady flow of PFI and PPP deals contribute to a higher sustainable level of investment in public sector infrastructure.

  Next steps

  3.118  These are first steps in developing a strategy for improving productivity which will be developed further in the DTI's forthcoming White Paper and the 1999 Budget. The Government would welcome views on its planned approach; publication of the Pre-Budget Report is the beginning, not the end, of the consultative process.