N 56 The Strategy by Paul Morris

the STRATEGY

Scotland Means Business

The Scotland Means Business reports have been prepared for N-56 by a study team that includes:

This report has been prepared by BiGGAR Economics, with contributions from all of the study team members â&#x20AC;&#x201C; and from number of Scottish business leaders. www.n-56.org

CONTENTS

PAGE

EXECUTIVE SUMMARY

1! EXECUTIVE SUMMARY

INTRODUCTION

11!

2! INTRODUCTION

12!

PART ONE: FRAMEWORK

17!

3! WHY A STRATEGY IS NEEDED

18!

4! FRAMEWORK FOR STRATEGY

26!

PART TWO: TRANSFORMATIONAL STRATEGIES

36!

5! EXPORT GROWTH

37!

6! INFRASTRUCTURE

49!

7! RENEWABLE ENERGY

56!

8! GROWTH SECTOR NICHES

69!

9! HUMAN CAPITAL, INNOVATION AND ENTREPRENEURSHIP

79!

10! TAXATION POLICY

85!

PART THREE: IMPLEMENTATION AND IMPACT

99!

11! CORPORATIVE POLICY MAKING

100!

12! IMPACTS OF STRATEGY

108!

APPENDICES

112!

13! APPENDIX A: POLICY MAKING IN DENMARK

113!

14! APPENDIX B: PUBLIC FINANCES OUTLOOK

121!

SCOTLAND MEANS BUSINESS: THE STRATEGY EXECUTIVE SUMMARY

Scotland Means Business: The Strategy

EXECUTIVE SUMMARY We live in a period of unprecedented global economic change and opportunity. It's important that all major stakeholders including business and government come together to ensure that Scotland can benefit fully from an overarching and comprehensive strategic economic plan that addresses how we will adapt to the opportunities and challenges of a new world. There are a number of significant economic challenges that need to be met, demonstrating the urgent need for change – and also providing opportunities. These include the unprecedented length of the current crisis from which the economy has yet to recover, imbalance in the UK economy with the dominant position of London and financial services, an ageing population, a consumption based economy with limited growth potential, climate change and lower levels of trade than prosperous competitors. N-56 believes that the overriding objective of Scotland’s new economic strategy should be to increase economic growth so that, over time, Scotland becomes one of the wealthiest five countries in the world, measured in economic output per person. This can be achieved through a set of policies that are designed to: • increase economic participation: to match the employment rate of the top five advanced economies; and • deliver export-based growth: increase Scotland’s trade volumes to match the average for small advanced economies. A range of mutually reinforcing transformational strategies has been suggested by N-56 in the Scotland Means Business reports, as a starting point for the development and implementation of the new economic strategy. These include: • Exports: a new exports strategy including development of a Scottish brand, enhancing the productivity of exporters, learning from success stories such as oil services and whisky on sales and distribution channel development; • Infrastructure: a new national development plan, including a substantial investment in infrastructure, which could be funded by a Scottish infrastructure bond, available on international bond markets and as a long term savings product in Scotland; • Renewables: realising the economic opportunities by commercialising new generation technologies such as wave and tidal power, for global markets, as the Danes have done in wind turbines, including developing co-investment models; • Frankfurt of the North: support for the financial services sector where long term growth opportunities exist, including the global growth markets for fund management. Measures include consistent regulatory and fiscal regimes, supporting innovation and skills development; • Growth Sectors: strategies to build competitive advantage in a range of other sectors where global growth niches exist, including tourism, transport, food and drink, creative industries, life sciences, universities and healthy ageing; • Energy: building on the recommendations of the Wood Review, a range policy measures in support of the oil and gas sector, including exploration incentives, ensuring fiscal stability, stimulating R&D and investment, incentives for the relocation of corporate headquarters to Scotland, education and skills initiatives and development of the Scottish engineering brand; • Human Capital: continued investment in the education sector including taking advantage of the highly skilled workforce that is associated with Scotland’s Scotland Means Business: The Strategy

university and college system and labour market initiatives to promote high economic participation; • Innovation: protecting investment in the existing innovation system and efforts to promote entrepreneurship to build longer term competitiveness in emerging sectors in the UK economy, including mechanisms to facilitate the provision of expansion capital, for long term growth; • Entrepreneurship: ensuring that public policy is supportive of business-led advice and support initiatives, including a tax system with low business compliance costs and incentives for investment in new businesses; and • Taxation system: reforming the tax system that applies in Scotland, based on the Mirrlees recommendations for a simpler tax system. The reforms will learn lessons from others that have simplified their tax systems such as the New Zealand. Business Incentives: a range of specific tax measures in support of the transformational strategies. The menu of options include: • an allowance for corporate equity, removing the tax disadvantages of equity financing compared with debt. This would make Scotland an attractive location for equity providers and other financial institutions, support the equity model of long term business finance, help to address the impact in pension funds of the removal of advance corporation tax in the UK and encourage increased equity investment in growing Scottish businesses; • increasing research and development support in key sectors such as oil and gas, financial services and renewable energy; • targeted measures such as reducing VAT and air passenger duty to boost the competitiveness of the tourism sector; • incentivising investment in high growth companies; • incentivising investment in start-up and growing family businesses; and • favourable tax treatment of technology-based businesses that have the potential to become companies of scale. The new economic strategy for Scotland should be at the top of the hierarchy of policy, providing a framework for all other areas of policy and ensuring integration across all areas of policy. A corporative approach to policy making is required, starting with the development of the new economic strategy for Scotland, involving government, businesses and others working on both the formation and implementation of policy, in the common interest. A new economic strategy for Scotland, based on the corporative approach recommended by N-56 should result in policies more suited to Scotland’s needs, opportunities and preferences. This should lead to a more competitive, better performing Scottish economy. Increasing productivity to match the top quarter of advanced economies, increasing the employment rate to the average of the top five and halving the gap between UK and Scottish population growth, would increase GDP from the baseline of £145 billion in 2012 to £269 billion by 2037, an 86% increase over 25 years. This would also increase GDP per capita by two-thirds (by more than £18,000) to more than £45,000 per person. Accelerating economic growth would also improve the public finances, with faster growth leading to the elimination of the current deficit within seven years and then the generation of significant surpluses. Scotland Means Business: The Strategy

1.1

N-56 and Scotland Means Business Objectives This document presents a range of policy proposals and an approach to policymaking aimed at improving the performance of the Scottish economy. Scotland is a wealthy country; however, it is not delivering the economic and social performance that has been achieved by some other small advanced economies and that might be expected given its natural resources and human capital. The context for the initiative is the debate over Scotland’s constitutional future. However, N-56 does not seek to make a case for voting either yes or no in the referendum. Its focus is firmly on articulating the range of economic policies and actions that will attract investment and improve economic performance. The objectives of N-56 are to: •

provide an independent analysis of Scotland’s economic performance and potential;

•

promote a culture of collective strategic decision-making about what is best for Scotland’s economy;

•

raise the level of the debate on Scotland’s economic future;

•

ensure that the debate is open, inclusive and informed by a wide range of stakeholders;

•

engage businesses from all sectors of Scotland’s economy in the debate and bring focus to the importance of the private sector; and

•

learn from international success stories.

1.2

The Need for a Strategy We live in a period of unprecedented global economic change and opportunity. It's important that all major stakeholders including business and government come together to ensure that Scotland can benefit fully from an overarching and comprehensive strategic economic plan that addresses how we will adapt to the opportunities and challenges of a new world. Six inter-linked economic challenges demonstrate the need for change and also the opportunities for change: •

Seven Lost Years: The recent economic crisis has been the longest lasting in modern times. The recovery from the 1930s depression required bold changes in economic strategy including the New Deal. A similarly radical change in strategy is now required;

•

Imbalance in the UK Economy: The economic crisis has highlighted the extent to which London and the financial sector dominates the UK economy. An economic strategy that meets the needs of Scotland will also address the current imbalances in the UK economy;

Scotland Means Business: The Strategy

•

Ageing Population: Scotland’s population is ageing faster than the UK’s (although an improving Scottish economy could change current demographic projections). Scotland will not be the only advanced economy to experience an ageing population and so products, services and public policies to address the challenge will be exportable;

•

Consumption Based Economy: The unsustainable consumption based UK economy, with long term downward pressure on consumption associated with a need to save more to meet the pension needs of an ageing population, means that a new economic strategy needs to focus on global rather than domestic markets;

•

Climate Change: Environmental considerations are an important influence on the formation of policy, in particular reducing carbon emissions. However, the challenges associated with climate change should also be considered to be business opportunities since products and services that reduce carbon emissions in the energy mix or deliver more efficient use of resources will be globally competitive;

•

The Trade Gap: Scottish levels of trade are well behind some of the most successful small advanced economies in Europe and would need to increase by a third to match the average, by 60% if oil and gas exports were excluded; some £94 billion in additional trade. The most successful small advanced economies have shown that this path to growth is achievable, if it is high enough as a strategic priority and supported with the right mix of policies.

The benefits of a new economic strategy for Scotland include providing a:

1.3

•

framework that sets out Scottish needs, opportunities and preferences;

•

long term perspective above and beyond the political cycle (at least in the many areas where there is a degree of consensus);

•

framework that provides long term stability sought by investors;

•

basis for prioritising scarce resources (including public sector resources) on the challenges and needs identified as strategic priorities;

•

mechanism for the integration of policy;

•

way to constantly review priorities and benchmark against leading economies.

Strategic Framework Businesses compete but governments provide the conditions that can make businesses competitive or uncompetitive in the global demand for people, skills, technology and investment, all increasingly mobile resources. Scotland Means Business: The Strategy draws on academic research including that of Professor Richard Vietor of Harvard Business School who’s framework includes the need for a strategy, structures for its implementation and a range of macroeconomic and microeconomic policies designed to achieve strategic goals. Economic growth can be achieved by: •

increasing the quantity of resources (natural, human, technology, capital); and

Scotland Means Business: The Strategy

•

the efficient use of those resources (productivity).

Scotland Means Business: The Strategy has also learned lessons from strategies for other economies. These include the Chicago Growth Strategy, which identifies three drivers of growth (economic sectors and clusters, human capital and innovation and entrepreneurship) and two enablers of growth (physical and virtual infrastructure and public and civic institutions) and sets out ten separate but mutually reinforcing transformational strategies. N-56 believes that the overriding objective of Scotland’s new economic strategy should be to increase economic growth so that, over time, Scotland becomes one of the wealthiest five countries in the world, measured in economic output per person. The transformational strategies set out in the strategy are based on creating the conditions for growth in the Scottish economy, primarily through two mechanisms: •

increasing economic participation: Scotland has a higher employment rate than the UK as a whole, but a lower rate the top five advanced economies. Matching the average for the top five would imply an additional quarter of a million people in employment, based on the current Scottish population. Even with no improvement in productivity, this would imply an increase in GDP of some £15 billion; and

•

export-based growth: Scotland’s trade volumes would need to increase by a third to match the average for small advanced economies (60% if oil and gas exports were excluded), some £94 billion in additional trade. Increasing exports is a credible strategy for the Scottish economy, since there are a number of existing and potential niches for Scotland in those sectors with the greatest global growth potential. Growth in trade would be a driver of economic growth, because it would both drive and result in the volume of factors of production (population and participation) and efficiency (productivity).

The transformational strategies set out in Scotland Means Business: The Strategy are presented separately but are mutually reinforcing. These strategies represent a business contribution to the development of a new economic strategy, which should be further developed and implemented in a collaborative way.

1.4

Transformational Strategies N-56 has identified a number of transformational strategies that have the potential to accelerate economic growth, by increasing exports and by increasing economic participation. These transformational strategies are a set of mutually reinforcing initiatives. They include: •

Exports: a new exports strategy including development of a Scottish brand and other measures to enhance the productivity of exporting or potentially exporting sectors through investment in infrastructure, research and development and education (including addressing skills gaps in languages). This will learn from success stories such as oil services and whisky on sales and distribution channel development;

•

Infrastructure: a new national development plan, including a substantial investment in infrastructure, improving Scotland’s international and internal transport links and other areas of infrastructure including information and

Scotland Means Business: The Strategy

communications technologies. This investment can be funded by a Scottish infrastructure bond, available on international bond markets and as a long term savings product in Scotland; •

Renewables: realising the economic opportunities from renewable energy, using the opportunity offered by Scotland’s natural resources and the technologies emerging from the research and development base to commercialise new generation technologies such as wave and tidal power, for global markets, as the Danes have done in wind turbines. The immediate priority is to attract private investment and engineering expertise into the sector using a co-investment model;

•

Frankfurt of the North: support for the financial services sector where long term growth opportunities exist, including the global growth markets for fund management. Measures include consistent regulatory and fiscal regimes, fostering financial services innovation through research and development tax credits, improving intermediate skills through an Apprenticeship system and a Financial Services Challenge Fund and an initiative to fund Scottish universities to examine how new technologies may radically alter the outlook for the financial services sector, and what can be done about it;

•

Growth Sectors: strategies to develop and build on existing competitive advantage in a range of other sectors where global growth niches exist, including tourism, transport, food and drink, creative industries, life sciences and universities. There are also opportunities to build new sectors of the economy, to deal with public policy challenges; these include the potential development of a cross-sector healthy ageing cluster;

•

Energy: building on the recommendations of the Wood Review, a range of macro and micro policy measures in support of the oil and gas sector, including exploration incentives, ensuring fiscal stability and a fiscal regime suited to a mature basin, stimulating R&D (as has happened in Norway), stimulating additional investment, incentives for the relocation of corporate headquarters to Scotland, education and skills initiatives and development of the Scottish engineering brand;

•

Human Capital: continued investment in the education sector to ensure that the necessary human capital is in place. This includes taking advantage of the highly skilled workforce that is associated with Scotland’s internationally competitive university and college system and a range of intermediate labour market initiatives to promote high economic participation;

•

Innovation: protecting investment in the existing innovation system and efforts to promote entrepreneurship to build longer term competitiveness in emerging sectors in the UK economy, including mechanisms to facilitate the provision of expansion capital, for long term growth;

•

Entrepreneurship: ensuring that public policy is supportive of business-led advice and support initiatives, including a tax system with low business compliance costs and incentives for investment in new businesses; and

•

Taxation: reforming the tax system that applies in Scotland, whether that means reform at the UK or Scottish levels (depending on the outcome of the referendum), based on the Mirrlees recommendations for a simpler tax system. The reforms will learn lessons from others that have simplified their

Scotland Means Business: The Strategy

tax systems such as the New Zealand example of the dividend imputation system to address double taxation of dividend income. Business Incentives: a range of specific tax measures in support of the transformational strategies. The menu of options include:

1.5

•

an allowance for corporate equity, removing the tax disadvantages of equity financing compared with debt. This would make Scotland an attractive location for equity providers and other financial institutions, support the equity model of long term business finance, help to address the impact in pension funds of the removal of advance corporation tax in the UK and encourage increased equity investment in growing Scottish businesses;

•

increasing research and development support in key sectors such as oil and gas, financial services and renewable energy;

•

targeted measures such as reducing VAT and air passenger duty to boost the competitiveness of the tourism sector;

•

incentivising investment in high growth companies;

•

incentivising investment in start-up and growing family businesses; and

•

favourable tax treatment of technology-based businesses that have the potential to become companies of scale.

A Corporative Approach to Policy Making A corporative approach to policy making means that government, business and other representatives of society work together collaboratively on the development of policies and integrated strategies designed to exploit Scotland’s competitive advantages. This approach is consistent with both Christian Democrat and Social Democrat traditions in European politics. The new economic strategy for Scotland should be at the top of the policy hierarchy, providing a framework and ensuring integration across all areas of policy. Ensuring that the economic performance of Scotland is central to policy will lead to a different approach to setting priorities and investing public funds. For example, transport infrastructure projects can be assessed and prioritised based on their contribution to strategic objectives, rather than discreet and competing cost benefit analyses. Integration of policy can also lead to better outcomes that take a more holistic and longer-term view of the costs and benefits of policy change. For example, an energy policy that was informed by economic development objectives as well as costs, security of supply and environmental impact may prioritise the commercialisation and growth of new sectors with export potential. A corporative approach to policy making is required, starting with the development of the new economic strategy for Scotland, involving government, businesses and others working on areas of common interest. This should apply to both the formation and implementation of policy. Business does already get involved in the policy making process; however, it tends to be in the form of responding to formal consultations or lobbying government on specific issues. A more strategic approach is required as is a Scotland Means Business: The Strategy

change in culture of how we do business and politics to ensure that we increase expectations and focus policy on improving the performance of the economy rather than symptoms of under-performance. In addition to a more strategic decision making process and the integration of policy, a corporative approach also reduces the chances of policy shocks that businesses had not been expecting (such as the recent policy changes on pensions, which had not been foreseen by the many Scottish providers of annuities). A corporative approach requires leadership and co-ordination and it is important that senior Ministers, officials, and central agencies need to own and champion this process. Such strategy functions are commonly located in the centre of government, cutting across the full range of policy portfolios. The development of a new economic strategy for Scotland needs to be informed by a process to develop a clear, well-understood, and over-arching sense of Scotland’s place in the world, the basis on which it will compete, and the strategic direction in which it will move. This process needs to be undertaken in an externally oriented way, looking at the international environment, and to be specific enough to guide a range of decisions and actions. This should be undertaken in collaboration with business and other stakeholder groups to ensure a broad range of perspectives are obtained. There needs to be clear connection and consistency between the diagnostic phase, the development of a medium-term strategic policy response, and the execution and delivery phase. A coherent strategy needs to integrate all three of these steps, and ensure consistency across a wide range of policy areas (rather than having specific policy areas guided by different goals). Institutions and capacity should be built to ensure that this can be delivered on an on-going basis.

1.6

Impacts and Benefits of the Strategy A new economic strategy for Scotland, based on the corporative approach recommended by N-56, should result in policies more suited to Scotland’s needs, opportunities and preferences. This will lead to a more competitive, better performing Scottish economy. Based on historic trends of productivity growth, but no change to population trends or the employment rate, Scottish GDP would increase by a third over the next 25 years to £192 billion. This would mean that Scotland was still behind faster growing competitors. By increasing productivity to match the top quarter of advanced economies, increasing the employment rate to the average of the top five and halving the gap between UK and Scottish population growth, would increase GDP from the baseline of £145 billion in 2012 to £269 billion by 2037, an 86% increase over 25 years. This can be delivered through increasing: •

productivity: increasing productivity by an additional 0.6% over historic trends, to match competitor economy, will increase output per person by £6,500 more than continuing with current trends;

•

population: increasing to 6.11 million from 5.31 million in 2012, equivalent to 330,000 more people than current projections predict, mostly of working age

Scotland Means Business: The Strategy

people, retained in Scotland and attracted to move to Scotland by a growing economy; •

participation: increasing the employment rate from 71% to 80% to match the top five competitor economies would, when combined with population growth, would mean more than half a million additional jobs in the Scottish economy.

This would also increase GDP per capita by two-thirds, by more than £18,000, from around £27,000 to more than £45,000. This is an ambitious but realistic target. However, it will require transformational strategies and a new corporative approach to policy making and implementation. Projections for Scottish public finances, albeit based on pessimistic forecasts on oil revenues, forecast a bigger deficit than for the UK economy as a whole. Whatever, the outcome of the independence referendum it is difficult to see a political future where the rest of the UK would fund such a deficit. The only way to deal with the deficit is therefore to accelerate Scottish economic growth. Even using the Treasury’s projected Scottish deficit of £9.5 billion, the faster growth scenario associated with increased productivity, an increased employment rate and additional population could eliminate this deficit within seven years, and generate significant surpluses thereafter. If oil revenues are higher than forecast by the Treasury, as the industry currently expects, Scotland’s public finances would be stronger than the UK’s (as they have been over the last three decades), providing an opportunity to eliminate the deficit earlier.

1.7

Implementation and Next Steps The need for a new economic strategy for Scotland is urgent and the benefits and impacts will be significant. Only a new, corporative approach can deliver the magnitude of change that is required. Whatever the outcome of the referendum in September 2014, there will be a need for further discussions and negotiations on constitutional issues. However, the collaborative development and implementation of a new economic strategy for Scotland should not wait for the outcome of these discussions and negotiations. Work should start immediately. This should include setting up an office in the heart of government, to take the lead to coordinate the contribution from government and the public sector. The role for business is to engage constructively on the development of a new economic strategy for Scotland, looking beyond the interests of individual businesses and sectors, to identify those measures that will increase competitiveness, boost productivity, create more high value jobs and accelerate economic growth. N-56 will seek further support in the business community for working more closely together with government, the third sector and communities in partnership towards the realisation of a single strategy, which will evolve over time.

Scotland Means Business: The Strategy

SCOTLAND MEANS BUSINESS: THE STRATEGY INTRODUCTION

Scotland Means Business: The Strategy

INTRODUCTION

2.1

N-56 and Scotland Means Business Background N-56 is an initiative by business leaders in Scotland to produce a new strategy to improve the performance of the economy. The context for the initiative is the forthcoming independence referendum. However, N-56 does not seek to make a case for voting either Yes or No in the referendum. The focus is not on which governments and parliaments should have control of the economic policy levers but on the policies and actions that need to be taken to improve the performance of the Scottish economy. The business leaders who launched N-56 have a range of views on politics and the constitution. However, they agree that the Scottish economy has the potential to do better and to compete with countries that have the highest economic output per person and also top the rankings of wider measures of economic and social development. Moreover, a founding principal for N-56 is that business has a responsibility to engage constructively in the debate on the future of the Scottish economy. In the context of the referendum debate, business voices have asked questions and demanded clarity from politicians on both sides of the debate. However, the rationale for N-56 is to be proactive; to set out a business perspective on how the performance of the Scottish economy might be improved and a new corporative approach to policy making. The starting point for the research was a recognition that the Scottish Parliament will have greater fiscal and economic powers in the future than it has had to date, possibly substantially greater powers, and that the political debate in Scotland rarely touches on what such powers might be used to achieve. As a business-led initiative, N-56 goes beyond an analysis of government economic management and policy, to consider where the growth opportunities might be and the factor conditions required to realise those opportunities. The initiative also considers how businesses can work collaboratively with government and others in the common interest to develop and implement the policies that can deliver economic success.

2.2

N-56 and Scotland Means Business Objectives The objectives of N-56 are to: •

provide an independent analysis of Scotland’s economic performance and potential;

•

promote a culture of collective strategic decision-making about what is best for Scotland’s economy;

•

raise the level of the debate on Scotland’s economic future;

•

ensure that the debate is open, inclusive and informed by a wide range of stakeholders;

•

engage businesses from all sectors of Scotland’s economy in the debate and bring focus to the importance of the private sector; and

Scotland Means Business: The Strategy

•

learn from international success stories.

This will allow us to move the economic debate from a discussion of economic powers for Scotland (constitution) to what should be done with those economic powers (policy), thinking beyond the referendum. The work programme for Scotland Means Business, commissioned by N-56, started in the Spring of 2013 and has involved a significant amount of research including: •

analysis of UK and Scottish economic performance, strategy and potential;

•

research into best practice examples of policy and policy making structures and processes in other successful economies; and

•

an extensive programme of consultations with business leaders in Scotland.

The output from the first phase of work is presented in a separate report published alongside this document, Scotland Means Business: The Facts. That report analyses issues such the UK’s and Scotland’s economic performance, the state of public finances, the performance and economic policies of successful small advanced economies and the future potential of the Scottish economy, including growth sectors and factor conditions such as infrastructure and skills. The consultations with business leaders were structured to ensure that a longterm view was taken, looking beyond current business challenges and policies that might address them. The discussions sought input from business leaders on: •

growth prospects, domestic and globally, for the sector(s) in which they operate; and

•

policy ideas to realise opportunities, including best practice from experience in other countries.

One recurring theme that emerged from the consultations was that there was a tendency in Scotland, with some notable exceptions, to set targets for businesses, sectors and the economy as a whole that are not ambitious enough. The analysis undertaken for N-56 finds no good reason why Scotland could not be amongst the leading few economies in the world. The policy ideas presented in this report are not intended to be a definitive and final set of proposals for Scottish economic policy. Rather, they are initial proposals for successful Scottish businesses that represent a first draft of a new economic strategy for Scotland, which should be constantly reviewed and developed over time, using the corporative policy making and implementation structures recommended in this report.

2.3

Scotland Means Business: The Strategy This report, Scotland Means Business: The Strategy, sets out a range of policy proposals and an approach to economic policy making that will help to ensure that Scotland can fulfill its potential as one of the top few performing economies and societies in the world.

Scotland Means Business: The Strategy

The framework for the strategy draws on academic research on how countries compete, including the work of Harvard’s Professor Vietor1 and examples of evidence based economic strategies that have been the output from extensive consultation with business including from Chicago2 and Denmark3. One of the main lessons from the review of the common features of small successful economies that was set out in Scotland Means Business: The Facts was that the development of a strategy can have the effect of integrating different policy areas, avoiding the contradictory policy mixes that can be a result of making policy in traditional ministerial portfolio ‘silos’. For example, a successful energy sector will require energy and economic development policy to be well integrated. N-56 also recognises that businesses will not have the depth of experience to cover all policy areas and so collaboration with government and others is necessary to develop an integrated strategy for Scotland. This report is intended to be a business contribution to that process, covering those areas where successful Scottish businesses have some experience and insight. The process for the development of the strategy has involved asking and answering a series of questions: •

What are the necessary conditions and drivers of economic success for advanced economies? What is the evidence on the relative importance of each?

•

How well does Scotland currently perform, relative to competitors, on the most important conditions and drivers?

•

What are the policies that are required to maintain existing strengths and address weaknesses?

•

How might these policies improve economic performance? And, how will economic performance impact on public finances?

•

How can such policies be further developed and implemented?

The over-riding consideration has been to identify policies that can accelerate economic growth in Scotland, above its recent and historic trend levels. As discussed in Scotland Means Business The Facts, the University of Strathclyde’s Professors McGregor and Swales4 have provided a useful summary of what is important to economic growth: “In very broad-brush terms, output depends on the quantity of different factors of production employed and the efficiency with which they operate. Factors of production are traditionally classified under labour, capital and natural resources. Efficiency is captured by various measures of productivity. For the economy to grow, the supply of inputs must be increasing (and be employed) and/or the productivity with which these resources operate must rise.”

Professor Richard H K Vietor (2007), How Countries Compete: Strategy, Structure and Government in the Global Economy, Harvard Business School Press 2 World Business Chicago (March 2012), A Plan for Economic Growth and Jobs 3 See Appendix on Denmark’s approach to policy making 4 Professor Peter McGregor & Professor Kim Swales (2013), The Impact of Greater Autonomy on the Growth of the Scottish Economy in Scotland’s Future, editor Andrew Goudie

Scotland Means Business: The Strategy

The measures in this strategy are therefore focused on policies that would be expected to impact on the quantity and quality of resources (human, capital and natural) and on the efficiency with which they are deployed (productivity).

2.4

Research Team The research team that has prepared this report includes experts on the Scottish economy, other successful advanced economies and sectors that are particularly important to the Scottish economy. Expertise on the Scottish economy has been provided by BiGGAR Economics, an independent economic consultancy based in Scotland. The lead author and editor of this report was Graeme Blackett, Director of BiGGAR Economics, an applied economist with more than 20 years experience in economic consultancy. The other members of the study team have included: •

Landfall Strategy Group, a Singapore based advisor to governments of successful small advanced economies around the world. Landfall Strategy Group has provided input on collaborative policy making and the approach to taxation in small successful advanced economies and on the development of national brands;

•

Capital Economics, headquartered in London and one of the leading independent macro-economic research companies in the world as well as analysis of financial markets, commodities and the consumer and property sectors. Capital Economics has provided input on how the financial services sector in Scotland could be strengthened;

•

Tulloch Energy, a specialist energy consultancy has provided input on the opportunities for the oil and gas sector, based on research and extensive consultation with leading figures in the sector;

•

DAMVAD, expert on the Nordic economies has offices in Denmark, Norway and Sweden and clients include the Nordic Council. DAMVAD has provided case studies on the oil and gas sector in Norway, the development of the wind turbine sector in Denmark and the Danish approach to collaborative policy making.

This team has been supported by the input from business leaders, for which we are grateful.

2.5

Report Contents Scotland Means Business: The Strategy is structured as follows: •

•

Part One describes the Framework for Scotland Means Business: The Strategy, including: -

Chapter 3: Why a Strategy is Needed; and

Chapter 4: Framework for Strategy;

Part Two: sets out a range of distinct but mutually reinforcing Transformational Strategies, including: -

Chapter 5: Export Growth;

Scotland Means Business: The Strategy

â&#x20AC;˘

Chapter 6: Infrastructure;

Chapter 7: Renewable Energy

Chapter 8: other Growth Sector Niches;

Chapter 9: Human Capital, Innovation and Entrepreneurship;

Chapter 10: Taxation;

Part Three: on Implementation and Impact, provides recommendations of how these strategies can be taken forward, including: -

Chapter 11: a new approach to Corporative Policy Making; and

Chapter 12: the anticipated Impacts of the Strategy;

Appendices covering: -

Appendix A: Case Study: Policy Making In Denmark;

Appendix B: Public Finance Outlook.

Scotland Means Business: The Strategy

SCOTLAND MEANS BUSINESS: THE STRATEGY PART ONE: FRAMEWORK

Scotland Means Business: The Strategy

WHY A STRATEGY IS NEEDED Key Findings • We live in a period of unprecedented global economic change and opportunity. It's important that all major stakeholders including business and government come together to ensure that Scotland can benefit fully from an overarching and comprehensive strategic economic plan that addresses how we will adapt to the opportunities and challenges of a new world; • Six inter-linked economic challenges demonstrate the need for change – and also the opportunities for change: Seven Lost Years: The recent economic crisis has been the longest lasting in modern times. The recovery from the 1930s depression required bold changes in economic strategy including the New Deal. A similarly radical change in strategy is now required; Imbalance in the UK Economy: The economic crisis has highlighted the extent to which London and the financial sector dominates the UK economy. A new economic strategy that meets the needs of Scotland will also address the current imbalances in the UK economy; Ageing Population: Scotland’s population is ageing faster than the UK’s (although an improving Scottish economy could change current demographic projections). Scotland will not be the only advanced economy to experience an ageing population and so products and services and public policies to address the challenge will be exportable; Consumption Based Economy: The unsustainable consumption based UK economy, with long term downward pressure on consumption associated with an ageing population means that a new economic strategy needs to focus on global rather than domestic markets; Climate Change: Environmental considerations are an important influence on the formation of policy, in particular reducing carbon emissions. Challenges associated with climate change should also be considered to be business opportunities since products and services that reduce carbon emissions or lead to resource efficiencies will be globally competitive; The Trade Gap: Scottish levels of trade are well behind some of the most successful small advanced economies in Europe and would need to increase by a third to match the average and, by 60% if oil and gas exports were excluded, some £94 billion in additional trade. The most successful small advanced economies have shown that this path to growth is achievable, if it is high enough as a strategic priority and supported with the right mix of policies. • The benefits of a new economic strategy for Scotland include providing a: framework that sets out Scottish needs, opportunities and preferences; long term perspective above and beyond the political cycle (at least in the many areas where there is a degree of consensus); framework that provides long term stability sought by investors; basis for prioritising scarce resources (including public sector resources) on the challenges and needs identified as strategic priorities; mechanism for the integration of policy; way to constantly review priorities and benchmark against leading economies. Scotland Means Business: The Strategy

3.1

Why a Strategy Is Needed Scotland Means Business: The Facts sets out details of Scottish and UK economic performance and strategy. The Scottish economy benchmarks well with the UK as a whole. With the oil and gas sector included, economic output per person is 15-20% higher than the UK average, on a par with the wealthiest part of the UK, London and the South East. Even without the oil and gas sector, Scottish economic output per person is the same as the UK as a whole. However, benchmarking Scotland against the rest of the UK has led to complacency about the performance of the economy since the UK, and by implication Scotland, has been overtaken by other advanced economies and is now 18th out of the 34 advanced economies that are members of the Organisation for Economic Cooperation and Development (OECD), having been the wealthiest a century ago. Much has changed in the Scottish economy in recent decades as it changed from being an industrial economy driven by coal, steel and heavy engineering to dealing with the challenges of industrial decline. The Scottish economy of today is not the post-industrial economy it has sometimes been characterised as by the less informed commentators during the referendum debate, such as The Economist’s ‘Skintland’ feature in April 2012. The Scottish economy of 2014 is an advanced, knowledge-based economy, with existing or potential comparative advantages in a wide range of global growth sectors. However, each of these global growth sectors is highly competitive and success requires a step change in what Scotland can offer to indigenous and international businesses in growth sectors. A strategy is required to make that step change.

3.1.1

Absence of Strategy Professor Vietor5 tells us that all countries have a strategy, whether that is explicit or implicit in the preferences and objectives set out by government. However, Scotland may be the exception to that, since neither the Scottish nor the UK Governments have a comprehensive strategy for the Scottish economy. The Scottish Government Economic Strategy, like some of its predecessors, includes a useful analysis of Scottish economic problems and opportunities. However, the scope of the strategy is limited to policy areas that are devolved to Scotland and so could be the only economic strategy in the world that does not set out a range of fiscal policies in support of economic development objectives. In common with previous administrations, the current UK Government’s economic strategy is implicit rather than explicit but can be seen in the Programme for Government, in Budgets and across a range of policy documents, including a series of industrial strategies. Many of these policies have relevance to the Scottish economy; however, there is no Scottish dimension (or regional dimension) to UK Government strategy, despite it having responsibility for many of the most important economic public policies that impact on the performance of the Scottish economy.

Professor Richard H K Vietor (2007), How Countries Compete: Strategy, Structure and Government in the Global Economy, Harvard Business School Press

Scotland Means Business: The Strategy

The absence of an overarching strategy for the Scottish economy means that the policies that are important to Scottish economic performance can be developed without full consideration of their impact on other areas of policy. One example would be the electricity generation sector. UK energy policy is based on security of supply, the cost of generation and environmental impacts, in particular carbon emissions. The UK Government has favoured nuclear generation to address concerns about security of supply and to reduce carbon emissions (although not electricity prices in the deal agreed on Hinkley Point, since the new nuclear power station, expected to generate electricity for 7% of UK homes for 60 years, has agreed a strike price of £92.50 per megawatt hour index linked, almost twice the wholesale electricity price). However, UK energy policy has taken no account of the Scottish Government Economic Strategy, which identifies renewable energy as an economic development opportunity or, indeed, the UK Government’s own industrial and innovation policies, which are supporting a range of renewable energy technologies. The UK has not built a nuclear power station for 20 years and so much of the technology and economic impact will be imported, from France and China. In contrast, there may be underinvestment in energy generation methods that might have higher costs, at least in short term but where Scotland (and the rest of the UK) has the opportunity to develop comparative advantage and, therefore, future exports (for example, carbon capture and storage and marine energy). While these sectors may have high short term costs in energy generation terms and so require high subsidies, if they lead to the development of comparative advantage and future export earnings they could generate economic benefits far greater than the costs of supporting in the short term. The precedent for integrated energy, economic development and taxation policies supporting the development of a new manufacturing, export-based sector is the Danish wind turbine sector. Other examples include: •

the strategies for the agriculture and fisheries sectors, influenced to a large extent by EU policy, do not take account of the needs and market opportunities identified by the food and drink sector; and

•

transport and taxation policy, including for example Air Passenger Duty have been motivated by environmental but do not fully take account of the competitive position of the tourism sector and other exporting sectors.

An overarching economic strategy for the Scottish economy would provide a framework for other strategies and provide a basis for the Scottish Government to work with other levels of government (local, UK and EU levels) to ensure policy consistency. 3.1.2

Economic Challenges The relative decline of the UK and Scottish economies compared with the top performing advanced economies has been a gradual process over time, which may help to explain why there has not been more of a clamour for change in economic strategy.

Scotland Means Business: The Strategy

However, the combination of the recent economic crisis and longer-term trends means that the current trajectory for the UK and Scottish economies is not sustainable. Six inter-linked economic challenges are summarised below; together they demonstrate that change is required for long-term economic success. Six Economic Challenges 1. Seven Lost Years The recent economic crisis has been the longest lasting in modern times. The UK and Scottish economies have yet to recover to the pre-recession peak of early 2008 and are 6 not predicted to reach this point until later in 2014, more than six years later . This compares with less than four years that it took to recover from the depression in the early 1930s and the recession of the early 1980s. 7

Analysis by the Fraser of Allander Institute shows that at the trough of the recession in 2009, Scottish economic output was 5.6% below the pre-recession peak and UK economic output was 7.3% below. By quarter three of 2013 the Scottish economy was still 0.9% below its pre-cession peak, while the UK was 1.9% below. The full impact of the crisis can perhaps be better illustrated by a comparison of the size of the economy today compared with what it would have been had the historic trend growth rate been maintained for the last seven years. The average growth rate for the 8 Scottish economy between 1977 and 2007 was 2.4% . While this is lower than the average for the UK and for comparable European countries, even maintaining this trend growth rate between 2007 and 2014 would have meant the output of the economy in 2014 would have been 19% higher than is expected, an additional output of £27 billion, equivalent to more than £5,000 per person. The recovery from the 1930s depression required bold changes in economic strategy including Roosevelt’s radical New Deal. A similarly radical change in strategy is required to ensure sustainable growth. 2. Imbalance in the UK Economy: the City of London Effect The economic crisis has highlighted the extent to which London and the financial sector dominates the UK economy. Research by the Bank of England has found that in the decade before the financial crisis, the UK financial services sector grew by 6% per year, more than twice as fast as the UK economy as a whole and the sector’s share of the economy also grew 9 significantly and by more than most other major advanced economies, to almost 10% . London has a more dominant position in the UK economy than most other capital cities. Eurostat analysis has found that economic output per person in Inner London is almost three times the UK average and almost five times the UK’s poorest region (West Wales 10 & the Valleys) . There has been a level of political consensus on the need to address the balance of the UK economy. David Cameron has said that the UK is too reliant on a few industries and regions, particularly London and the southeast and that, “We are determined that should change.” Peter Mandelson has called for “more real engineering and less financial engineering”. Vince Cable has said that, "London is becoming a kind of giant suction machine, draining the life out of the rest of the country. More balance in that respect would be helpful.” The disagreement sits around the substance and impact of different solutions. 6

For comparison of UK GDP estimates and comparisons with previous recessions, see monthly GDP estimates published by National Institute of Economic and Social Research at www.niesr.ac.uk/publications 7 Fraser of Allander Institute Economic Commentary Vol 37 No 3 (March 2014), University of Strathclyde 8 The Scottish Economy (November 2013), The Scottish Government 9 Bank of England Quarterly Bulletin, Q3 2013 10 See chapter 4 of Scotland Means Business: The Facts

Scotland Means Business: The Strategy

However, recent economic trends show that London is becoming even more dominant. For example, Centre for Cities has found that London accounted for 79 per cent of national private-sector jobs growth between 2010 and 2012, almost 10 times more 11 private-sector job creation than the second fastest-growing city (Edinburgh) . One of the consequences of London’s dominance of the UK economy is that the public policy needs of the London economy will increasingly diverge from that of the rest of the UK; one example is the housing market. This highlights the need for an economic strategy for Scotland (and indeed for the other regions and nations of the UK) that is designed to meet the needs of the Scottish economy, which would help to address the current imbalances in the UK economy. 3. Ageing Population th

Scotland’s population has grown by less than the UK as a whole. In the early 18 century Scotland had a population estimated at 1.25 million compared to 5 million in England and Wales and so accounted for 20% of the British population. Scotland, with 5.3 million people, now accounts for 8.3% of the UK population. Had Scotland matched the UK’s population trends since 1951 (a 30% increase), there would be an additional 1.3 million people in Scotland.

Scotland has had higher emigration and lower immigration than the UK, which has affected the structure of the population as well as the total. In its submission to a 12 Scottish Parliament Committee Inquiry into the ageing population the National Records of Scotland indicate that although the working age population is set to increase by 7% between 2010 and 2035 those of pensionable age will increase by 26% over the same period (with 82% growth expected in those over 75). The dependency ratio (the ratio of people aged under 16 and over pensionable age to those of working age) is projected to rise from 60 per 100 in 2010 to 64 per 100 in 2035. In Scotland, any political debate on the ageing population tends to focus on the implications for public policy, including the costs of pensions and healthcare. These will indeed be challenges, whatever Scotland’s constitutional future is. The development and implementation of a new economic strategy could change current demographic projections. Moreover, Scotland is not the only advanced economy to experience an ageing population and so products, services and public policies to address the challenge will be exportable. Other regions with an ageing population have identified this as an economic opportunity, including, for example, Groningen and the Northern Netherlands where healthy ageing is a strategic priority for both economic development and healthcare. 4. Consumption Based Economy The need for re-balancing the economy and an ageing population mean that there will be a need for greater levels of saving and investment, in Scotland, the UK and many other advanced economies. This will mean a relative decline in the contribution of household consumption to demand in the economy. The UK is particularly vulnerable to this trend since household consumption is 13 equivalent to 66% of GDP, compared to an average for advanced economies of 56% . The UK has the fourth highest level of household consumption, relative to the size of the economy amongst OECD economies. No comparable statistics are available for Scotland, although Scotland’s higher level of exports is likely to mean that the household’s share of consumption will be lower. High levels of household debt in the UK mean that it is not sustainable to rely on household expenditure as a driver of the economy. Household debt in the UK in 14 February 2014 was £1.44 trillion , more than £28,000 per adult. While household debt 11

Centre for Cities (January 2014), Cities Outlook Scottish Parliament (February 2013), Finance Committee 2nd Report, 2013, Demographic change and an ageing population 13 OECD Household Final Consumption as % GDP, 2012 14 Bank of England (31 March 2014), Total Lending to Individuals (excluding student loans) Feb 2014 12

Scotland Means Business: The Strategy

reduced during the recession, it has now risen to pre-recession levels in nominal terms (although the effects of inflation mean that it has fallen as a proportion of household income from 167% in 2007 to 140% in 2014). Exports accounted for just 32% of GDP for the UK in 2012, compared with the OECD average of 60%. However, perhaps the most concerning of the macroeconomic indicators of the UK economy is that gross capital formation (a measure of investment) accounted for 14% of GDP in 2012, one of the lowest levels in the OECD, where the average is 20%. The unsustainable consumption based economy, with long term downward pressure on consumption associated with a need to save more to meet the pension needs of an ageing population, means that a new economic strategy needs to focus on global markets rather than domestic markets. 5. Climate Change Climate change and its consequences is one of the big challenges for the global economy. Economic growth in the developing world cannot be delivered in the resource and energy intensive ways of the past due to limited resources and the brake of global warming. A range of international initiatives include the World Economic Forum’s Climate Change Initiative which recognises that “greening economic growth” is the only way in which sustainable, inclusive development can be achieved that will satisfy the basic needs of 9 billion people and provide them with equal rights to material prosperity. At the national level, climate change considerations are an important influence on the formation of policy, in particular targets to reduce carbon emissions, an area of public policy where Scotland has been in the lead. However, the challenges associated with climate change should also be considered to be business opportunities since products and services that reduce carbon emissions in the energy mix or deliver more efficient use of resources will be globally competitive. 6. The Trade Gap Trade is more important to the Scottish economy than to the UK, as might be expected given the relative size of the two economies; trade per capita in small advanced economies is $75,000 per capita on average while in large advanced economies the 15 average is $32,000 . However, benchmarking the Scottish economy with the rest of the UK masks considerable underperformance of the Scottish economy relative to competitor economies. Even if trade with the rest of the UK is included in Scottish trade figures, Scotland’s trade per capita of £35,300 ($55,800) is well short of the average for a small advanced economy. Scotland is also heavily reliant on one ‘export’ market, the rest of the UK, which accounts for almost two-thirds of total Scottish trade flows. Scottish levels of trade are well behind some of the most successful small advanced economies in Europe such as Ireland (which has high levels of trade associated with foreign direct investment), Switzerland, Norway and Denmark. Scotland’s trade volumes need to increase by a third to match the average for small advanced economies and, if oil and gas exports were excluded, Scottish trade would need to increase by 60% to match competitors, some £94 billion in additional trade. The limits to growth of a domestic market that is so heavily dependent on household consumption mean that future growth will require a focus on global rather than domestic markets. Broader trends such as globalisation facilitate such a strategy since it is now possible for niche products and services to serve global markets, rather than be confined to 15

See Chapter 14 of Scotland Means Business: The Facts for more detail on trade statistics for Scotland, the UK and international comparators

Scotland Means Business: The Strategy

domestic markets or trading blocks. The most successful small advanced economies, with considerably higher levels of trade than Scotland, have shown that this path to growth is achievable, if it is high enough as a strategic priority and supported with the right mix of policies.

While each of these economic challenges may seem daunting, if they are seen as opportunities, the development of an economic strategy for Scotland to take advantage of a rapidly changing world should deliver a more successful Scottish economy. The findings of Scotland Means Business: The Facts, identified a number of assets and advantages on which such a strategy could be built, including:

3.2

•

global growth niches: Scotland has strengths in many niches in many global growth markets, from renewable energy to life sciences to computer games;

•

human capital: Scotland has world leading universities and a skilled workforce, with one of the highest proportion of adults with higher or further education level qualifications in the advanced economies;

•

intellectual property and innovation: Scotland’s universities undertake research which has a high impact globally, as citations by other researchers demonstrates but has low levels of investment in R&D, in particular R&D by businesses;

•

the level of investment in capital and infrastructure: Scotland has a number of sectors that are experiencing rapid global growth. Infrastructure investment in the UK has been declining but there are opportunities for infrastructure investments to drive growth in Scotland; and

•

natural resources: Scotland’s natural resource advantages include oil and gas and renewable energy resources.

Benefits of a Strategy Both the process of developing a comprehensive strategy for the Scottish economy and the role of the strategy of providing an overarching framework for public policy will deliver a range of benefits. These will include: •

a framework that coherently sets out the needs, opportunities and preferences of Scotland;

•

a long term perspective on priorities and strategic objectives, above and beyond the political cycle (at least in the many areas where there is a degree of consensus);

•

a framework that provides the long term stability sought by investors who wish to understand and manage the risks associated with investing in Scotland;

•

a mechanism to prioritise scarce resources on the challenges and needs identified as strategic priorities. These include public sector resources as well as human, natural and technological resources;

Scotland Means Business: The Strategy

â&#x20AC;˘

a mechanism for the integration of policy since the strategy will provide the framework within which more detailed policies and sector based strategies can be developed;

â&#x20AC;˘

the process of developing and reviewing strategy encourages a regular review of the progress that is being made and benchmarking against and learning from the best; and

â&#x20AC;˘

the process also encourages thinking about and discussion of preferences as well as economic needs and opportunities, answering the question of what kind of country should Scotland be.

The next section of this report describes the framework that has been used for the development of Scotland Means Business: The Strategy.

Scotland Means Business: The Strategy

FRAMEWORK FOR STRATEGY Key Findings • businesses compete but governments provide the conditions that can make businesses competitive or uncompetitive in the global demand for people, skills, technology and investment, all increasingly mobile resources; • Scotland Means Business: The Strategy draws on academic research including that of Professor Richard Vietor of Harvard Business School whose framework includes the need for a strategy, structures for its implementation and a range of macroeconomic and microeconomic policies designed to achieve strategic goals; • economic growth can be achieved by: increasing the quantity of resources (natural, human, technological, capital); and the efficient use of those resources (productivity). • Scotland Means Business: The Strategy has also learned lessons from strategies for other economies. These include the Chicago Growth Strategy, which identifies three drivers of growth (economic sectors and clusters, human capital and innovation and entrepreneurship) and two enablers of growth (physical and virtual infrastructure and public and civic institutions) and sets out ten separate but mutually reinforcing transformational strategies; • N-56 believes that the overriding objective of Scotland’s new economic strategy should be to increase economic growth so that, over time, Scotland becomes one of the wealthiest five countries in the world, measured in economic output per person; • The transformational strategies are based on creating the conditions for growth in the Scottish economy, primarily through two mechanisms: increasing economic participation: Scotland has a higher employment rate than the UK as a whole, but a lower rate than the top five advanced economies. Matching the average for the top five would imply an additional quarter of a million people in employment, based on the current Scottish population. Even with no improvement in productivity, this would imply an increase in GDP of some £15 billion; and export-based growth: Scotland’s trade volumes would need to increase by a third to match the average for small advanced economies (60% if oil and gas exports were excluded), some £94 billion in additional trade. Increasing exports is a credible strategy for the Scottish economy, since there are a number of existing and potential niches for Scotland in those sectors with the greatest global growth potential. Growth in trade would be a driver of economic growth, because it would both drive and result in the volume of factors of production (population and participation) and efficiency (productivity); • the transformational strategies set out in Scotland Means Business: The Strategy are presented separately but are mutually reinforcing strategies. These strategies represent a business contribution to the development of a new economic strategy, which should be further developed and implemented in a collaborative way.

Scotland Means Business: The Strategy

4.1

How Countries Compete N-56 recognises that business leaders need to take care when contributing to the development of a national economic strategy. A strategy for a country must be very different to a strategy for a company. As Professor Paul Krugman has observed16, the concept of national “competitiveness” can be dangerous, skewing domestic policies and threatening the international economic system since it is companies that compete, not countries. The business leaders that initiated N-56 are well aware that it is companies that compete in global markets. However, there is a need for an economic strategy for Scotland since countries and the policies of their governments provides the environment that helps to make companies more or less competitive. While countries may have fundamental advantages and disadvantages for particular sectors related to, for example, the availability of natural resources or their geographic location, government policies are also important since they affect the ability of companies to compete for people, skills, technology and investment, all increasingly mobile resources. There is an extensive academic literature on best practice in economic strategies for countries. It is not the role of N-56 and the Scotland Means Business reports to review that literature; where international lessons are highlighted in this report, they are based on the direct experience of the research team and the business leaders rather than the research of others. However, the framework for the strategy does draw on the work of Professor Vietor17 of Harvard Business School, who provides a comprehensive yet simple framework, as follows: •

strategy: all countries have a strategy, either explicit or implicit, which sets out goals. These can be general (e.g. “economic growth”) or more specific;

•

structure for implementation: including political structures that provide the ability to change policy and to have long-term objectives, where appropriate. Institutions must include banks and other institutions that facilitate the level of savings and investment that are required to achieve goals;

•

polices designed to achieve goals, including: ! macroeconomic policies (including, fiscal policy, budgetary stance, spending priorities within fiscal stance, taxation, monetary policy, exchange rates and income policy); and ! microeconomic policies (including trade policy, policy on foreign direct investment, policy on nationalisation and privatisation, economic regulation, competition policy and subsidy programmes.

Professor Vietor makes a number of observations, based on extensive research, including that government provides distinct advantages to firms (from property rights to publicly funded research and development programmes) and that each country’s strategy and structure must fit its context (taking account of issues such as culture, level of corruption, natural resources, education, income distribution, international security). 16

Paul Krugman (1994), Competitiveness A Dangerous Obsession, in Foreign Affairs Professor Richard H K Vietor (2007), How Countries Compete: Strategy, Structure and Government in the Global Economy, Harvard Business School Press 17

Scotland Means Business: The Strategy

Economic growth can be achieved by: •

increasing the quantity of resources (natural, human, technology, capital); and

•

the efficient use of those resources (productivity).

Professor Vietor highlights that no country has accelerated growth without capital and identifies five sources of capital: domestic banks (from household savings), domestic equity and venture capital, foreign direct investment (FDI), intentional foreign debt financing (e.g. US railroad bonds) and unintentional foreign debt financing (i.e. current account deficits). Ten policy generalisations are offered, for countries wishing to accelerate growth: •

basic property rights;

•

sound macroeconomic policies, no structural fiscal deficits;

•

more saving and investment, linked to growth supporting institutions (that provide capital for investment);

•

strong central bank backing non-inflationary growth;

•

sound microeconomic policy including avoiding barriers to trade;

•

labour market flexibility;

•

resource endowments, provided distortions are avoided (e.g. Dutch disease);

•

corruption hinders development;

•

income inequality holds back economic progress; and

•

asymmetry in current account balances is unsustainable.

Finally, Professor Vietor identifies a number of roles for government in accelerating economic growth: •

providing domestic and international security;

•

ensuring that the legal system backs contracts and property rights;

•

macroeconomic management;

•

backing extraordinary risks (examples include appropriate guarantees for the financial system and research and development for new industries); and

•

industrial policy, either explicit or implicit.

In the context of Scotland Means Business: The Strategy, these policy lessons are noted. In some areas, such as property rights and the legal system, as an advanced economy, Scotland already has appropriate institutions in place, although a written constitution could entrench them further. However, a number of the other policy generalisations are included in the proposals set out in this document.

Scotland Means Business: The Strategy

4.2

Chicago Growth Strategy The background research undertaken as part of the development of Scotland Means Business: The Strategy included a review of strategies of other economies, to identify best practice. The approach to collaborative policy making is discussed in some detail in chapter 11 and a case study on Denmark is appended to this report. However, there are also good examples elsewhere, including Chicago’s growth strategy, which was developed by a business led group commissioned by Mayor Rahm Emanuel. The Chicago strategy18 is a good comparator for Scotland since Chicago can also be considered to be a wealthy advanced economy, but perhaps one that has underperformed compared with some competitors. It is also an ambitious strategy, based on an analysis of performance and potential, with a framework that is comprehensive without being too complex. The Chicago strategy identifies five market levers, including three drivers and two enablers of growth. The three drivers of growth are: •

economic sectors and clusters;

•

human capital; and

•

innovation and entrepreneurship.

The two enablers of growth are: •

physical and virtual infrastructure; and

•

public and civic institutions.

Building on the drivers and enablers of growth, the Chicago strategy sets out ten separate but mutually reinforcing transformational strategies, each of which has a number of key components:

•

become a leading advanced manufacturing hub;

•

increase attractiveness as a centre for business services and headquarters;

•

become more competitive as a leading transportation and logistics hub;

•

make Chicago a premier destination for tourism and entertainment;

•

make Chicago a nationally leading exporter;

•

create demand-driven and targeted workforce development;

•

foster innovation entrepreneurship;

•

invest to create next generation infrastructure;

•

develop and deploy neighbourhood assets to align with regional economic growth; and

mature

and

emerging

sectors

and

support

World Business Chicago (March 2012), A Plan for Economic Growth and Jobs

Scotland Means Business: The Strategy

•

create an environment and processes that allow businesses to flourish.

Scotland Means Business: The Strategy also sets out a number of transformational strategies based on analysis of the potential and opportunities for the Scottish economy.

4.3

Strategic Objectives N-56 believes that the overriding objective of Scotland’s new economic strategy should be to increase economic growth so that, over time, Scotland becomes one of the wealthiest five countries in the world, measured in economic output per person (GDP per capita). However, the success of the strategy should not be assessed entirely on Scotland’s GDP per capita growth. Other measures of the economy such as gross national income (GNI) and wider measures such as the Human Development Index and the Gini-coefficient should also be monitored19. Accelerating economic growth can improve living standards in Scotland. However, increasing economic dynamism can also facilitate other policy objectives. For example, addressing inequality in an environment of economic growth, using policies that enhance growth as well as reducing inequality may be easier to achieve than attempting redistribution in a static economy. As discussed in Scotland Means Business: The Facts, there are a range of growth enhancing policy reforms that are likely to reduce inequality including, for example, improving the quality and reach of education, active labour market policies, measures to improve labour market outcomes of women and a taxation system that allows equitable growth. A focus on economic growth does not necessarily mean use of more resources. Indeed the policies outlined in this document are focused on improving productivity, that is, making more efficient use of resources. The transformational strategies set out in this document are based on creating the conditions for growth in the Scottish economy, primarily through two mechanisms:

4.3.1

•

increasing economic participation; and

•

export-based growth.

Economic Participation While Scotland has a higher employment rate than the UK as a whole, at 69.4% of the 15-64 population, it is only 14th in the OECD. The top five are Iceland at 80.2%, Switzerland at 79.4%, Norway at 75.8%, Netherlands at 75.1% and Sweden at 73.8%20. If Scotland was to match the average of the top five, an employment rate of 76.9%, it would require a 7.5% increase. There are just over 2.5 million people employed in Scotland currently, so matching the top five average would imply an additional quarter of a million people in employment, based on the current

See Scotland Means Business: The Facts for other broader measures of economic and social development. 20 Source: High Level Summary of Statistics Trend – Labour Market (February 2014), Scottish Government

Scotland Means Business: The Strategy

Scottish population. Even with no improvement in productivity, this would imply an increase in GDP of some ÂŁ15 billion. Such an increase may take some time to deliver and will require a range of longterm supply side initiatives. These initiatives should be targeted at groups that are under-represented in the labour market. This will include measures to support female participation since the female employment rate in Scotland is 6.2% lower than the male employment rate. Investment in childcare may be part of the policy mix required to address this; however, other measures will also be required including further efforts to promote equality in the workplace. Figure 4-1 â&#x20AC;&#x201C; Employment Rate in Scotland by Gender, 2012 80.0%$

70.0%$

60.0%$

50.0%$

40.0%$

30.0%$

20.0%$

10.0%$

0.0%$

Male%

Female%

Source: Annual Population Survey (2012)

Geographical differences will also need to be addressed. Even at local authority level, there are significant differences in employment rates; at the more local ward level, the differences are even greater.

Scotland Means Business: The Strategy

Figure 4-2 – Employment Rate in Scotland by Local Authority, 2012 80.0%)

70.0%)

60.0%)

50.0%)

40.0%)

30.0%)

20.0%)

10.0%)

Or Sco kn tla e n Ab y)Is d) la e Sh rdee nds ) et la nsh nd ire )Is ) la nd Ab M s) er or de ay en ) )C Hi ity) gh So M lan ut idl d) h ) ot La hi na an rk ) Pe East shir rth )Lo e) )an th d) ian Ki nr ) os Ea W An s) st es )D t)L gus un o ) ba thi rto an ns ) hi Ed re in bu Fa ) Ea rg lkir st h,) k) )R e Ci t Sc nfre y)of oP w ) sh sh i r ) e Re Bor ) nf de re rs) w E i sh i r le e Ar an) ) gy Sia So ll)& r)) u t )B h) ut Ay e) rs hi No re rth ) )L a na Fife Du rk ) m sh fri ir e W s)a S e) es nd Trl t)D )G in un allo g) ba w rt ay E on ) Cl ast shi ac r km )Ayr e) an shi na re) n In shir ve e) Du rcly d n No de e) rth e)C )A ity) Gl yrs as hir go e) w )C ity )

0.0%)

Scotland)

Source: Annual Population Survey (2012)

A range of education, training and labour market interventions will be required to address the geographical differences in economic participation. The policy mix will build on existing trends; so for example, the proportion of working age adults in Scotland with qualifications at level four or below (i.e. the new National 4 qualifications or the General level at Standard grade) has fallen from 19% in 2004 to 13% in 2012. Addressing these gender and geographic inequalities can be a driver of growth since it will increase the human resources available for productive use in the Scottish economy, resources that are currently being wasted. However, in addition to supply-side labour market measures, there will also be a need for demand side initiatives, for example to create more jobs in deprived areas, promote terms and conditions attractive to parents and carers, or ensure work places are accessible for people with disabilities. 4.3.2

Export Based Growth Strategy Scotland Means Business: The Facts found that trade accounted for a larger proportion of the Scottish economy than is the case for the UK. Scotland’s exports have been growing (up 38.4% between 2006 and 2012 according to the Global Connections Survey). However, Scotland is still under-performing small advanced economies, indicating the potential for further significant growth. Scotland’s trade figures are usually reported as part of the UK trade statistics with unreliable regional breakdowns. In the absence of regularly published reliable statistics, it is often assumed that with oil and whisky exports, that Scotland does well on exports. However, benchmarking with the rest of the UK means that under-performance – and the economic opportunities associated with growth in trade – have been missed. Even if trade with the rest of the UK is included in Scottish trade figures, Scotland’s trade per capita of £35,300 ($55,800) is well short of the average for a small advanced economy. Scotland Means Business: The Strategy

Scotland is also heavily reliant on one ‘export’ market, the rest of the UK, which accounts for almost two-thirds of total Scottish trade flows. Scottish levels of trade are well behind some of the most successful small advanced economies in Europe such as Ireland (which has high levels of trade associated with foreign direct investment), Switzerland, Norway and Denmark. Scotland’s trade volumes per capita (including trade with the rest of the UK as well as the rest of the world) are around $56,000 ($47,000 if oil and gas is excluded) compared with just over $25,000 for the UK and the average of $75,000 for small advanced economies. Figure 4-3 – Trade Volumes Per Capita, 2012 !100,000!! !90,000!! !80,000!! !70,000!! !60,000!!

!50,000!! !40,000!! !30,000!! !20,000!! !10,000!!

Fin la nd ! Ge rm Un an ite y! d! Ki ng do m Un ! ite d! St at es !

al l)! Be lg iu m Ne ! th er la nd s! Ire la nd ! Sw itz er la nd ! No rw ay ! De nm ar k! Sc ot la nd ! Sw ed en ! I Sc ce ot la nd la nd ! !(e x!O &G )!

e) !

!(s m

ag e

!(l ar g er Av

ag e er

ag e

!(a ll) !

!"!!!!

Source: World Trade Organisation (WTO) Statistics Database (September 2013) & BiGGAR Economics Calculations (Scotland)

Scotland’s trade volumes would need to increase by a third to match the average for small advanced economies and, if oil and gas exports were excluded, Scottish trade would need to increase by 60% to match competitors, some £94 billion in additional trade. This is a distinctive strategy for the Scottish economy; however, it would require divergence from the UK’s economic strategy, with its high reliance on the financial services sector in the City of London. It is a credible strategy for the Scottish economy, since there are a number of existing and potential niches for Scotland in those sectors with the greatest global growth potential. So, for example, as economies grow: •

there is increased demand for healthcare – including the products from the life sciences sector;

•

there is increased demand for education – including university education;

•

leisure spend increases – increasing demand for services such as tourism and products such as computer games;

Scotland Means Business: The Strategy

•

demand for luxury products grows – including high quality food and drink products;

•

the demand for energy increases – providing opportunities for sectors that are already strong like oil and for emerging sectors such as marine renewables;

•

the wealth of individuals grows – increasing demand for financial services such as asset management.

This does not imply a strategy where the state ‘picks winners’ – Scotland will not be successful in all of these niche opportunities and it is difficult to predict in which ones the greatest opportunities will lie (the books written in the 1960s21 about the Scottish economy highlight industries like steel and shipbuilding but do not predict that there will be opportunities in regenerative medicine and computer games). However, there are a large number of opportunities for the Scottish economy and so it does not seem unreasonable to expect success in some of them. A strategy that is based on export growth does not need to be confined to particular industries – it can be a strategy that ensures the conditions for growth are in place across all sectors. Indeed, the consultations undertaken with business leaders have confirmed that many of the opportunities and constraints are common across different sectors of the economy. Scotland cannot expect to be dominant in any of these global markets at the macro level – since each of these markets is huge. However, with globalisation, a small country like Scotland can perform well economically by developing niche competitive advantages in markets that might be small in individual countries but are significant globally. The growth in trade would be a driver of economic growth, because it would both drive and result in the volume of factors of production (population and participation) and efficiency (productivity). Increasing trade (export promotion would be the focus although this also implies higher levels of imports to balance trade) would drive and result in higher levels of productivity since it will require competitive advantages to be developed in high value added sectors and will mean that businesses serving only domestic markets will need to respond to increased competitive pressures (from imports of goods and services and for resources with exporters). Scotland is currently in the third quartile of OECD countries for productivity, measured by GDP per hour worked (on an index where the United States is 100, Germany is 92.7 and Scotland is 78.4; comparator economies, with higher levels of trade include Norway at 137.8, Luxembourg at 129.7, Ireland at 112.6, Switzerland at 89.1, Denmark at 88.8, Sweden at 85.9, Austria at 85.6 and Finland at 79.8). Increasing trade will be associated with increasing productivity levels. These increasing productivity levels should be associated with high value added jobs. And provided that the growth in exports is broadly based, this should help to address inequality, by increasing income levels (rather than relying on the state to redistribute income to address inequality).

See for example, “Scotland’s Future”, Gavin McCrone (Blackwell, 1969)

Scotland Means Business: The Strategy

Increased demand for resources will also create opportunities that should result in lower levels of emigration – and so higher net migration – and so population trends more in line with comparator countries. If Scotland had matched UK population trends since 1951 the Scottish population would be 1.3 million higher than it is in 2014. Scotland’s population is often compared with Norway and Denmark. Norway had 2.2 million people in 1901, 3.3 million in 1951 and has 5.1 million now. Denmark had 2.2 million people in 1901, 4.3 million in 1951 and 5.6 million now. But Scotland had 4.5 million people in 1901, 5.1 million in 1951 and only 5.3 million now. The policy package required to support an exports-based growth strategy will require a number of elements, including:

4.4

•

building on current strengths – innovation policy and education and skills;

•

addressing perceived weaknesses – infrastructure and global connections;

•

targeted fiscal policies in areas with greatest export potential – those sectors where Scotland has existing and potential; and

•

supporting initiatives that will require government and business collaboration, including investment in the development of a Scottish brand.

Transformational Strategies Part two of this report summarises a series of transformational strategies. These encompass measures that would increase economic participation and export based growth. They are presented separately but are mutually reinforcing strategies. What is clear is that there is no one thing that will transform the performance of the Scottish economy. There is a need for a wide range of activity, across many policy areas. A new economic strategy for Scotland is therefore essential to provide the framework for public policy and ensure that all policies are aligned behind the strategic objective of increasing economic growth by increasing economic participation and growth in exports. These strategies are not intended to cover everything and in many areas more detailed analysis is required. However, they represent a business contribution to the development of a new strategy, which should be further developed and implemented in a corporative way, as recommended in Part three of this report.

Scotland Means Business: The Strategy

SCOTLAND MEANS BUSINESS: THE STRATEGY PART TWO: TRANSFORMATIONAL STRATEGIES

Scotland Means Business: The Strategy

EXPORT GROWTH Key Findings • Export growth is driven by productivity growth and so the best policies to promote export growth are those that enhance the productivity of exporters and potential exporters, such as investment in infrastructure, research and development and education. • Expanding exports will be dependent on maintaining access to global markets. While there are many ways that this can happen, Scotland’s continued membership of the European Union, either as part of a UK that remains a member or as an independent country that maintains membership, provides the easiest access to markets. • Being part of the EU means that Scotland’s domestic market has a population of more than 500 million and a GDP of some €13 trillion and has access to international markets as a result of trade agreements made at EU level as well as bilateral agreements. • Successful Scottish exporters have demonstrated the importance of sales and distribution networks. There may be potential to reach agreements for large companies to work with small and medium sized companies in export markets, as well as a role for government agencies to assist businesses to establish new distribution channels, particularly in emerging markets. • An export-based growth strategy will require that skills gaps in sales and languages are addressed. • English is increasingly the language of international business and so Scottish businesses have some advantage over those where English is not the first language. However, businesses which operate in other languages are likely to do better. The role of languages in the Scottish education system should be reviewed to ensure that Scottish children are equipped to compete in an increasingly global labour market. • The development of a national brand can assist businesses in export markets, since it provides a foundation on which they can build their own brand, if they choose to. This is also a good practical example of an initiative that can be developed by collaboration between government and business. • The national brand has to be realistic and authentic. In sum, the focus should be on generating outcomes, not simply investing in marketing or PR. This is important because the branding efforts need to be consistent and sustained – and to be linked to policy settings. • Scotland already has a strong national brand. The Scottish diaspora is large and could be used in a similar way to the Irish diaspora. It is well liked and people have a sense of what Scotland is. • Irrespective of the result of the independence referendum, this process is an opportunity for Scotland to continue to build a modern brand – both for an external audience, as well as for Scots to think about where and how Scotland is distinctive. The referendum has already elevated the profile of Scotland, and provides a point of difference with the rest of the UK. • The Scottish Government could also provide opportunities for Scottish businesses by targeted international engagement. That might include applying to join the Nordic Council to participate in programmes like the Green Growth initiative and establishing a leadership role in the EU in energy.

Scotland Means Business: The Strategy

This chapter of has been drafted and edited by BiGGAR Economics. However, the section on the experience of country branding in New Zealand, Singapore, Ireland and Finland has been based on a paper produced by Landfall Strategy Group, which has been incorporated into the chapter.

5.1

Exports and Productivity Productivity growth (making more efficient use of natural and human resources and capital) is the driver of economic growth in advanced economies. Studies of productivity growth and export growth in economies comparable to Scotland22 have concluded that there is a strong correlation between the two. While there is not universal agreement on the subject, the balance of evidence is that it is more likely that productivity is the driver of export growth rather than the other way round. This is important when designing an export based growth strategy since it implies that exports should not be promoted by subsidy but by stimulating productivity growth (through investment in infrastructure, research and development and education). Policies that support export growth are the productivity enhancing measures set out in other sections of this document. The wide range of policies required can be seen in best practice strategies from elsewhere. For example, the Danish Globalisation Strategy (the development process for which is described in Appendix D) consists of 350 policy measures under 14 areas of focus. As can be seen in Figure 5-1, eight of the 14 areas of focus are concerned with education, three with research and innovation and one each with interaction with other countries, entrepreneurship and the collaborative approach to implementing the strategy. Figure 5-1 â&#x20AC;&#x201C; Focus Areas in the Danish Governmentâ&#x20AC;&#x2122;s Globalisation Strategy World top performing primary and lower secondary school system All young people should complete a general or vocational upper secondary education programme A coherent education system and professional guidance At least 50 per cent of young people should complete a higher education programme Education and training programmes with a global perspective World top level short-cycle and medium-cycle higher education programmes World top level universities More competition and better quality in public sector research Good framework conditions for companiesâ&#x20AC;&#x2122; research, development and innovation Stronger competition and greater openness and transparency to strengthen innovation Strong interaction with other countries and cultures More high-growth start-ups Everyone should engage in lifelong learning Partnerships to promote the implementation of the Globalisation Strategy Source: Danish Government, Progress Innovation and Cohesion, May 2006

Learning from Denmark, education and innovation will be important elements of an export-based strategy for Scotland, building on existing strengths.

See, for example, Nesset (2004), Exports and Productivity in a Small Open Economy: a causal analysis of aggregate Norwegian data (in Journal of Policy Modeling)

Scotland Means Business: The Strategy

However, the starting position for Scotland’s new economic strategy is different from Denmark’s globalisation strategy. For example, Scotland already has world leading universities and high levels of participation in higher and further education, although continued investment will be required to maintain this position as others seek to compete. Conversely, Scotland’s infrastructure, including global connections for people and goods, has benefitted from lower levels of investment than Denmark’s and so requires greater attention. The opportunity associated with Scotland’s geographic position to develop hub airport services and international freight ports would lower the barriers to export for Scottish businesses that are not currently exporting. Proposals for infrastructure investment are set out in Chapter 6. While there may be a gap in trade levels between Scotland and competitor economies, there are some sectors of the economy that have achieved significant success in export markets and from which lessons can be learned. These include the whisky industry and more recently other food and drink such as salmon, as well as the oil services sector. A common feature of these sectors is that they rarely distinguish between domestic and export markets, seeing their markets as global. In the case of whisky, entrepreneurs such as Johnnie Walker travelled to sell his product in all markets to which ships sailed and in oil and gas, supply chain companies that grew in Scotland as the North Sea has grown have followed their customers to wherever there has been oil to discover and extract. These successes help to demonstrate the potential benefits from a corporative approach to policy making as recommended by N-56, since such a process would involve inviting representatives from those sectors to share their experience with others.

5.2

Access to Markets Scotland Means Business: The Facts included a section on the success of small advanced economies, which identified two sets of issues that might explain their success. These are intrinsic issues such as high levels of trust and globalisation trends that had removed barriers to trade for small advanced economies. Expanding Scottish exports will be dependent on maintaining access to global markets. While there are many ways that this can happen, Scotland’s continued membership of the European Union, either as part of a UK that remains a member or as an independent country that maintains membership, provides the easiest access to markets. Being part of the EU means that Scotland’s domestic market has a population of more than 500 million and a GDP of some €13 trillion and has access to international markets as a result of trade agreements made at EU level as well as bilateral agreements.

5.3

Distribution and Sales Successful Scottish exporters have demonstrated the importance of sales and distribution networks. Larger companies are able to establish their own networks; however, this may be more challenging for small and medium sized companies and high barriers to export may discourage such companies from exporting at all. Scotland Means Business: The Strategy

The corporative approach recommended by N-56 applies as much to the implementation of strategy as well as the development of policy. One area worth further consideration is whether larger companies with established sales and distribution networks might be in a position to assist new exporters. There is a potential for mutual interest here since such an approach would allow established exporters to offer a wider range of products to their existing customers and would lower the barriers for new exporters. Making export based growth a national strategic priority could encourage companies to reach such agreements. There may also be a role for government agencies to assist businesses to establish new distribution channels. While it is almost always preferable for businesses to lead such activity, there are some markets, particularly emerging markets, where intervention by government to establish some framework agreements may ease the way for businesses. Developing sales and distribution networks also requires the necessary skills to be available. While every successful company requires an effective sales force, selling skills do not always have the same social status as other professions in Scotland. The development of sales skills is often through on-the-job training and effective sales staff are in demand. An increased focus on exports will increase the demand for sales staff able to operate internationally. The strategy should therefore include analysis of the need for and feasibility of developing training in international sales. English is increasingly the language of international business and so Scottish businesses will have some advantage over those where English is not the first language. However, while it may be possible to operate internationally in English, businesses which do most to understand and respect the culture of the countries in which they operate, including language, are likely to do better. There may also be skills gaps in languages. Scottish businesses already operating internationally tend to have international staff with a range of language skills. The role of languages in the Scottish education system should be reviewed to ensure that Scottish children are equipped to compete in an increasingly global labour market.

5.4

Development of a Brand The development of a national brand can also assist businesses in export markets, since it provides a foundation on which they can build their own brand, if they choose to do so. This is also a good practical example of an initiative that can be developed by collaboration between government and business. However, the development of a national brand for Scotland and Scottish products is a long-term undertaking. There have been previous initiatives, such as Scotland the Brand, in which significant sums of public money were invested, but which were not sustained for long enough to become well established. The Scotland the Brand initiative was a country of origin mark and so more narrowly focused that the international examples described below. VisitScotland has undertaken extensive research on attitudes to Scotland in its own target markets and has done much to develop a brand on which other sectors of the Scottish economy can also build. The reasons to visit, live, study or invest in Scotland are similar so there is potential for better integration of branding and marketing initiatives. The brand values identified by VisitScotland â&#x20AC;&#x201C; human, enduring, dramatic â&#x20AC;&#x201C; transfer well to sectors such as food and drink and textiles. Scotland Means Business: The Strategy

However, they also have relevance to technology-based sectors such as life sciences and energy. So, for example, the tourism branding and marketing activity related to Scotland’s dramatic landscape could be adapted to show why there are good reasons to invest in renewable energy, to take advantage of abundant wind and wave resources. Similarly, the enduring theme could be adapted to help revitalise Scotland’s historic reputation in engineering. 5.4.1

Building a Valuable National Brand The potential benefits to Scotland associated with developing a national brand is best illustrated by looking at other small countries’ experience. What is a national brand, what sort of benefits does the national brand generate (particularly for small countries), and how do small countries build a national brand? These questions are examined in the context of several small country case studies, focusing primarily on New Zealand and also looking at Singapore, Ireland and Finland.

5.4.2

Brand and Reputation There are many ways to define or measure national brand value. There are several different international rankings of soft power, each which include different factors. For example, Monocle Magazine has an annual ranking of soft power in which the whole of the UK does well ( Scotland is not separately ranked. Anholt undertakes a survey in which Scotland ranks 15th in the world. And there are numerous others including the FutureBrand Country Brand Index and BrandFinance Nation Brands 100. Small countries frequently do well in these rankings. A strong national brand can have a positive impact on exports, tourism, attracting investment and people – as well as advancing national interests. Countries are more likely to get their way if they have a favourable background reputation. Indeed, many governments believe this to be important and are investing behind strengthening the national brand. Small countries need to find ways of standing out, and to get attention in a crowded international space. And for small countries, the development of a strong national brand is an important foundation for an overall export strategy – a central contributor to growth and employment in a small, open economy like Scotland. Countries like Denmark, Switzerland, Norway, New Zealand, and Singapore are good examples of small countries that project various forms of soft power. It is interesting that small countries seem to have stronger national reputations than larger countries; according to the latest edition of the Reputation Index, 7 out of the top 10 countries by reputation have populations of less than 10 million people.

Scotland Means Business: The Strategy

Figure 5-2 – The 2013 Reputation Index 1.

Canada

Sweden

Switzerland

Australia

Norway

Denmark

New Zealand

Finland

Netherlands

10. Austria Source: http://www.reputationinstitute.com/thought-leadership/complimentary-reports-2013

There are a variety of approaches to building a national brand: some are focused on specific goals (tourism) while others are focused on telling a high-level story about the country. In addition to government strategies, national reputation and soft power is frequently bottom-up in nature (for example, music and culture in Ireland, K-Pop (and Psy) in South Korea). It also seems to be the case that smaller countries are more likely to have a deliberate branding strategy, even when large countries (e.g. the US) are able to organically build soft power. Some countries have built strong ‘country of origin’ label branding – such as that used by ‘Scotland the Brand’, launched in 1994, or ‘The New Zealand Way’ – but have struggled to broaden targeted campaigns into wider national branding efforts. The most effective national brands promote a country in multiple ways (e.g. FDI, export education, export promotion, tourism). The international experience suggests that the national brand development process needs to have strong government involvement in terms of coordination and funding because successful, effective national brands require sustained investment, and will involve multiple sectors – and firms. Of course, individual sectors and firms will invest behind specific branding activity, but the experience suggests that national brands require a government role (acting in a collaborative way with business and other stakeholders). 5.4.3

Small Country Case Studies This section describes a series of case studies; focusing primarily on New Zealand, but also examining other small countries that have interesting experiences with respect to national branding – and where there are instructive lessons.

5.4.3.1 New Zealand New Zealand is widely regarded as having one of the most coherent and effective national brands in the world. This has been based around a brand known as ‘100% Pure’, which emphasises the clean, green nature of New Zealand (beautiful landscape, friendly people). When the 100% Pure New Zealand campaign was launched in 1999, it was the first time New Zealand had used a single, clear message to communicate in all its target markets. In addition to the general campaign, Tourism New Zealand has made targeted investments – using this brand – around high-profile international events such as the Americas Cup yachting and the Lord of the Rings movies, clearly linking these to New Zealand. Scotland Means Business: The Strategy

This branding campaign has built on the reputation New Zealand established over time through its actions (such as being a good global citizen). Its actions and branding together have helped New Zealand rank well internationally on various measures of reputation; people are favourably disposed towards the country. Although the 100% Pure brand has been highly successful, it works better on some dimensions than on others. In particular, it has been very successful in terms of promoting tourism as well as exports of food and beverage products (particularly in the context of increasing concerns about food safety). In the first ten years of the campaign (1999 to 2009), visitor arrivals to New Zealand increased 50 per cent, from 1.6 million to 2.4 million; foreign exchange earnings for New Zealand from tourism increased from NZ$3.5 billion (£1.77 billion) to NZ$5.9 billion (£2.98 billion). And total user sessions on Tourism New Zealand’s website, www.newzealand.com, increased from 1.4 million in 2002 to 10 million a year in 2008. On these measures, the branding campaign was widely regarded as a success. However, there has not been an overall assessment of the return on investment from the campaign. Various announcements have been made over the past few years that suggest that a more formal economic assessment will be undertaken. To give an indication of the scale of return, Tourism New Zealand’s total annual budget during this period was less than NZ$100 million (£50 million), including funding for special projects. In the financial year ended 2012, Tourism New Zealand’s international media programme generated an estimated $74 million (£37 million) worth of international media profile (on an advertising equivalence basis) and coverage for New Zealand by leveraging approximately NZ$1 million (£500,000) of investment. However, despite these successes, there was a concern that the 100% Pure brand only communicated a portion of the overall New Zealand brand, and didn’t have much to say about knowledge and innovation (or people). New Zealand was seen as attractively clean and green, but not knowledge or innovation based. This did not help the image and sales pitch of New Zealand exporters. In response, there has been an active process of brand development over the past several years to build a consistent, more comprehensive story that would support all sectors, not only tourism. This resulted in ‘The New Zealand Story’ that was released in late 201323. Tourism New Zealand, New Zealand Trade and Enterprise and Education New Zealand led the development of the New Zealand Story, working closely with public and private sector stakeholders. The objective was to provide a compelling story that would differentiate New Zealand from other countries and showcase what it has to offer to international audiences. The main idea is that New Zealand is “Open to the New” (and welcoming of business): “Welcome to the country of open spaces; open hearts; open minds”. The Story is presented in three chapters, each demonstrating cultural values associated by New Zealanders with their national identity, and which have been tailored to appeal to international audiences: •

open spaces: our land and sea; we are guardians of this place. Building on the 100% Pure New Zealand brand, this shows New Zealand as a beautiful and fresh country with “room to breathe; places to find”.

http://story.newzealand.com/story

Scotland Means Business: The Strategy

•

open hearts: our people, warm, honest, welcoming. For business partners, this means “lasting partnerships” can be formed; tourists are invited to enjoy authentic cultural experiences, because “strangers are treated as friends”.

•

open minds: our resourcefulness and fresh outward way of thinking. New Zealand is shown to value learning and creativity: a land “where ingenuity drives innovation for productivity”, in an environment where “freshness” and “quality” are valued.

Economic Development Minister Steven Joyce explained the rationale for the New Zealand Story: “When New Zealand exporters first go out into the world or visit a new market, they need something which places New Zealand and their business into context. We are a small country, and often outsiders don’t understand who we are, how innovative we are, and what drives us as a country…This initiative is about broadening the perception of New Zealand internationally, beyond the scenic beauty of the country to include attributes like our innovation and resourcefulness, our unique Māori culture, our integrity and our welcoming friendly approach.” Strong collateral has been developed that can be used to provide a consistent, meaningful picture for visitors, international students, investors and consumers. The primary focus of the New Zealand Story collateral is to support business-tobusiness communication.

5.4.3.2 Singapore As a small island state, with effectively no natural resources, Singapore is very focused on presenting and promoting itself to an international audience. And Singapore has succeeded in achieving a prominent international reputation. For decades it has promoted an image designed to attract multinational companies and foreign investors: it is an attractively clean, green, safe, modern global city; an efficient, business-friendly, and orderly hub for Asia. Its standing as a high-quality destination is consistently reinforced by government agencies’ marketing efforts, as well as by the country’s sustained policy decisions (emphasising the rule of law, lack of corruption, world-class infrastructure and so on). The back-story of ‘Third World to First’ adds strength to its brand. The ‘Little Red Dot’ of Singapore now stands tall in the world, and is widely respected (as one marker of this, Singapore is regularly invited to G20 meetings). Singapore’s focus on the country brand has consistently been with a view to increasing GDP. Promoting a stable and well-organised business-friendly environment was the chief branding strategy when Singapore set out to attract multi-national companies to establish bases in Singapore. More recently, Singapore has sought to develop a broader image that extends beyond efficiency and stability. Singapore’s re-positioning as a liveable city has occurred as wealthy investors, potential high net worth residents and tourists have placed greater weight on a country’s vibrant cultural life, entertainment options and environmental concerns. In line with this, Singapore has broadened its image to focus on its ethnic diversity and the arts and has constructed new attractions, entertainment and cultural venues (such as the integrated resorts/casinos, the Formula 1 night race, the precincts around Gardens by the Bay, as well as new developments for the arts, restaurants and bars). Specific tourism promotions are undertaken for major events such as the Formula 1 race; in addition to the direct economic benefits, it is Scotland Means Business: The Strategy

estimated that there are substantial indirect benefits in terms of promoting Singapore. A notable feature of Singapore’s approach is the coherence of government activity: multiple agencies are involved in different aspects of the branding exercise, which is carried out in a coordinated way. Most of the effort is undertaken by agencies under the Ministry of Trade and Industry: The Economic Development Board (EDB) and the Singapore Tourism Board (STB) are two key agencies. Positioning Singapore to attract investment (for example, to establish research facilities, major regional offices and global headquarters) is carried out by the EDB, through offices worldwide. This investment promotion work is supported by other government agencies; for example by streamlining visa applications, constructing a straightforward tax and R&D incentive system, actively developing business parks, and ensuring that the education system delivers people with the right skills. Singapore’s brand positioning is consistent, extending also to the role of government-linked companies like Singapore Airlines. The positioning of this airline – efficient, premium, with high-quality service – is also part of building Singapore’s international reputation.

5.4.3.3 Ireland Ireland, like Singapore, has promoted itself as an attractive destination for companies. Through its effective policy settings and the promotional activities of the Industrial Development Authority (IDA), Ireland has focused attention on its well-educated, flexible workforce and favourable business environment. Pre-2007, Ireland’s economic performance and success in re-positioning itself as a European platform for overseas companies earned it the name of the ‘Celtic tiger.’ The 2007 crisis damaged the Irish brand. Restoring Ireland’s national reputation by recovering, paying down debt, and exiting from the bailout provisions has been seen as important for wider reputational reasons. Attracting FDI was made easier because of Ireland’s positive international image; its status as an educated, English speaking, low-tax area of Europe; and the way in which Ireland has used the Irish diaspora in the US to advocate for investment. More than 70 million people worldwide claim Irish descent, and the Irish government has invested significantly in diaspora communities - €60 million (£50 million) by the Department of Foreign Affairs alone over the five year period 20042009. Ireland targets its diaspora in a range of ways, but Ireland’s success at attracting FDI has most often been linked to ‘quality not quantity’; with help provided by a small number of exceptional people in the diaspora, sometimes now referred to as the ‘Global Irish 1000’. Strong home institutions, with excellent execution, are needed to support these key individuals. Enthusiasm is maintained through long-term face-to-face relationships and an ‘ask and task’ approach. Since the late nineteenth century, Ireland has promoted its culture and its people; the sophistication of this national branding has increased over the past twenty years as it has consciously built a reputation based on its sociable people, living and historic culture, and scenic beauty. The soft reputation that Ireland has built up is very powerful. Bodies involved in promoting Ireland’s brand include Tourism Ireland, the IDA, Bord Bia, and Culture Ireland. Fáilte Ireland is the National Tourism Development Authority, which supports the tourism industry. Scotland Means Business: The Strategy

Tourism Ireland and the IDA both put Irish people at the core of their communications: Tourism Ireland features the friendliness of the Irish as a key tourist attraction and the IDA features their education, innovativeness and creativity. Creative people are also at the heart of Culture Ireland’s campaigns; and although Bord Bia concentrates on a ‘green’ positioning for Irish food, this message is fully consistent with the scenic attributes of Tourism Ireland’s campaigns. Three qualities are at the heart of Brand Ireland’s destination marketing: •

sociable people – people are spontaneous, fun, engaging, authentic;

•

a unique culture – a living and historic culture that awakens the senses; and

•

scenic beauty.

The branding focuses on the island of Ireland as an immersive cultural experience that appeals to the senses and emotions. As one recent example (that was based on Homecoming Scotland in 2009), Ireland held ‘The Gathering’ in 2013 – a series of events to attract people back to Ireland. The official estimate was that 250-275,000 overseas visitors to Ireland travelled specifically because of a Gathering, or because of the Gathering, and that the growth in visitor numbers, directly attributable to the Gathering, was worth approximately €170million (£141 million) in revenue. The Gathering was able to harness the power of the personal invitation from people in Ireland to friends, relatives and affinity groups abroad. Overall, about 8 million people visited Ireland in 2013. Tourism Ireland’s 2014-2016 marketing plan continues to focus on quintessentially Irish emotional experiences, targeted to key segments within each major market. For example, independent North American youth are targeted by advertisements promoting the Irish pub (think Guinness – aggressively marketed as quintessentially Irish; the Guinness Storehouse is the most visited tourist destination in Ireland) and music. Taglines include “In Ireland, a good time is never far away”.

5.4.3.4 Finland Several years ago, Finland undertook a process to develop a national brand. In 2008 the Minister for Foreign Affairs established a group, chaired by a private sector representative, to create a strategy for Finland that would promote Finland’s economy, tourism and international status. The delegation worked for two years to pinpoint Finland’s strengths. The delegation met as a group, in smaller working groups, and at various seminars (business, education, youth, environment, marketing), expert meetings, and public meetings with Finns. A television programme even enlisted the public’s ideas for action. The aim was to ensure transparency and to make the branding work accessible to all Finns. This national conversation helped to identify the things that were distinctive and valued about Finland – and which would help to position Finland internationally. The idea was that that the brand had to resonate domestically, as the process was about building on existing strengths and capacities.

Scotland Means Business: The Strategy

This process defined the country’s brand identity as being the functionality of Finnish society, the Finns’ close relationship with nature, and a propensity for education. The statement was: “In 2030 Finland will be the problem-solver of the world. Finland offers the world functionality and sustainable solutions in the form of both products and services as well as a functional society. Finland offers the world its ability to negotiate so that the world can be a better place to live. Finland offers the world clean water and food and related expertise. Finland offers the world better education and teachers.” Coherent, coordinated, effective international branding for Finland was a key priority identified by the Mission For Finland group. A country branding expert body was proposed, with coordinated implementation by other government agencies: Finland’s embassies, agencies under the Ministry of Employment and the Economy (Finpro, Tekes, and the Finnish Tourist Board) and the Finnish cultural and science institutes supported by the Ministry of Education and Culture. The Government’s response was to include the national branding work under the umbrella of a wider review of external economic relations. After further work, a ‘Team Finland’ approach was recommended to promote Finland’s external economic relations. This would involve high-level cooperation across government and be chaired by the Prime Minister, and with key Ministers involved. Relevant agencies now coordinate their efforts to promote Finland and its interests abroad (including the country brand). The Team Finland Strategy was launched in June 2013, with substantial support from Finnish businesses and government stakeholders. Country branding will be promoted through creating unique events that focus on cleanliness, design, education and competence. 5.4.4

Lessons and Implications for Scotland The way in which a country is perceived has multiple benefits; this matters particularly for small countries (benefits include business, tourism, advancing interests through diplomacy, and so on). Ultimately the national brand has to be backed up by outcomes and be understood and owned by the population. The Nordic branding works because they are also very successful economies and societies. Similarly, Singapore has built a reputation on strong performance. The national brand has to connect with reality and be authentic. The focus should be on generating outcomes, not simply investing in marketing or PR. This is important because the branding efforts need to be consistent and sustained – and to be linked to policy settings. Many small countries (the Nordics, New Zealand, and others) have been active in deliberately building a brand around being a good global citizen, with a focus on environmental sustainability and foreign development assistance (e.g. Norway has partnered with Indonesia on deforestation with about USD$1 billion (£600 million) of funding). For small countries, this will require a need to focus on specific distinctive niches (Singapore oftem focuses on building public sector capacity and ; New Zealand has a strong geographic focus on the Pacific). Scotland already has a strong national brand; the Scottish diaspora is large (and could be used in a way more similar to the Irish diaspora); and people have a sense of what Scotland is. However, the country case studies show the benefits of being able to invest behind a specific brand – and particularly one that is supported by a coherent policy approach. It is important that countries are able to approach the branding exercise in a way that is consistent with their context, preferences and objectives (the branding needs to be matched with the policy Scotland Means Business: The Strategy

agenda and approach). For example, there are debates in countries like New Zealand and Norway regarding the consistency between a branding based on sustainability and the environment and the economics of the oil and gas industry. Irrespective of the result of the independence referendum, this process is an opportunity for Scotland to continue to build a modern brand â&#x20AC;&#x201C; both for an external audience, as well as for Scots to think about where and how Scotland is distinctive. The referendum has already elevated the profile of Scotland and provides a point of difference with the rest of the UK. This process would necessarily involve a range of stakeholders; businesses, key civil society groups, as well as government. From observation of successful international experience, this needs to be championed by senior Ministers and to be treated as a strategic government priority. There should be strong business involvement, but a government leadership role is needed for a long-term national project such as this. The process should develop a position on how Scotland should present itself to an external audience today, building on some of the existing perceptions (history, culture) and the diagnosis of the emerging challenges and opportunities for Scotland to address. The New Zealand process is a good example to consider, both in terms of the process used as well as the goal of building on an already successful brand. The aim would be to create an overall national brand, in which more specific campaigns could be located e.g. tourism, export education, exports, inward investment attraction, and so on. The national brand should have a responsible agency, and regular assessments should be undertaken of its impact.

5.5

International Co-operation The development of an export-based growth strategy would be strengthened by increased international co-operation at the Scottish Government level. Such interactions should focus on initiatives that can do most to support the development of sectors in which Scotland has existing or potential competitive advantage. This might include, for example, applying to join the Nordic Council (whose members include both independent countries and devolved nations) so that Scotland can participate in joint initiative such as the Green Growth strategy currently being developed. Scotland could also seek to establish a leadership role at EU level in energy, given the combination of oil and gas and renewable energy resources. There are many energy issues that are better tackled at the supranational level, such as the feasibility of and need for a European energy grid. If Scotland was to establish a leadership role in such areas, it is likely to provide development opportunities for Scottish businesses.

Scotland Means Business: The Strategy

INFRASTRUCTURE Key Findings • High quality infrastructure can facilitate economic growth while poor quality infrastructure can inhibit competitiveness and constrain growth. • The UK invests less in infrastructure than other advanced economies, which makes the UK economy less competitive. UK investment in infrastructure has fallen below the 0.8% of GDP benchmark widely considered to be necessary to support an advanced economy. If investment is not taken back to this level it could cost the UK economy £9 billion per year by 2026 (Scotland’s share of that loss could be at least £750 million). • On this benchmark, Scotland would require annual infrastructure investment of at least £1.2 billion per annum, possibly more to deal with historic underinvestment. The requirement is for the equivalent of a new Forth Crossing (the biggest ever Scottish infrastructure project), every year. • This level of investment could generate significant economic impacts, for each £1 billion, a one off GDP increase of £1.3 billion could be expected and an increase in overall economic activity of £2.8 billion. • Investment in infrastructure should be planned strategically, rather than on a case-by-case basis. The starting point for the long-term plan should be the national economic strategy, with projects prioritised based on their contribution to strategic objectives. Ireland’s National Development Plan is an example of how this can be done. • While infrastructure planning should be based on meeting Scotland’s economic and social needs and opportunities, there may be some areas of infrastructure where a more entrepreneurial approach might be appropriate. Airport and port services are two areas where a more entrepreneurial approach may be appropriate since Scotland’s geographical location presents opportunities that are worth further examination. • The infrastructure priorities of an export-based growth strategy will include global transport connections, including air links to make business travel easier and facilities to make exporting goods easier. • Connections between Scotland’s main centres of population will also be increasingly important to compete against the growth of global cities. • It seems unlikely that Scotland’s infrastructure requirements can be funded in full under current capital budgets. However, investment in improving infrastructure need not be entirely funded from public sector sources. • One potential model would be Scottish Infrastructure Bonds, which could be offered to international bond markets and as domestic savings products. • The feasibility of a model similar to Singapore’s Central Provident Fund should be examined, since it has the potential to both address the need for pension and saving reforms and expansion and the need to invest in infrastructure to facilitate an acceleration in economic growth.

Scotland Means Business: The Strategy

6.1

Infrastructure Investment Trends High quality infrastructure can be a facilitator of economic growth and investment in infrastructure can generate economic impacts in the short term and increase the economic growth rate. Conversely, poor infrastructure will reduce overall economic competitiveness. The World Economic Forum’s Global Competitiveness report ranks the UK as 24th for the overall level of infrastructure (the top three are Switzerland, Singapore and Finland) and so with better infrastructure, the UK’s overall competitiveness would be higher than its 8th ranking. In the years before the recession, 2000-07, the UK was the lowest investor in infrastructure amongst the OECD advanced states24. Research published by the Civil Engineering Contractors Association (CECA)25 on UK infrastructure trends also found that infrastructure spending fell below a threshold level of 0.8% of GDP in early 2003 and was as low as 0.5% of GDP by 2007. Comparable figures are not readily available for Scotland; however, the CECA analysis suggests that major projects (such as the Channel Tunnel, Crossrail and the London Olympics) have made a significant contribution to overall UK infrastructure related output over the last 30 years and so it is possible that the decline in spending in Scotland may be even lower than the UK as a whole. UK trends highlighted in the CECA report included a shift in the source of capital for infrastructure from 96.5% public sector in 1980 to 61.6% private sector in 2010, mostly via the private finance initiative.

6.2

Benefits of Infrastructure Investment CECA recommends that investment in infrastructure should be maintained at least at 0.8% of GDP. For Scotland that would be £1.2 billion per annum and given the historic under-investment in infrastructure, there may be a case for substantially higher levels of investment over the next 5-10 years. To put this in some context, the new Queensferry Crossing, the biggest ever infrastructure project in Scotland is budgeted at around £1.4 billion, with construction taking place over a five-year period. The M74 extension in Glasgow cost almost £700 million. CECA estimates that the cost to the UK economy of failing to increase infrastructure investment back to the levels more typical for advanced economies could be an annual loss to the economy of some £9 billion by 2026. Scotland’s share of that loss could be at least £750 million per annum. However, investment in infrastructure generates both immediate economic impacts and a sustained contribution to economic growth. CECA estimates that each £1 billion in infrastructure investment: •

increases GDP by £1.3 billion as a result of economic multiplier effects (e.g. associated supplies for the construction and the knock-on benefits from construction employment); and

OECD (2010), Going for Growth, 2010: Country Notes, UK Civil Engineering Contractors Association (May 2013), Securing our economy: The case for infrastructure 25

Scotland Means Business: The Strategy

•

increases overall economic activity by £2.8 billion, by creating a competitive environment for business.

The role of infrastructure could be even more important to the future of the Scottish economy than in the past. The growth and economic dominance of London is not an isolated phenomenon; other large global cities have grown, taking advantage of agglomeration effects, where businesses and people clustering together deliver economies of scale from network effects to drive economic growth. If Scotland is to compete in such a global environment, the role of infrastructure in connecting the main cities and towns, physically and virtually, becomes more important.

6.3

Approach to Infrastructure Investment Decisions on infrastructure investment in the UK and in Scotland tend to be made on a case-by-case basis. There are well-developed processes in place to prepare and assess cases for investment. These include, for example, the Scottish Transport Appraisal Guidance (STAG) system of appraising transport projects. A STAG appraisal is prepared when Government funding, support or approval is required for transport projects. The STAG appraisal system is comprehensive and claims to be objective-led rather than solution-led, that is, designed to start with a definition of the transport problem rather than a pre-conceived solution. However, the starting point for such analysis is the current transport system and a set of objectives for changing it. Moreover, in most cases the STAG is undertaken by or commissioned by the local authority or transport authority promoting a project and so a STAG appraisal that identifies an alternative solution to the proposed project would be rare. An alterative approach would be more strategic, taking the national economic strategy as the starting point and identifying the investments required in pursuit of the objectives set out. It seems likely that such an approach would generate a long list of projects, far in excess of the capital funding likely to be available. However, the advantage of a strategic approach is that projects are not accepted or rejected for funding; rather they are prioritised in a long-term programme, with projects that will do most to facilitate economic growth given the highest priority. The example of the process used in Ireland shows how such a strategic approach to infrastructure investment can work.

6.3.1

Ireland’s National Development Plan Ireland has had a series of four National Development Plans (NDPs), covering the periods 1989-93, 1994-99, 2000-06 and 2007-13. The first of the NDPs was produced primarily as a spending plan for EU structural funds, setting out an €11.6 billion spending programme, of which €4.3 billion was EU funds. However, by the time of the third NDP (2000-06) the document had become more strategic in nature and covered a total of €60 billion in spending, only 5% of which was from EU sources. Almost half of this total was on infrastructure, including transport, water, waste, energy, telecommunications, health, education and housing. Taking the Irish Government’s objectives as their starting point, the objectives of the NDP were: Scotland Means Business: The Strategy

•

maintaining sustainable national economic and employment growth;

•

the consolidation and improvement of Ireland’s international competitiveness;

•

fostering balanced regional development; and

•

promoting social inclusion.

The development of the NDP also involved extensive consultation, in particular with the social partners (the Government, representatives of industry such as the Irish Business and Employers Confederation and the Construction Industry Federation, trade union representatives the Irish Congress of Trades Unions, the voluntary and community sector) as well as research into Ireland’s economic and social needs and opportunities and evaluations of the previous NDP. Another feature of the NDP was the integration of different measures. So, for example, a regional dimension focused more per capita resources in the Border, Midland and Western (BMW) region and ensured that the transport and other infrastructure was in place to service greenfield industrial sites which were the focus of inward investment promotional activities. The 2007-13 NDP set out spending of €184 billion, including €55 billion for economic infrastructure, the largest proportion of which was for transport projects (€33 billion). The financial crisis meant that this spending plan was scaled back; however, the strategic approach to prioritising infrastructure spending survived the spending reviews. The strategic approach has been maintained in the Infrastructure and Capital Investment plan for 2012-16, part of the Irish Government’s Medium Term Exchequer Framework. The plan sets out capital investment of more than €17 billion over 5 years, including €4.4 billion in transport infrastructure. The NDP approach was not an alternative to assessing the costs and benefits of individual investment decisions; indeed, the use of cost benefit analysis has increased in recent years. However, it has ensured that national (and initially EU) investment in infrastructure was focused on projects that aligned with national economic and social objectives. Perceptions about the quality of infrastructure have depressed Ireland’s performance in international rankings of competitiveness. However, investment in infrastructure has seen improvements; for example, in 2005 the IMD World Competitiveness Yearbook scored Ireland 4.48 out of 10 for perception of infrastructure but this had increased to 7.96 by 2011. Over the last two decades, the average investment in what would be defined as infrastructure in Scotland (the Irish definition is wider, including both housing and health services investments) has exceeded €2 billion per year. The Scottish Government’s Infrastructure Investment Plan follows good practice in that it is also set in the context of the Government Economic Strategy. However, the corporative approach to policy development and implementation recommended by N-56 means that the plan will need to be reviewed and refreshed as part of the development of the new economic strategy for Scotland.

Scotland Means Business: The Strategy

6.4

Infrastructure Needs and Business Opportunities While infrastructure planning should be based on meeting Scotland’s economic and social needs and opportunities, there may be some areas of infrastructure where a more entrepreneurial approach might be appropriate. Airport and port services are two areas where a more entrepreneurial approach may be appropriate since Scotland’s geographical location presents opportunities that are worthy of further examination. Scotland is well placed for air transport links between North America and Europe. However, Edinburgh airport, with 9.8 million passengers in 2013 was Europe’s 42nd busiest airport and Glasgow, with 7.4 million passengers in 2013 was the 59th busiest. To put this in context, the four busiest air hubs in Europe in 2013 were London Heathrow (72.4 million passengers), Paris Charles de Gaulle (62.3 million), Frankfort (57.5 million) and Amsterdam (52.6 million). While it might not be realistic for Scottish hub airports to compete with the busiest hubs in Europe, the development of Copenhagen airport demonstrates what might be possible. With 24.1 million passengers in 2013, it was Europe’s 16th busiest airport. It is the hub for Scandinavian Airlines (SAS) and for Norwegian and has flights operated by most European airlines and other international carriers. Passenger numbers have increased from 17 million in 1998 and there are plans to increase to 40 million. The airport is well connected by road and rail to Copenhagen and the rest of Denmark and, via the Oresund Bridge, to Sweden. Another example of an airport development that has taken advantage of its geographic position, despite a limited domestic market, is Iceland’s Keflavik International Airport. While it only has 2.8 million passengers a year, the population of Iceland is only 300,000 and the development of hub services has allowed regular flights to both North American and European cities, reducing Iceland’s peripheral disadvantages. The successful hub airports elsewhere have good road and rail links with the cities and regions in which they are based, an issue that would have to be addressed in Scotland, whether hubs were developed at existing airports or at a new site. There may also be an opportunity for Scotland associated the increasing use of the Northern Sea Route linking the Pacific and Atlantic, north of Norway and Russia (as an alternative to the Suez Canal). While hub airport services and an international freight port would provide services to Scottish businesses and residents, their feasibility will depend on securing a share of European and global markets. The development of hub services at Scottish airports and of improved sea freight services would lower the barriers to exporting for Scottish companies and could also help to ease the congestion at the London airports, particularly Heathrow. Transport links with the rest of the UK will continue to be important since the rest of the UK is an important market for Scottish firms (and Scotland is the second largest ‘export’ market for rest of UK firms, after the United States). The development of High Speed Two (HS2) rail links could improve these links, and deliver significant economic benefits for Great Britain (the business case26 puts the net benefits of phase one and phase two at £70 billion, and possibly as high

Department of Transport (October 2013), The Economic Case for HS2

Scotland Means Business: The Strategy

as £99 billion). However, the majority of the wider economic impacts will be delivered when HS2 moves into phase two, north of Birmingham. However, the planning of the project has assumed that the construction will start in London; consideration should be given to also constructing connecting high speed services from Scotland. This would improve transport connections between Scotland and Northern English cities as well as with London. There would also be environmental benefits associated with reduced demand for short haul air services.

6.5

Infrastructure Priorities While the Irish approach to infrastructure planning has been highlighted as an example, the position of Scotland’s infrastructure is not comparable with the situation faced by Ireland in the late 1990s, which, for example, still had a road network that predated the acceleration of Irish economic growth and was constraining further growth. However, the business leaders who have contributed their views to N-56 believe that Scotland has less well developed infrastructure than many of its competitors and the analysis presented in Scotland Means Business: The Facts showed how UK investment in infrastructure has been in long term decline. The infrastructure priorities of an export-based growth strategy will include global transport connections, including air links to make business travel easier and facilities to make exporting goods easier. Global trends such as the growth of global cities, taking advantage of agglomeration effects, also means that road and rail infrastructure that improves access between Scotland’s centres of population will become increasingly important to competitiveness, to facilitate the development of critical mass in key economic clusters. However, planning should avoid focusing on connecting the rest of Scotland with the capital since that could lead to the economic dominance of the economy by one city, in the same way as has happened in the UK as a whole. Given the distribution of the Scottish economy a networked approach is more appropriate than a ‘hub and spokes’ centralisation of activity. It is not the role of Scotland Means Business: The Strategy to identify individual projects. Indeed, the recommended approach to infrastructure planning is that it should be driven by the priorities set out in the economic strategy. This has not always been the case for transport planning in Scotland. For example, the Scottish railway franchise has only recently had tourism issues added as one of the requirements of the bidding process. An example of how infrastructure can support economic strategy can be found in the North East of Scotland. Aberdeen City and Shire Economic Future has developed the Energetica project, which builds on the existing energy related assets in the 30-mile Aberdeen to Peterhead coastal region (such as Peterhead Port, Peterhead Power Station and proposed carbon capture and storage demonstrator, Aberdeen Science and Energy Parks, Aberdeen Harbour and the proposed European Offshore Wind Deployment Centre). The area’s transport connections will be considerably improved by the Aberdeen Western Peripheral Route; however, the improvement of roads infrastructure in the Energetica corridor itself would remove potential constraints on the delivery of this ambitious project.

Scotland Means Business: The Strategy

6.6

Funding Model for Infrastructure The Scottish Government’s Infrastructure Investment Plan shows capital investment of between £2.1 billion and £2.7 billion per year over the period to 2029-30. However, this compares with more than £3.5 billion in 2007-08 and more than £4.0 billion in 2009-10 and includes social infrastructure (health, schools, further and higher education, culture, housing, regeneration, justice and sport) as well as economic infrastructure (transport, digital, energy, water and environment). As discussed above, CECA recommends that investment in (economic) infrastructure should be maintained at least at 0.8% of GDP (i.e. £1.2 billion in Scotland) and there may be a case for substantially higher levels of investment over the next 5-10 years to address historic under-investment in infrastructure. It seems unlikely that this will be possible under current capital budgets. However, investment in infrastructure need not be entirely funded from public sector sources. By definition, the benefits of infrastructure are long term and so there is merit in also spreading costs out over time. There may be opportunities to fund infrastructure privately, particularly more ambitious projects, which have the potential to generate revenue income. There are many examples of such a model around the world; these include the Panama Canal, funded by Citibank. One potential model would be Scottish Infrastructure Bonds, which could be offered to international bond markets and as domestic savings products. The long-term nature of infrastructure projects is a good fit with the increasing need for long term savings products that will increasingly be required as the ageing population structure increases the need to save to fund pensions. There are several international examples of combining the need for infrastructure investment with domestic savings systems. One example is Singapore’s Central Provident Fund model, originally a plan for funding pensions but subsequently expanded to fund education, health and housing. Employers (13%) and employees (20%) are required to contribute a proportion of wages to the Fund, which then invests in government bonds. The government uses these bonds to finance infrastructure (as well as investing in government owned businesses). The feasibility of such a model for Scotland should be examined, since it has the potential to both address the need for pension and saving reforms and expansion and the need to invest in infrastructure to facilitate acceleration of economic growth. The model may require taxation treatment that promotes the long-term savings that would be required to encourage take-up.

Scotland Means Business: The Strategy

RENEWABLE ENERGY Key Findings • Scotland could be characterised as an energy extraction economy, with the historic importance of coal, the oil and gas sector and the increasing importance of renewable energy. • The development of renewable energy has widespread public support, despite the impression that some newspapers might give. • The development of renewable energy in Scotland to date has been mostly in the hydro and onshore wind sectors. • However, greater economic opportunity could be in the new generation of technologies, including wave and tidal power (marine renewables). Scotland has the natural resources required to develop these sectors as well as political support, a leading academic research base and growing technology companies. • The Danish wind turbine sector has grown from a small sector serving a niche domestic market into an industry with a turnover of £9 billion in 2012, of which almost 2/3rd was export. • The Danish wind turbine case study demonstrates a wide range of circumstances and policies are needed for the development of a new sector. • For marine energy (and possibly other energy technologies in the future), many of the requirements are already in place in Scotland. These include the natural resources, political support, the academic research base, an innovation culture and a group of growing technology companies. • However, not all of the elements required to fully commercialise the sector are currently available. Significant investment is required, perhaps in the order of £250 million over the next few years, to realise the potential. The involvement of large scale engineering expertise, which exists in Scotland, is also required. • Given the scale of the opportunity, consideration should be given to setting up a New Technology Energy Extraction Fund, which would focus on funding commercialisation of energy technologies using public funding to lever in private investment. This approach could also be used to help attract engineering companies into the sector. • While public spending may be required to accelerate the growth of this sector, this might be considered to be investment rather than spending since a return will be expected, both economic and financial. • The additional benefit of investing in the renewable energy sector is that there can be two long term returns to the economy: the development of an exporting technology based sector and, in the longer term, competitive energy prices, compared to economies more reliant on fossil fuels. • The final element required for success is to ensure that energy policy is consistent with the overall new economic strategy. One practical way to achieve this would be to introduce economic development considerations as part of energy policy, alongside price, security of supply and environmental issues.

Scotland Means Business: The Strategy

7.1

Energy Extraction Economy Scotland might be characterised as an energy extraction economy. The coal industry was an important part of the Scottish economy for generations and the offshore oil and gas sector has been important to the domestic economy as well as providing a basis for global growth in the oil services sector. Scotland has also been a pioneer in renewable energy, hydro power in the middle of the 20th Century and wind power more recently. Scotland has the potential to become a pioneer in emerging energy technologies, based on an endowment of natural resources, provided that the appropriate innovation and commercialisation environment is put in place to develop energy generation companies of scale. Scotland has 1% of the EU’s population but has 25% of the EU’s wind and tidal power resources and 10% of wave power resources27. When the renewable energy sector in Scotland is covered in the press it is often in the context of opposition to individual wind farm developments, with several national newspapers taking a position against the onshore wind energy sector. However, the level of public support for renewable energy sector is in fact very high. The UK Government’s Department of Energy and Climate Change (DECC) tracks public attitudes to energy issues and policies on a quarterly basis. The findings of the last survey, undertaken in December 201328 included that: •

77% supported the use of renewable energy (including wind power, solar energy and biomass) for providing our electricity, with just 4% opposed;

•

71% agreed that renewable energy industries and developments provide economic benefits to the UK, with just 7% disagreeing; and

•

56% would be happy to have a large scale renewable energy development in their area, compared with 21% who would not.

Scotland has led the UK in renewable energy generation, initially with hydro power in the 1950s and 1960s and more recently in onshore wind. As a result, Scotland accounts for more than a per capita share of Renewable Energy Certificates (ROCs), the mechanism that is used to support the renewable energy sector. In 2013-14 there were 48.1 million ROCs granted to electricity producers in the UK, valued at £42.02 per ROC, so around £2 billion in total. Of these 12.8 million were awarded for electricity produced in Scotland, 26.6% (with a value of £536 million). Onshore wind energy in Scotland accounts for 67.5% of the total Scottish ROCs (£362 million). The largest category of ROCs by country is offshore wind in England, which generated 17.5 million ROCs (£735 million). While the support for renewable energy (which is reflected in consumer bills rather than in taxation) has been an issue that has been the subject of much political debate in the UK, leading to considerable uncertainty in the sector. However, the value of the support is modest compared with that provided elsewhere in the energy sector. For example, it has been estimated29 that the ‘contract for difference’ agreement that the UK Government has reached on the Hinkley Point nuclear power station will be worth £800 million a year, over 35 years, a total of £28 billion. 27

Scottish Government research on marine renewables accessed on 14/06/13 http://www.scotland.gov.uk/Topics/marine/marineenergy 28 Department of Energy and Climate Change (4 February 2014), Public attitudes tracking survey: wave 8, December 2013 29 CF Partners (October 2013)

Scotland Means Business: The Strategy

While onshore wind can continue to be an important contributor to the electricity generation mix in Scotland and deliver economic impacts in companies supplying the sector, the longer term economic opportunity may be in the next generation of technologies. Scotland currently has an international reputation for being supportive of the development of renewable energy. Part of this is due to the target set for the equivalent of 100% of electricity used in Scotland to come from renewable sources by 2020 (this does not imply that all electricity generated will be from renewable resources; there will still be non-renewable electricity generation since Scotland exports a considerable amount of electricity to the rest of the UK). The combination of the natural resources and this reputation creates an opportunity for new energy technologies. The technologies current under development in Scotland include wave power energy generation, although others may emerge.

7.2

Scale of Opportunity Recent analysis by the Fraser of Allander Institute shows that offshore renewable energy can have significant economic multiplier effects i.e. that the value to the economy is significantly higher than the direct investment in the sector. It has been estimated that the UK economy could gain ÂŁ6.7 billion per year and 150,000 jobs by 2020 from the development of offshore renewable energy resources 30. Scotland might expect a significant proportion of the impact to be centred around the existing energy cluster in Glasgow and the ports that will service the offshore installations. The Carbon Trust31 has estimated that marine energy has the potential to provide up to 20% of the UKâ&#x20AC;&#x2122;s electricity demand, with around half that level realistic by 2050. Job creation associated with design and manufacturing of equipment as well as deployment and servicing could be 26,000 in wave and tidal power. While the wave and tidal energy industry is still in its infancy, it is already generating some economic impact. Scottish Renewables estimates that the sector is already supporting around 500 jobs in Scotland32. Facilities designed to support the development of the sector include the FloWave test tank in Edinburgh and the European Marine Energy Centre in Orkney, which provides a base for testing technology. However, the real economic opportunity comes from pioneering in energy technologies that have global markets. Even a small proportion of a global market that could be worth hundreds of billions would deliver significant economic impacts for Scotland. The potential benefits of the development of a new energy sector are best demonstrated by considering the example of the establishment and growth of the wind turbine sector in Denmark. The section below on the experience from Denmark has been prepared by DAMVAD. That is followed by a discussion of the lessons for Scotland, prepared by BiGGAR Economics.

Offshore Renewable Energy Catapult (March 2014), Generating Energy and Prosperity: Economic Impact Study of the offshore renewable energy industry in the UK 31 Carbon Trust (July 2012), Marine Energy Briefing 32 Scottish Renewables (2012), Creating an Industry

Scotland Means Business: The Strategy

7.3

Case Study: Wind Turbine Sector in Denmark The Danish wind turbine industry is today a well-known global business. It has developed from small-scale production to an important export industry in about 40 years. Developers, producers, buyers, stakeholders and policymakers have worked together to make the sector succeed. The wind turbine industry is the largest industry within renewables in Denmark today, with a turnover of DKK 81.1 billion (£9.0 billion) in 2012, of which almost 2/3 was export (DKK 51.9 billion, £5.8 billion). The sector employs 28,500 people full time. Danish wind companies are also present internationally, and in 2012, Vestas and Siemens Wind Power were numbers one and three respectively in the global market for wind turbines. This means that the largest share of their market is outside Denmark; in 2012, Vestas sales in Denmark accounted for 1 per cent of their total sale, for Siemens Wind Power it was 3 per cent of their total sale. The Danish wind turbine sector started developing in the 1970s in the wake of the oil crisis and the sudden focus on being independent of oil imports. Until the early 1980s the majority of wind turbines were small and connected to their own electrical installations and consumers saved money on electricity and electricity taxes. As turbines grew larger, they had to be connected to the public grid. This required a system to take care of the cost (and benefits) imposed by the grid, and different support schedules developed. Even early in the process, the Danish wind turbine producers combined their production for both domestic and international markets and already in the 1980s export took place, primarily to US (California). During the 1990s the wind turbine sector grew in size, becoming more professional and commercial and during the last decades, the number of countries involved in wind turbine production has increased enormously. This is partly due to the increasing focus on being independent of imported oil, but also the increasing international focus on sustainable development and renewable energy has played a role. Wind is among the most advanced of the new renewable technologies, especially relevant to Denmark due to the meteorological conditions, with relatively few hours of sun compared to the hours with good wind conditions. The Danish focus today is on introducing all forms of renewable energy into the energy systems; solar, thermal, bio and wind. With a long-term goal of being independent of fossil fuels, it is important to ensure there are incentives for developing – and applying – renewable energy in the energy system. Today, the installed wind power capacity in Denmark has reached approximately 4,700 MW, including offshore (2013), and wind power now covers almost 30 per cent of Danish electricity use. A Danish political energy agreement points the direction for 2020, with the aim to reach 50 per cent of electricity consumption to be covered by wind. The agreement has support from both government and opposition, as well as the business sector, NGOs and civil society, making it relatively safe for business to act on the agreement. The support scheme is also set up to provide sufficient incentives to reach this goal. This will also support the continuing development of Denmark as a laboratory for developing new and better wind turbines.

Scotland Means Business: The Strategy

7.3.1

The Economic case Wind is one of the most advanced of renewable energy technologies. This is especially true of onshore wind, while offshore wind develops rapidly, it is still unable to compete with conventional energy. The two leading Danish wind turbine developers are among the most important players in the global market. Vestas and Siemens Wind Power were numbers one and three respectively in the global wind turbine market in 2012; together, they accounted for 25 per cent of installed wind globally. This has been achieved despite the modest size of the Danish market because the right conditions are available: support for research and development, test sites, access to skilled labour and a large number of skilled subcontractors.

7.3.1.1 Key figures The Danish wind industry had a turnover of DKK 81.1 billion (ÂŁ9 billion) in 2012, of which almost two thirds was exported. The sector employs approximately 28,500 people full time, including a large number of engineers and highly skilled personnel. Figure 7.1 - Relative development in employment, export and turnover (index 2006=100)

Source: DAMVAD for Danish Wind Industry Association, 2014

As with other sectors, the wind turbine industry was heavily influenced by the financial crisis, with impacts on turnover, exports and employment. But even during the crisis, exports continued to develop more positively than turnover and employment in the sector. The employment today is 3 per cent above the 2006 level while turnover is 16 per cent above and exports have actually increased 35 per cent compared to 2006. Despite the growth compared to 2006, turnover continues to be below turnover in the best years. Export of wind technology has generally performed better than total exports, though in 2012 the relative export of wind has been below total exports. In 2012 the wind power sector accounted for 4.2 per cent of total Danish exports.

Scotland Means Business: The Strategy

Figure 7.2 - Development of Danish export and wind export, 2006-13

Source: DAMVAD for Danish Wind Industry Association, 2014

Over the entire period, exports decreased because of the financial crisis. The wind industry's exports decreased by 18 per cent from 2008 to 2010, from just under DKK 61 billion in 2008 to just over DKK 50 billion in 2010. However, exports in 2012 are still higher than in 2007. The largest Danish wind turbine developer, Vestas A/S is also a large international player. When looking at the development in stock prices, it shows a rather unstable trend. Figure 7.3 - Vestas stock 2000-2013 (DKK) 800! 700! 600! 500! 400! 300! 200! 100! 0!

Source: Nasdaq OMX Note: closing price

The large Danish wind turbine developers have also used the crisis to streamline their production line which has resulted, for example, in layoffs. This can also be seen in Vestas stock price, where the current trends indicate higher confidence in the company.

7.3.1.2 Capacity development The development in installed MW in Denmark has been on the rise since the early 1980s, despite some years in the beginning of 2000s where no new capacity was installed. Over the years, turbines have become larger and more effective, and fewer turbines will have to be installed to reach the same MW when the oldest Scotland Means Business: The Strategy

turbines are being replaced. Still, to make the companies able to develop, test and adjust turbines, a continuing focus and availability of test facilities and market introductions are of great importance to companies. Figure 7.4 - Installed capacity and number of turbines in DK

7,000

6,000

5,000

4,000

4,000 3,000 3,000 2,000

2,000

1,000

Number of turbines

2012

2007

2002

1997

1992

1987

1982

1977

1,000

Installed capacity (MW)

Source: Danish Energy Agency

With the national goal to have 50 per cent of electricity consumption covered by wind in 2020, the development will continue in this direction the coming years, as will the domestic support required. The national policy direction thus supports the Danish status as a test lab with wind as a major focus. 7.3.2

The policy case

7.3.2.1 Current policy Wind and other renewables enjoy great support across political parties. All but one party supported the latest political agreement on energy from 2012. This makes the longer-term framework for the renewable sector – and especially wind – more stable. The agreement includes a target of 50 per cent of wind power in electricity use by 2020, 100 per cent renewables in electricity and heat in 2035 and towards 100 per cent renewable energy in 2050. While the longer term targets can be interpreted as intention, the framework targets for 2020 are perceived as rather stable. There is substantial confidence in the wind sector that they can deliver against these targets – and at the right cost. With a target of 100 per cent renewables in 2050, it is the expectation that it is able to compete on market terms. Within the policies regulating and supporting the Danish wind turbine industry, there is a focus on developing the turbines (from research to market entry) and on stimulating proper demand.

7.3.2.2 From research to market In the initial phases, research, development and demonstration are supported by various support schemes and programmes and test facilities are available e.g. a newly established test centre Østerild, where large proto type wind turbines (up to Scotland Means Business: The Strategy

250 m) can be tested and tried with the aim of developing new and better turbines. To ensure a continuous development in the wind turbine industry, substantial resources must be allocated to research, development, demonstration and testing of new products. Support is important, even early in the research phase. Funds for wind power research in Denmark come from a number of foundations. The total funding for wind power research between 2004 and 2009 are displayed in Figure 8-5. Figure 7.5 - Funds for wind power research (DKK mil., annual prices)

Amount

2004

2005

2006

2007

2008

2009

137

Source: Danish Energy Agency Note: EUDP, ForskEL, the Danish council for Strategic Research, Danish National Advanced Technology Foundation

A development like this can only take place successfully if partnerships across knowledge institutions, business communities and other organisations are established. There are many steps on the way to market and many areas where policy can assist development. Throughout the process, the entire value chain needs to be present, in order to develop new techniques or improve existing, with access to all kinds of production facilities. Figure 7.6 - Innovation chain for climate-related technology

Source: Danish Business Strategy on Climate Change, Danish Government 2009

7.3.2.3 Regulation Areas of regulation in the Danish wind turbine sector include taxes and charges and direct measures, such as targets for installed wind capacity that stimulate the demand. It has proved necessary to provide support for new technology in the initial phases to secure demand. At first, support was given in the form of capital installation subsidies, but in the mid 1980s it switched to funding for electricity production to set proper incentives. In 2001 support for wind power was converted into a price supplement, a Public Service Obligation (PSO), which is paid by all electricity consumers and administered by the transmission system operator (TSO). Scotland Means Business: The Strategy

With the PSO, the manufacturers of environmentally friendly energy are guaranteed a fixed price for electricity, when the TSO pays a subsidy â&#x20AC;&#x201C; price supplement - in the form of the difference between the current market price for electricity on the Nordic power exchange Nord Pool and the price set by the law. During periods of high electricity prices the PSO tariff is low because it is expected that environmentally friendly electricity only needs a small grant to be profitable when electricity prices are high. Conversely, a high PSO tariff is charged during periods of low electricity prices, as environmentally friendly electricity during those periods needs a larger subsidy to be profitable. The exact price supplement for onshore wind turbines depends on the point in time when the turbine is connected to the grid and how old it is. Until 2013, a wind turbine received a price supplement of DKK 0.25/kWh for 22,000 peak load hours, then production will be sold at the market price. There is however also a small allowance of DKK 0.023 for balancing cost in the entire lifetime of the turbine. This allowance is still granted from 2014, but the price supplement of DKK 0.25/kWh is only for the sum of 6,600 peak load hours and electricity production on 5.6 MWh/m2 rotor area. Also, the price settlement will be reduced when the market price of electricity exceeds DKK 0.33. This is a step towards having wind energy on commercial terms â&#x20AC;&#x201C; but without changing the business case for already installed turbines. Offshore wind is different, and the price supplement is a part of the call for tenders. There is no pre-defined price supplement.

7.3.2.4 Challenges Regulation can foster continuous development of new technologies, but regulation should also allow space for innovation. If regulation is introduced too quickly, there is a risk that companies or industries close down instead of deliver the desired output. Thus, it is necessary for authorities and policy makers to work in close collaboration with businesses, which have the deep knowledge of the ideas and innovative possibilities the sector offers. There has to be a match between regulation and technological feasibility and realistic deployment of renewables. The phasing out of support for onshore wind is getting closer, not least to allocate the necessary funds to support offshore wind, which is extremely expensive. This has also been recognised by the wind industry in Denmark. Despite long-term continuous research, there is still massive potential for cost reductions through market development and R&D for wind energy before a full potential for large-scale supply of electricity is reached. The support schemes must develop to continue to support the sector but at the same time make sure that mature technologies also enter the market. 7.3.3

Conclusion The Danish wind turbine industry has developed from a small niche area with pioneers and ecologists to be a strong and important commercial sector. Through support and partnerships from the research level to the early introduction to market, the sector has grown to be an important part of Danish export industry and in 2012 accounted for 4.2 per cent of total Danish exports. The largest Danish wind turbine developers are also among the worldâ&#x20AC;&#x2122;s largest. The industry has managed to survive the financial crisis and is back on a positive development path. There is continued domestic support to develop the sector Scotland Means Business: The Strategy

further, and test facilities for larger turbines are becoming available in order to maintain Denmark a leading â&#x20AC;&#x153;test labâ&#x20AC;? for wind turbines. The framework conditions for wind turbine development, demonstration, test and commercialisation has proved useful in order for a small country like Denmark to maintain the international companiesâ&#x20AC;&#x2122; research and development departments on Danish soil.

7.4

Development of a Scottish Renewable Energy Sector: Lessons from Denmark Scotland has taken a lead in the development of a wave and tidal industry. In the tidal industry several of the key players have been acquired by major OEMs such as Siemens, Alstom and the French industrial giant DCNS. This is a measure of success for the tidal industry but the lack of involvement of Scottish companies in the tidal industry could be viewed as a failure. Scottish innovation has become German and French technology. There is still potential for economic impact for Scotland in the supply chain and from inward investment from the major multinationals now in the sector. The wave industry is at a different stage; still dominated by small businesses, with significant investment and the involvement of large scale private investment and engineering still required for the technologies to be fully commercialised products. The involvement of major Scottish engineering companies is essential for this industry to develop and to achieve export potential There are lots of parallels between the Scottish tidal and wave sector now and the early stages of the Danish wind industry experience. The Danish wind industry is an example of how an industry can grow from a small domestic market into a global business, with the right policy support. There are also historic lessons since Scotland had many of the same opportunities in wind energy as Denmark but did not pursue them in the 1970s. The lessons that can be learned from the Danish experience are summarised in the table below.

Scotland Means Business: The Strategy

Denmark (Wind)

Scotland (Wave)

“The two leading Danish wind turbine developers are also some of the most important players in the global market. Vestas and Siemens Wind Power was no. 1 and 3 on the global wind turbine market in 2012, together, they accounted for 25 per cent of installed wind globally. When this is possible despite the modest size of the Danish market it is because the right facilities are offered: support to research and development, test sites, access to skilled labour and a large number of equally skilled subcontractors.”

The UK had a similar support environment (to Denmark) for wind technology during the early days of the industry This was lost due the faltering nature of the support, the discovery of North Sea oil and the lack of a support mechanism to deploy wind in the domestic market Scotland has a head start in the development of both wave and tidal technologies Scotland accounts for 25% of Europe’s wave resource The challenge of developing new energy technologies is great – Scotland has invested in the research and now must continue to support the technology on its pathway to commercialisation The technology will become a reality – now is the time for private investors to be encouraged and the great tradition of Scottish engineering to be brought to bear on the challenge

“There are many steps on the way to market, and thus also many areas where policy can assist the development, and maybe also steps that are already almost working on market terms. Throughout the process, the entire value chain needs to be present, in order to develop new techniques or improve existing, you need to have access to all kinds of production facilities. This secures jobs in a large range of different companies.”

Scotland has several small independent companies involved in the development of the wave industry

“Regulation in the Danish wind turbine sector includes taxes and charges, and direct measures like targets for installed wind capacity that stimulate the demand. It has proved necessary to provide support for the new technology in the initial phases on the commercial market to secure demand. At first, support was given in the form of capital installation subsidies, but in the mid 80’s it switched to funding for electricity production to set proper incentives. In 2001 support for wind power was converted into a price supplement, a Public Service Obligation (PSO), which is paid by all electricity consumers and administered by the transmission system operator (TSO).”

Scotland has the market pull mechanisms in place with a healthy ROC regime – an incentive for energy production

Scotland Means Business: The Strategy

There is good academic support for the wave industry in Scotland The supply chain is not yet interested in the wave industry as it is focused on short-term profitability There is a need to bring focus and support to assist the supply chain to get engaged in this challenge for the industry and for Scotland

The industry in Scotland is stalled in terms of funds to support the technology development A programme to investment is required

encourage

private

7.5

Denmark (Wind)

Scotland (Wave)

“Despite long-term continuous research, there is still massive potential for cost reductions through market development and R&D for wind energy before a full potential for large-scale supply of electricity is reached. The support scheme must develop to continue to support the sector but at the same time makes sure that mature technologies also enter the market.”

We are at an early stage of the wave industry

“The Danish wind turbine industry has developed from a small niche area with pioneers and ecologists to be a strong and important commercial sector. Through support and partnerships from the research level to the early introduction to market, the sector has grown to be an important part of Danish export industry and in 2012 covered 4.2 per cent of total Danish exports, and the largest Danish wind turbine developers are also among the world’s largest.”

Scotland has the beginning of a new industry

There is political support, there is academic support, there is a culture of innovation There is a lack of willing investors in Scotland at this time – this is something has must change for the industry in Scotland to flourish

Policy Priorities for New Energy Technologies The Danish wind turbine case study demonstrates a wide range of circumstances and policies are needed to contribute to the development of a new sector. For marine energy (and possibly also other energy technologies in the future), many of the requirements are already in place in Scotland. These include the natural resources, political support, the academic research base, an innovation culture and a group of growing technology companies. However, not all of the elements required to fully commercialise the sector are currently available. Significant investment is required, perhaps in the order of £250 million, over the next few years to realise the potential. To put this in some context, in terms of investment in renewables elsewhere, the China Development Bank invested £28 billion in 15 Chinese solar photovoltaic manufacturers in 2010, which was used to cut the costs of production and establish a dominant market position, in a technology that was already well developed with products in the market for some years. The involvement of large scale engineering expertise, which exists in Scotland, is also required. The assumption in Scotland and the UK is that, at this stage in an industry’s development, it is the role of the private sector to commercialise technology once the concepts have been proven. However, as the Danish wind turbine case study makes clear, a partnership between public and private sectors is required. This has been the case even in the US, where the role of government is often thought of as more limited than in Europe, with significant public sector investment in developing new technologies, through both defence and health research and Scotland Means Business: The Strategy

commercialisation funding. This approach is discussed further in Chapter 11 of this report. Given the scale of the opportunity, consideration should be given to setting up a New Technology Energy Extraction Fund, which would focus on funding commercialisation of energy technologies (rather than R&D funding for which a number of funding schemes are already available), using public funding to lever in private investment. This approach could also be used to help attract engineering companies into the sector to work with the technology developers, for example, by making collaboration a requirement of access to funding. While public spending may be required to accelerate the growth of this sector, this might be considered to be investment rather than spending since a return will be expected, both economic and financial. The additional benefit of investing in the renewable energy sector is that there can be two long term returns to the economy. The first is the development of an exporting technology based sector and the employment that it can support. The second is the contribution to the energy mix. Marine renewables is not currently cost competitive with other forms of generation and this is what the investment is required to address. The sector needs to be cost competitive to succeed and so investment now may lead to relatively inexpensive electricity in the future (compared with economies more reliant on fossil fuels). The final element required for success is to ensure that energy policy is consistent with the overall new economic strategy. One practical way to achieve this would be to introduce economic development considerations as part of energy policy, alongside price, security of supply and environmental issues.

Scotland Means Business: The Strategy

GROWTH SECTOR NICHES Key Findings • There are a number of sectors where Scotland has an opportunity to exploit or establish comparative advantage and these fit well with global growth sectors. Long term trends have seen increased demand for healthcare and education, increased spending on leisure and luxury products and increased demand for energy. • The new economic strategy for Scotland should be based on a balanced portfolio of sectors including both those sectors in which Scotland is already strong (from which modest growth might be expected) and more speculative high risk, high reward sectors (where more significant growth might be possible). • Tourism is a sector than is often undervalued but can be both a high value added sector (as advanced economies such as Switzerland, Denmark and Austria have shown) and a source of growth. Policy issues include the further development of the Scottish brand, more emphasis on sales skills and tax treatment (including VAT and air passenger duty) that is impacting on Scotland’s price competitiveness. • The food and drink sector also has growth potential based on exports, following the successful examples of whisky and, more recently, salmon. The main opportunities will be in premium products but this will require integration of the food and drink strategy with the approach to support of agriculture. • Universities and schools can continue to grow their competitiveness in the international education market, based on the reputation of Scottish education. Universities also have an important role to play in attracting mobile international research and development investment. • Life sciences provides an example of a technology based sector that has done well in academic research, including attracting private sector research income. However, while there have been notable successes, companies of scale founded in Scotland have seen headquarters move to other countries as growth capital has encouraged trade sales. A new approach to funding high-growth technology companies will be required to grow and retain global companies in Scotland. • The delay in implementation of the new research and development tax credits for the computer games industry demonstrates the need for a corporative approach to policy making. Other opportunities in the creative industries include growth in radio and television if the BBC was compelled to invest licence fee income from Scotland in Scotland. • There are also opportunities to build new sectors of the economy, to deal with public policy challenges; these include the potential development of a crosssector healthy ageing cluster and a transport cluster, serving global as well as Scottish markets. A new cross-sector cluster group should be established to bring public sector, businesses and universities together to identify and pursue business opportunities associated with an ageing population structure. • Professional and business services could benefit from the development of an inward investment proposition to attract European and functional headquarters of the high growth companies from emerging regions. • Financial services: support for the financial services sector where long term growth opportunities exist, including the global growth markets for fund management. Measures include consistent regulatory and fiscal regimes, Scotland Means Business: The Strategy

supporting innovation and skills development; • Energy: building on the recommendations of the Wood Review, a range policy measures in support of the oil and gas sector, including exploration incentives, ensuring fiscal stability, stimulating R&D and investment, incentives for the relocation of corporate headquarters to Scotland, education and skills initiatives and development of the Scottish engineering brand. There are a number of sectors where Scotland has an opportunity to exploit or establish comparative advantage and these fit well with global growth sectors. Long term trends have seen increased demand for healthcare and education, increased spending on leisure and luxury products and increased demand for energy. While Scotland cannot expect to establish a dominant position in global markets, even niches in these markets can deliver substantial financial and economic returns. This Scotland Means Business: The Strategy report has examined three sectors where there are significant opportunities for Scotland: financial services, oil and gas and renewable energy. However, there are several other opportunities in other sectors with export growth potential. Each would benefit from more in-depth work; however, some of the opportunities and issues for other growth sectors are discussed in this section. As in business, a sensible economic strategy for a country focuses resources on the best opportunities. However, care must be taken to avoid a strategy that focuses on too few opportunities, since forecasting long term global economic trends is very difficult. The new economic strategy for Scotland should be based on a balanced portfolio of sectors including those sectors in which Scotland is already strong (from which modest growth might be expected) and more speculative high risk, high reward sectors (where more significant growth might be possible).

8.1

Tourism According to Scottish Government statistics33, tourism related businesses in Scotland had a turnover of £6.2 billion in 2011, contributing £3.1 billion gross value added (GVA) to the Scottish economy, supporting 181,500 jobs and earning £1.2 billion in exports (including spending by visitors from the rest of the UK as well as international visitors). However, analysis by Deloitte and Oxford Economics for VisitBritain34, suggests that official statistics may be underestimating the economic contribution of the tourism sector in the UK. It estimates that tourism spending in Scotland was £10.9 billion in 2013 (with 18% from international tourism), providing direct GVA of £5.4 billion. The sector supported 167,000 jobs directly, or 354,000 if supplier and income multiplier effects are also included, more than 13% of total Scottish employment. It could be argued that the contribution of tourism to the Scottish economy has been undervalued in a wider sense. There is often an assumption that the tourism sector supports relatively low value service sector jobs. However, the growth of

Scottish Government (April 2014), Growth Sector Statistics Database Deloitte & Oxford Economics (November 2013), Tourism: Jobs and Growth The Economic Contribution of the Tourism Economy in the UK 34

Scotland Means Business: The Strategy

high value tourism in wealthy economies, notably Switzerland, Denmark and Austria, has shown that tourism can make an important economic contribution. These tourism destinations have focused on improving the quality of service and value the contribution of tourism to the economy. This has included raising the social status of tourism-related professions, as long has been the case in, for example, Italy and France. The Deloitte research has forecast real growth (over and above inflation) of 6.1% per annum in international tourism to the UK, with 3% growth in tourism from domestic sources, but growth in outbound tourism of just 1.5%. On this basis, the tourism sector can be the source of significant real growth in GDP and in employment over the next decade. The national tourism organisation, VisitScotland, has worked on understanding perceptions of Scotland and building a national brand (as discussed in Chapter 5). The development of the national brand, building on these foundations, can support the global growth of other sectors. The growth of the tourism sector also creates wider opportunities for sectors such as food and drink, textiles and creative industries, if these sectors use the opportunity to market to visitors while they are in Scotland (who may then become export customers when they return home). There may be a case for VisitScotland to be part of the economic development network that supports other sectors, to facilitate more cross-sector initiatives. The role of the sales function is another feature of successful high value tourism destinations from which Scotland might learn. If service staff were trained to sell to existing visitors, tourism expenditure could be increased significantly even without attracting additional visitors. Sales should be integrated into training for all tourism related staff. If tourism is to achieve its growth potential, there will be a need to look at its taxation treatment, in particular VAT and air passenger duty, both of which place Scotland at a competitive advantage when compared to competitor destinations. Tourism is the only export sector where VAT is payable. However, many other EU countries have reduced the rate of VAT on visitor accommodation (the UK is one of only four of the 28 EU countries that applies the full VAT rate), visitor attractions and restaurant meals. Air passenger duty (APD) also puts Scottish tourism at a price disadvantage compared with destinations without such a tax. Given that most international tourists arriving in Scotland travel via London airports, Scotland is at a particular disadvantage since APD is paid on international flights into and out of London and on flights between London and Scottish airports.

8.2

Food and Drink The Scottish food and drink sector has a turnover of £13.1 billion, contributes £5.5 billion in gross value added to the Scottish economy and has 118,000 employees35. Its exports have grown by 50% in a decade, to around £5 billion and the sector has targeted growth of another £2 billion by 201736.

Scottish Government (April 2014), Growth Sector Statistics Database Scotland Food & Drink (March 2014), Tomorrow the world: An export plan for Scotland’s food and drink industry 36

Scotland Means Business: The Strategy

The food and drink sector consists of more than 17,000 businesses, 40% of whom have less than 50 employees. With a sector dominated by small and medium sized businesses, there is merit in working on a common strategy to boost exports. An industry partnership, made up of public and private sector organisations has developed a strategy that targets 15 markets, with an initial focus on seven, to present the best opportunity to strengthen an existing presence or gain new footholds in: North America (USA & Canada); France; Germany; Middle East (UAE, Saudi Arabia & Bahrain); Mainland China; and Hong Kong, Japan and SE Asia (Singapore, Thailand). The export success story in the food and drink sector is whisky, which has been exporting now for 200 years and had export sales worth £4.3 billion in 201337. The success of the whisky industry is often taken for granted; however, the success was not inevitable, Irish whiskey exports in comparison are valued at less than a quarter of Scotch whisky exports. The development of the Scotch whisky ‘brand’ and of individual brands have been important, as has the development of sales and distribution channels. Other parts of the food and drink sector have also grown exports in recent years, notably the salmon sector. In 2013, exports to North America increased by almost a quarter to £200 million and exports to China almost doubled to £50 million. Both of these success stories are in relatively high valued added products. The costs of production of food and drink products and the scale of production mean that Scotland is unlikely to be in a position to compete, on price, in volume markets. For example, in the beef market, Brazil has more than 100 million beef cattle, compared with 400,000 in Scotland. However, in this market, as in many other food and drink markets, Scotland has a reputation for a quality, premium product, with further growth potential. The constraint in some aspects of the Scottish food and drink sector is the supply of products. In beef this is associated with the legacy of the foot and mouth outbreak in 2001 and the long term impact this has had on stock numbers. So growth in the Scotch beef sector requires co-ordination between the food and drink sector strategy and agricultural policy. If agricultural policy were to incentivise breeding, the parallel food and drink strategy would help to develop the export market for the premium Scotch beef product. The further growth in exports by the food and drink sector can be assisted by the development of a Scottish brand. The corporative approach to policy making recommended by N-56 can also work at an industry level (as the development of the export strategy for the food and drink sector has demonstrated) and also in pursuit of specific opportunities, where some co-ordination is required. This can be in areas of established strength, as has been the case in recent years in salmon. However, there may also be opportunities in new markets. For example, New Zealand has become the world’s leading dairy exporter, based on its reputation for high quality natural produce with exports including dried milk to China and elsewhere in Asia. This has required co-ordination to invest in strategic assets like drying plants and marketing of the high quality product, using New Zealand’s national brand. 37

Scotch Whisky Association (April 2014)

Scotland Means Business: The Strategy

8.3

Universities and Education The role of the Scottish education system in providing the skills required for the Scottish economy is discussed in Chapter 9. However, education can also be considered to be an economic sector in its own right. Scottish universities have a role in generating exports from teaching and research activities, both of which have further growth potential. Already, more than one in five university students in Scotland are from outside Scotland. This activity generates long term benefits as well as short term export earnings. As well as enhancing the experience of Scottish students, this helps attract some of the brightest young people to Scotland; some may stay and contribute directly to the Scottish economy and others will return home and become advocates for Scotland. The reputation of Scottish universities (as set out in Scotland Means Business: The Facts, with five in the world top 200, Scotland has more top universities per capita than any other country) and the use of English as the language of tuition in the international education market, means that Scottish universities have a competitive proposition for further growth. There may also be opportunities for Scottish independent schools to generate growth from the international education market, building on the reputation of Scottish education, teaching in English and preparing students for access to Scottish universities. Expansion of the independent schools’ international student numbers may also contribute to attracting families to Scotland, highly skilled individuals, including entrepreneurs. The universities also have a role in attracting inward investment, in the form of research funding from international companies. Scotland has been relatively successful in attracting inward investment. From the 1950s to the 1980s, the focus was on attracting large manufacturing plants, including in the electronics sector and by the 1980s, ‘Silicon Glen’ was producing around a third of Europe’s personal computers. In more recent times, the focus of inward investment agencies has been on attracting high value added jobs, including in research and development. While 10 or 20 years ago this would have meant research and development departments of companies, the recent trend in multinational companies across several sectors has been outsourcing of research and development to those considered to be global leaders in relevant fields. This means research funding of university research and collaborative research programmes. Scottish universities have been successful in identifying and pursuing these opportunities and as this trend continues, the good reputation of the Scottish sector means that there are further growth opportunities.

8.4

Life Sciences Life sciences is an example of a sector that has already been successful in attracting significant research funding into universities and research institutes. Companies in the Scottish life sciences sector have a combined turnover of £2 billion, contribute £1 billion in gross value added to the Scottish economy and have 16,000 employees38. However, activity in the universities and research institutes is probably the same again.

Scottish Government (April 2014), Growth Sector Statistics Database

Scotland Means Business: The Strategy

The sectorâ&#x20AC;&#x2122;s strategy for 202039 is to build on existing strengths in businesses and on investment in Scotland's research excellence to double its contribution to the Scottish economy. Life sciences is a global sector in terms of both decisions made on where to invest in research and development and in markets. Companies in the sector do not distinguish between domestic and global markets. Growth in the sector can come from growth in research income in the academic research base and also from company growth. Scotland has a well established reputation in medical and biological sciences. Research by the academic publisher Elsevier, commissioned by Scottish Enterprise40, has shown that outputs from the Scottish research base also compare well with international competitors, with Scotland ranked in the top three in the world for the productivity of its researchers, the impact of its researchers and the efficient use of resources. Life sciences provides an example of a technology based sector that has done well in academic research, including attracting private sector research income. However, while there have been notable successes, companies of scale founded in Scotland have seen headquarters move to other countries as growth capital has encouraged trade sales. A new approach to funding high-growth technology companies will be required to grow and retain global companies in Scotland. There have been significant corporate successes in the Scottish life sciences cluster. Inverness Medical Technology (now Lifescan Scotland), a pioneer in diabetes, was the subject of a $1.3 billion takeover by Johnston & Johnston in 2001 and Inveresk Research, a clinical trials organisation, was taken over by Charles River Laboratories in a $1.5 billion deal in 2004. Both companies remain significant employers in Scotland. However, headquarters functions are based elsewhere, and so their associated multiplier effects and corporate taxation revenues are less than they might otherwise have been. In a global market, there will always be circumstances where it is in the interests of shareholders for a particular Scottish company to be taken over at a particular time and, indeed, for Scottish headquartered companies to takeover companies based in other countries. However, there are currently few routes for business owners and initial investors to realise their investment in founding and growing technology companies, and so trade sales, usually to companies based in other countries, are the most common exit route. If such companies had access to other sources of long term capital it is likely that more high growth companies of scale could be retained in Scotland. The experience of other leading life science clusters is that one major success story can lead to the growth of a whole sector, if the successful company has been domestically funded (examples, include Cambridge Antibody Technology, the success of which has helped drive the Cambridge life sciences cluster). A single successful company helps generate positive feedback loops including attracting and retaining scientists and technology company managers and generating financial returns that are often re-invested in the sector. Building a life sciences company of scale may require long term investment in the hundreds of millions. However, the potential returns are also significant, with the 39

Scottish Life Sciences Strategy 2011: Creating Wealth, Promoting Health Elsevier for Scottish Enterprise (October 2013), How Scotland's life sciences research compares with other countries worldwide 40

Scotland Means Business: The Strategy

top biotech companies valued in the tens of billions. The issue of funding life sciences companies over the long term, to move from research and development to market is common across technology sectors; this stage of development is sometimes known as ‘the valley of death’. Long term funding for technology companies is discussed further in Chapter 9.

8.5

Creative Industries The creative industries turnover around £5 billion per annum, contribute £2.8 billion in gross value added and employ 65,200 people in Scotland41. There are growth opportunities in many parts of the creative industries sector. One of the highest profile parts of the creative industries sector is the computer games industry, which employs more than 1,000 people across Scotland, including the cluster based in Dundee42. A report by the Westminster Scottish Affairs Select Committee43 estimated the global market for computer games to be worth £33 billion per year, growing at more than 10% per annum. In 2009 the industry organisation, The Independent Games Developers Association (TIGA), made a case to the UK Government to introduce a research and development tax credit scheme. This was a response to the increased international competition from other locations that offered similar incentives to the industry, notably Canada, which grew from a minor player to overtake the UK in the global computer games market. Despite cross party support in advance of the UK general election in 2010, the tax credit scheme was not introduced in the 2010 budget, although it has recently been introduced. While the industry has welcomed the introduction of the tax credit, the three to four year delay in its introduction is likely to have had some impact on a sector where the market has grown by more than 10% per year. A corporative approach to policy making, as recommended by N-56 would create structures which could accelerate the introduction of policies that could help build competitive advantage in sectors where there is significant export opportunity. However, not all of the growth in the creative industries sector will be as a result of exports. One area of opportunity could be radio and television, which currently contributes £160 million in gross value added to the Scottish economy, supporting 3,200 jobs. This includes both publicly funded services (the BBC) and the independent broadcasting and production sectors. The BBC receives income from TV Licence fees of some £3.7 billion per annum as well as an additional £1.4 billion from commercial activities (including selling programmes overseas). If the BBC was required to spend a per capita share of its operating costs of £4.8 billion in Scotland, this would generate £400 million for the radio and television sector from the publicly funded services alone, generating thousands of jobs in the Scottish creative industries sector.

8.6

Healthy Ageing If Scotland’s ageing population structure is a subject of political or economic debate, it is generally framed in terms of the public policy challenges associated

Scottish Government (April 2014), Growth Sector Statistics Database Scottish Enterprise evidence to Scottish Affairs Select Committee, February 2011. 43 Scottish Affairs Select Committee (February 2011), Video games industry in Scotland, Second Report of Session 2010–11 42

Scotland Means Business: The Strategy

with funding pensions and care for a growing elderly population. However, while Scotland’s population may be ageing sooner than some other countries, an ageing population is an issue that will need to be addressed in every advanced economy. So products and services that are developed for an ageing population in Scotland will have a significant export market. A number of other regions have identified ‘healthy ageing’ as a sector with growth potential, including for example, the Northern Netherlands, which has a similar population profile projection to Scotland. Initiatives include the Healthy Ageing Network Northern Netherlands (HANNN), a knowledge and development initiative involving local and provincial government, international and indigenous companies, the University of Groningen and the University Medical Centre Groningen (UMCG) and the Healthy Ageing Campus, which allows companies to co-locate with UMCG. Health and social care will be part of the healthy ageing cluster. However, almost all sectors of the economy will be affected in some way and so there will be a wide range of opportunities. Realising these opportunities can also have wider economic benefits. For example, the introduction of compulsory superannuation in Australia in the early 1990s has helped to develop the financial sector in Australia, which is now competing globally, as well as providing one of the best pension systems in world. A corporative policy making approach can help to develop emerging sectors by identifying opportunities, such as that presented by healthy ageing, which both public and private sectors can pursue. Such a focus provides opportunities for the public sector to redirect public spending to find solutions to problems related to ageing, rather than symptoms. For example, investment in homes so that they can be equipped for independent living will deliver savings for health and social care budgets. The Reshaping Care for Older People initiative is already delivering changes to the allocation of public spending. If such an approach can be combined with an economic development focus on meeting the needs of older people in the home, new products and services could be developed, which become exportable. These could include building methods and construction products as well as a range of care related and communications products. The Changing Age for Business initiative in Newcastle has already demonstrated the variety of business opportunities that can emerge from considering ageing as a business opportunity rather than a social policy challenge. Outputs have included re-designed street furniture, a nutrition planning tool, a bed rail that can be retro fitted and new technology to assist with health and care decision making. A new cross-sector cluster group should be established to bring public sector, businesses and universities together to identify and pursue business opportunities associated with an ageing population structure. This group should focus on products and services in areas where export markets can be served.

8.7

Transport Transport is another area where business opportunities can arise from addressing public policy challenges. As discussed in Chapter 6, Scotland’s geographic position creates opportunities for hub air services and in serving new northern sea freight routes. The key to both is to examine the business opportunity of serving global markets, rather than to consider only meeting transport needs in Scotland. Scotland Means Business: The Strategy

Scotland is already home to Europeâ&#x20AC;&#x2122;s largest two transport companies and so already has foundations for further growth in the transport sector. Such growth must be based on more than providing transport services within Scotland. Technology will be increasingly important to the development of the transport sector, as is the case with most sectors of the economy. In the short term, key developments will be associated with increasing productivity, further developing yield management models pioneered initial by budget airlines and, more recently, in coach travel. Further growth will be based on innovation associated with the management and development of the customer relationship, providing transport customers with a range of different services.

8.8

Professional and Business Services The financial and business services sector in Scotland has a total of 215,800 employees. However, less than half of these employees are in the financial services sector. Professional and business services (legal, accounting, business advice, market research etc.) have almost 125,000 employees, a turnover of ÂŁ8.1 billion and contribute ÂŁ5.8 billion in gross value added to the Scottish economy44. The prospects for these business services will depend very much on the health of other sectors of the economy. The presence of headquarters functions, or at least regional or functional headquarters, is particularly important. Takeovers of Scottish companies have reduced the number of corporate headquarters in Scotland over the last 20-30 years. The new economic strategy for Scotland will seek to grow the number of indigenous companies of scale. There may also be new opportunities for the Scottish economy from inward investment from emerging global companies. Research by the McKinsey Global Institute45 predicts that more than 45% of Fortune 500 companies in 2025 will be from emerging regions. Many of these companies will need European headquarters and functional headquarters (e.g. for research and development). Scotland should develop a proposition to target these growing companies; the essential elements will include access to European markets, the highly skilled Scottish workforce, the quality of life that can be offered and the provision of the range of professional and business services required. These companies should be inward investment targets since it will be easier to attract new and dynamic companies than those already well established and rooted in their current locations. As well as the direct benefits of such investment, this would facilitate the growth of professional and business services.

8.9

Financial Services There is potential to create a Frankfurt of the North, by building on an already strong Scottish financial services sector. Policies would include support for the financial services sector where long term growth opportunities exist, including the global growth markets for fund management. Measures include consistent regulatory and fiscal regimes, fostering financial services innovation through research and development tax credits, improving intermediate skills through an Apprenticeship system and a

44 45

Scottish Government (April 2014), Growth Sector Statistics Database McKinsey Global Institute (October 2013), Urban world: The shifting global business landscape

Scotland Means Business: The Strategy

Financial Services Challenge Fund and an initiative to fund Scottish universities to examine how new technologies may radically alter the outlook for the financial services sector, and what can be done about it. A separate Scotland Means Business report considers the financial services opportunities in more detail.

8.10 Oil and Gas The oil and gas sector remains an important part of the Scottish economy and can continue to be a driver of economic growth. The policies that will be required building on the recommendations of the Wood Review and include a range of macro and micro policy measures in support of the oil and gas sector, including exploration incentives, ensuring fiscal stability and a fiscal regime suited to a mature basin, stimulating R&D (as has happened in Norway), stimulating additional investment, incentives for the relocation of corporate headquarters to Scotland, education and skills initiatives and development of the Scottish engineering brand. A separate Scotland Means Business report considers the oil and gas sector opportunities in more detail.

Scotland Means Business: The Strategy

HUMAN CAPITAL, INNOVATION AND ENTREPRENEURSHIP Key Findings • Export growth and productivity growth are strongly correlated and the balance of evidence suggests that productivity is the driver of export growth rather than the other way round. This means that measures to stimulate productivity growth, developing human capital, innovation and entrepreneurship, should be the focus of an export based growth strategy. • Scotland has an existing competitive advantage in human capital. For example, Scotland has one of the highest proportions of adults with tertiary level qualifications amongst the advanced economies. • Further investment and reform in Scottish education will be required to maintain this competitive advantage, given the investment and progress being made by competitors. The recommendations of the Reform Scotland and Centre for Public Policy joint-commission on education and of the Commission for Developing Scotland’s Young Workforce chaired by Sir Ian Wood, deserve serious consideration. • Scotland’s innovation system is unusual – amongst advanced economies it has one of the highest levels of investment in R&D in the university system and one of the lowest levels of business investment in R&D. • Scotland has a long history of invention and discovery. However, there have been few if any examples of generating significant commercial and economic returns from technological breakthroughs, by building companies of scale, based in Scotland. • There is an opportunity to invest in innovation now, particularly in green technologies, which can deliver economic growth and sustainable development for both the advanced and emerging economies. • Over the last 20 years, Scotland has been a pioneer in analysing the barriers to commercialisation and designing programmes to overcome them. Many other countries have followed the model developed in Scotland including university technology transfer offices and programmes to support early stage technology companies and greater interaction between businesses and the academic research base. • It is now time to build on these structures, with particular attention to what is required to build technology based companies of scale. Seed and early growth funding programmes are already in place. Longer term, patient funding of technology companies is required. • Securing investment may require direct investment by the public sector as well as leveraging in private sector investment. The public sector investment could be from state investment banks and sovereign funds, learning from the model that has been successful in Germany and Singapore. • Taxation tools, such as an allowance for corporate equity, could also provide a powerful incentive for equity funds to be based in Scotland and to invest in Scottish companies with growth potential. • Public policy should also support encouraging signs of recent increases in entrepreneurship, including simplified business taxation and encouragement for business led support networks.

Scotland Means Business: The Strategy

As discussed in Chapter 4, productivity growth (making more efficient use of natural and human resources and capital) is the driver of economic growth in advanced economies. Export growth and productivity growth are strongly correlated and the balance of evidence suggests that productivity is the driver of export growth rather than the other way round. Measures to stimulate productivity growth, developing human capital, innovation and entrepreneurship, should therefore be the focus of an export based growth strategy.

9.1

Human Capital Scotland has an existing competitive advantage in human capital. For example, as shown in Scotland Means Business: The Facts46: •

in per capita terms, Scotland has more universities in the top 200 (five) than any other country;

•

42% of adults in Scotland have tertiary level qualifications, as defined by the OECD, which would place Scotland 4th in the OECD (behind only Canada, Israel and Japan) and well ahead of the OECD average of 31%.

However, all advanced economies are investing in education and training to develop the human capital required for economic growth and so a failure to continue to invest would mean that Scotland would lose existing advantages. There have been significant changes in the Scottish education system in recent years, including the introduction of the Curriculum for Excellence in the school system, an expansion in higher education participation and structural reform in further education. The development of a new economic strategy for Scotland will need to consider the need for continued investment and reform in education. However, extensive analysis has been undertaken and recommendations made by others and so there is no need to repeat that analysis in this document. In school education a research report by the think tank Reform Scotland and the Centre for Public Policy47 in 2013 set out a range of recommendations to improve Scottish education. For school leavers, the Commission for Developing Scotland’s Young Workforce was established by the Scottish Government in January 2013, chaired by Sir Ian Wood, to bring forward a range of recommendations designed to improve young people’s transition into employment. The interim report of the Commission was published in September 201348 and the final recommendations are due to be published in 2014.

9.2

Innovation: Building Companies of Scale The research and development (R&D) system in Scotland differs from most other advanced economies. As set out in Scotland Means Business: The Facts:

For more details, see Chapter 17 of Scotland Means Business: The Facts CSPP and Reform Scotland (March 2013), By Diverse Means: Improving Scottish Education. 48 Commission for Developing Scotland’s Young Workforce (2013), Interim Report 47

Scotland Means Business: The Strategy

•

Business Enterprise R&D (BERD) expenditure in Scotland was 0.56% of Scottish GDP in 2011, which places Scotland in the fourth quartile of OECD countries, ahead of only the Slovak Republic and Poland;

•

Higher Education R&D (HERD) expenditure in Scotland was 0.77% of GDP in 2011, higher than any other region or nation of the UK and behind only Sweden and Denmark in the OECD; and so

•

total expenditure on R&D in Scotland was 1.56% of GDP, behind 1.79% for the UK and 1.94% for the EU but much higher than might be assumed if the BERD figures were considered out of context.

There is a long-running and widely held perception that Scotland is good at the process of discovery and invention but not so good at realising their commercial and economic benefits. Wikipedia has an extensive entry49 on Scottish inventions and discoveries and few of these have been commercialised in Scotland. Improving Scotland’s track record on commercialising scientific and technological breakthroughs to create companies of scale, based in Scotland, would have significant positive economic impacts. The interaction between government and business in innovation and entrepreneurship has been important in terms of historic economic performance and could be even more important in the future. This is an area that has often been ignored in policy making which focuses on creating conditions for growth that is limited to institutions, macroeconomic management and infrastructure. However, this is also an area where policy makers in several countries are currently examining and considering changes. Recent work by Professor Mariana Mazzucato50 (the RM Philips Chair in the Economics of Innovation at the University of Sussex) is increasingly being referenced by policy makers. Mazzucato’s research reviews some of the most significant technological breakthroughs, in pharmaceuticals to the internet and some prominent innovative companies, including Apple, and demonstrates how many of the risks taken in the commercialisation of the products, as well as in the research and development, were taken by public sector organisations. The global technology giants of today have developed and commercialised technology that emerged from publicly funded research programmes. However, they also received public investment in commercialisation and in their early growth phases. In the US companies such Apple, Compaq and Intel were supported with funding from the Small Business Innovation Research (SBIR) scheme. Indeed, Silicon Valley has benefitted from the vision of the public sector as well as targeted investment. Mazzucato argues that the role of the state is and should be beyond investing in infrastructure and demand to expand production when the private sector freezes in a downturn and that there is a role in promoting and funding high risk, high reward innovation. She identifies an opportunity for the public sector to invest in innovation in the green economy, as a route to recovery from the current economic crisis. The observation for the global economy is that emerging markets cannot follow the resource and energy intensive path of the past due to limited resources and the brake of global warming. The development of green technologies will therefore find market opportunities and can deliver both economic growth and sustainable development. However, such an approach will 49 50

http://en.wikipedia.org/wiki/Scottish_inventions_and_discoveries Mariana Mazzucato (2013), The Entrepreneurial State: Debunking Public vs. Private Sector Myths

Scotland Means Business: The Strategy

require both a long-term effort and policy consistency (which she argues has not been the case in the UK). This approach requires the public sector to take a more active role than in correcting market failure; the role includes shaping and creating new markets. Rather than “crowd-out” private investment, the public sector can “dynamise-in” the private sector by creating the vision, mission and plan for innovation. The policy recommendations emerging from this work include: •

supporting private sector R&D; however, if R&D tax credits are used they should be focused on supporting R&D workers, as in the Netherlands, rather than R&D spend (which is more problematic to define);

•

setting up an innovation fund, paid for by royalties from successful commercialisation, which can be re-invested in future technologies. This could be achieved by attaching conditions to loans and grants where royalties are paid when profits rise above a threshold (in a similar way as conditions for student loans);

•

direct investment in technology companies, by state investment banks (a model that is common in Germany, for example);

•

avoiding innovation policies that would not result in profits arising from innovation being re-invested in innovation (such as the UK’s preferential tax treatment of profits arising from patents); and

•

additional investment in public agencies with a remit for near market research (such as the Technology Strategy Board, in the case of the UK), investing directly in research through agencies, using the US model of the Defense Advanced Research Projects Agency and, more recently, the Advanced Research Projects Agency – Energy.

While some of the policy recommendations represent savings to the taxpayer, rather than costs, in an environment such as Scotland, where the objective would be to make a step change in innovation, it is likely that a net investment will be required. However, there is payback from that investment. For example, the Brazilian State development bank, BNDES, which has been investing in innovation in both cleantech and biotechnology, made a return on equity in excess of 20% in 2010. There are also benefits to the taxpayer from the additional taxes associated with the economic growth stimulated. Such models work in small advanced economies as well as in the large emerging economies. Singapore is one model from which Scotland might learn. While Singapore has a reputation as a relatively low tax economy, the state is active in the corporate sector. This includes sovereign wealth funds such as GIC Private Limited (formerly the Government of Singapore Investment Corporation) and Temasek. These funds invest, long term, both domestically and internationally. The scale of funds are significant. Temasek has a portfolio in excess of £100 billion, almost a third of which is invested in companies in Singapore. While it has delivered impressive returns (delivering total shareholder return of 16%) its charter has wider objectives translated into investment themes such as “deepening comparative advantages” and “emerging champions”. The focus of the public sector should build on investment in the research base, providing the long-term patient finance required to bring new technologies to market. While it must be accepted that there will be failures as well as successes Scotland Means Business: The Strategy

(since innovation is high risk), the successes can pay for the failures, providing mechanisms are in place for the public sector to share in the proceeds of success. The approach is already being debated by politicians in several European countries (for example, in the Netherlands, Denmark and Norway) and by the European Commission where it is consistent with the Horizon 2020 strategy of delivering smart and inclusive growth. Scotland might be the ideal place to take these policy lessons on board, given the strength of the academic research but the failure to grow and retain companies of scale in Scotland. Twenty years ago, Scottish Enterprise undertook a â&#x20AC;&#x2DC;commercialisation inquiryâ&#x20AC;&#x2122; that considered Scotlandâ&#x20AC;&#x2122;s track record in research and development and in commercialisation. That process led to a number of new programmes and investment including the expansion of technology transfer offices, the development of science parks, co-investment schemes (focused mainly on seed and early stage capital), programmes to link businesses with universities, proof of concept funds to assist academics with commercially promising ideas and R&D funding programmes for small companies. Many of these programmes have been replicated in other European countries, where Scotland and the UK are considered to be leaders in innovation and policies to realise economic benefits from the academic research base. However, the range of programmes has not delivered any technology based companies of scale. The development of a new economic strategy for Scotland presents an opportunity to re-open the commercialistion inquiry to assess the lessons that have been learned over the last 20 years and what action is now required to make the next step in transforming Scotland into an innovation economy. These actions are likely to focus on how to provide long term, patient funding for high growth technology companies. Securing investment may require direct investment by the public sector as well as leveraging in private sector investment. The public sector investment could be from state investment banks, learning from the model that has been successful in Germany and the sovereign wealth fund approach that has been successful in Singapore. The taxation system can also encourage the provision of long term, patient capital. The allowance for corporate for corporate equity (ACE) model highlighted in chapter 10 would make Scotland a more competitive location for equity financed business and encourage a shift in asset allocation to long term investment in company growth. The returns to the taxpayer from such investment are possible in the form of financial returns from successful companies and economic returns from the growth that is generated.

9.3

Entrepreneurship Another area that has been much examined and debated in Scotland is the relatively low level of business start-up. As Scotland Means Business: The Facts set out Scotland has had a lower level of entrepreneurship than the rest of the UK.

Scotland Means Business: The Strategy

However, recently published research51 has found evidence of an improvement, with Scotland matching its benchmark nations (26 advanced ‘innovation-driven’ nations) in early stage entrepreneurial activity for the first time in 2013 and a doubling of high aspiration early stage entrepreneurship since the start of the recession. There are also a number of emerging success stories in Scotland, such as the rapidly growing Edinburgh Tech Cluster. A new policy framework for entrepreneurship in Scotland52 has recently been published with the ambition to become a “world-leading entrepreneurial and innovative nation”. A number of new, business-led initiatives have been established in recent years. These include Entrepreneurial Spark, a business accelerator for early stage and growing ventures based in Glasgow, Edinburgh and Ayrshire, inspired by the Boston based Mass Challenge. New and young businesses with growth ambitions are located in a collaborative office environment with free IT services and given supported over 12-18 months with business advice, mentoring, networking opportunities and workshops. Entrepreneurial Spark’s vision is to develop an entrepreneurial revival in and from Scotland, through the development of entrepreneurial mindsets and behaviours. Another new organisation, Entrepreneurial Scotland, launching in June 2014 by the Entrepreneurial Exchange business network and the Saltire Foundation, which develops young Scottish business talent, aims to catalyse a new era of entrepreneurial growth. Initiatives such as these should be encouraged, since promoting and supporting entrepreneurship is an area where the private sector should be expected to take the lead. However, it is important that the public policy environment should be supportive. For smaller scale start-ups, the impact of the taxation system should be reviewed. The self assessment income tax payment system means that payments are made twice a year, partly on the previous year’s earnings and payments on account for the current year while corporation tax is payable nine months after the end of the financial year. For first time business owners, this can mean significant tax liabilities in the second year of operation, which can cause cashflow challenges for growing businesses. A reformed tax system should ensure that administrative systems are appropriate for growing businesses. A more efficient tax system, with lower administration burdens for business, like that in New Zealand (described in Chapter 10) would also assist new and growing companies. For higher potential start-ups, access to finance is often a constraint on growth. As discussed above, policies to provide and incentise the supply of long term, patient capital will help accelerate growth, as well as providing more opportunities for the founders and initial funders of successful companies to secure a financial return without a need for an overseas trade sale of the business.

Hunter Centre for Entrepreneurship, University of Strathclyde (May 2014), Global Entrepreneurship Monitor Scotland 2013 52 Scottish Government (November 2013), Scotland CAN DO: Becoming a World-leading Entrepreneurial and Innovative Nation

Scotland Means Business: The Strategy

TAXATION POLICY Key Findings • Taxation policy should support the new economic strategy for Scotland, to be developed collaboratively by government, business and others. • The current tax system is complex (and the Scotland Act will mean that it becomes even more complex in Scotland) but recommendations have been made for reform – at the UK or Scottish level, depending on the outcome of the referendum. The reforms should be based on the principles of simplicity, neutrality, stability and flexibility. • Internationally there has been increased tax competition, for companies and high income individuals; however, this is not a ‘race to the bottom’, because governments still have significant revenue raising requirements. • There has also been an international trend that has shifted the overall tax base from corporate and personal tax rates to consumption taxes. • New Zealand’s tax reforms from the mid-1980s provide a number of lessons from which Scotland can learn. These include the lack of capital gains tax to avoid double taxation of dividend income, tax competitiveness with its larger neighbour and an efficient tax administration system. • The design of the tax system can have a material impact on the competitiveness and efficiency of the overall economy, as well as by strengthening the competitive position of specific sectors of the economy. • Reform of the tax system should also take account of the principles of corporative policy making. In particular, there is merit in a requirement to consult on any significant changes to taxes that can impact on business performance. • The UK’s tax take, relative to the size of the economy, is less than the average for advanced economies in Europe, and considerably less than countries such as Denmark, Sweden, Belgium, Italy and France. • Given Scotland’s economic strengths, it should be competing on the basis of a quality proposition as a business location, rather than on the basis of price (i.e. low taxation). • However, in the shorter term, if the independence referendum was to result in a Yes vote, there would be a strong case for reducing one of the headline tax rates (for example Corporation Tax), to send a message that Scotland was open for business. • A range of specific measures could support the pursuit of particular objectives or the growth of particular sectors. The menu of options include: - an allowance for corporate equity, removing the tax disadvantages of equity financing compared with debt. This would make Scotland an attractive location for equity providers and other financial institutions, support the equity model of long term business finance, help to address the impact in pension funds of the removal of advance corporation tax in the UK and encourage increased equity investment in growing Scottish businesses; - increasing research and development support in key sectors such as oil and gas, financial services and renewable energy; - targeted measures such as reducing VAT and air passenger duty to boost the competitiveness of the tourism sector; Scotland Means Business: The Strategy

- incentivising investment in high growth companies; - incentivising investment in start-up and growing family businesses; and - favourable tax treatment of technology-based businesses that have the potential to become companies of scale. â&#x20AC;˘ Taxation levers can also be used to support other areas of policy, as has happened with support for professional sport in Ireland. The development of a new economic strategy for Scotland, to be developed collaboratively by government, business and others, is necessary since existing economic policies do not take account of the full range of public policy interventions that are available. In particular, the Scottish Government Economic Strategy does not set out taxation policies in support of its strategic objectives, since the important fiscal powers are reserved to Westminster. An independence Scotland would have control of taxation and, in the event of Scotland voting against independence, the Scotland Act will devolve some additional taxation powers to Scotland. The UK parties have also raised the possibility of further devolution of tax powers. The business leaders that have supported N-56 have a range of views on Scotlandâ&#x20AC;&#x2122;s constitutional future. This Chapter considers the appropriate taxation policies that could support a new economic strategy for Scotland. It will be for the Scottish electorate to decide whether the UK or Scottish Government has the responsibility for implementing those policies. In any event, the new economic strategy for Scotland should include taxation policies, wherever those powers rest. This chapter considers both the overall approach to taxation and some examples of specific, targeted taxation measures. The chapter has been drafted and edited by BiGGAR Economics. However, the section that discusses small country approaches to tax has been prepared by Landfall Strategy Group.

10.1 Overall Approach Adam Smith set out the principles of effective taxation (equity, certainty, convenience and efficiency) in the Wealth of Nations and these remain relevant in the modern economy. Noble prize winning economist Professor Sir James Mirrlees has reviewed the UK tax system and how a tax system for an independent Scotland should be designed. His recommendations for reform are based on the principles of simplicity, neutrality, stability and flexibility, which will minimise administration and compliance costs, maximise tax-take and boost investment and growth. Mirrlees notes that the tax system can be used to increase productivity and economic growth and to tackle inequality. Recommendations for the UK tax system include simplification, including the merging of income tax and national insurance, homogenising the tax incentives on savings and introducing one single welfare payment (the only element of the recommendations currently being implemented). In line with the approach recommended by N-56 to the development and implementation of a new economic strategy, Mirrlees recommends that the reform process should be open and consultative, involving independent experts, employer groups, and the general public.

Scotland Means Business: The Strategy

10.2 Small Country Approaches to Tax This discussion examines how small countries use tax policy (the tax rate, composition, and design features), including an analysis of the international experience and several selected small country case studies. Tax is often an important part of the overall economic strategy, and it is important that it is designed to reflect local context and objectives. To examine this in some detail, several small country case studies are presented: New Zealand, Singapore, and Ireland. This provides a basis for a comparison with the Scottish situation and the lessons that can be learned from the small country case studies. This section has been prepared by Landfall Strategy Group. 10.2.1 International Background on Tax Across the developed world, governments are collecting more tax revenue in order to finance increased demands for various government spending programmes. Over the past 30 years, tax revenue to GDP has increased by several percentage points. Despite a common intuition that government has shrunk, public spending levels have been robust. For example in Europe, expenditure on social protection and health increased 2.3% as a proportion of GDP in EU-27 countries between 2002 and 2011. At the same time, there have been two marked, related trends. First, there has been a sharp reduction in the corporate tax rate as well as top personal rates of income tax. In terms of corporate tax rates, KPMG note that the average OECD corporate tax rate reduced from 35% to 26% between 1999 and 2009. Across the OECD, the average top personal tax rate reduced by about four percentage points in the 1990s and by about another five percentage points in the first decade of the 2000â&#x20AC;&#x2122;s (the average rate in 2010 across OECD members was 41.7%). This is in large measure because of increased tax competition: companies and high income individuals can more readily relocate. Arguments are also made that high tax rates had a negative incentive effect. Sometimes these lower corporate rates are accompanied by tax incentives for inward investment, further reducing the effective corporate tax rate. This is not a â&#x20AC;&#x2DC;race to the bottomâ&#x20AC;&#x2122;, because governments still have significant revenue raising requirements. But there is clearly competitive pressure on governments. Second, there was a shift in the overall tax base. Consumption tax rates have been increased and broadened in order to allow for these reductions in corporate and personal tax rates. Consumption (and property) taxes are seen as more efficient, as they are not levied on mobile factors of production (and do not distort incentives as much). Consumption taxes now account for about a third of revenue across the OECD. 10.2.2 The Small Country Context In broad terms, these trends are seen in both small and large advanced economies. But small countries are faced with some sharper tax policy choices in response to a competitive global environment. Tax revenue tends to be higher in small countries than in larger countries (with high government spending, and lower fiscal deficits). Tax revenue as a share of GDP is about 40% for small advanced economies, compared to about 38% for larger advanced economies. There are exceptions (such as Singapore and Hong Scotland Means Business: The Strategy

Kong, which have low levels of tax revenue) but in general small countries raise more tax. This regularity occurs for a few reasons: it partly reflects local preferences for a more extensive government role (the collective provision of public goods and services); as well a response to the higher income volatility that small, open economies face – and the consequent demand for various forms of social insurance. Small countries face some particular challenges in raising this revenue, because they are more exposed to cross-border competition for companies, capital, and labour. If tax rates are not lower than in other, larger countries, small countries may be at a competitive disadvantage. Tax is not the only factor that influences the competitive position, but it is one factor. This means that debates about the balance of taxation on mobile factors (such as companies and individuals) versus consumption tax and property tax are sharper. As will be discussed in the case studies below, some small countries have deliberately introduced very low headline rates of corporate tax for this reason. Indeed, on average, corporate tax rates are slightly lower in small advanced economies (28% v 22% in 2012) as are the top rates of personal income tax (43% v 40%). In addition, the specific design of tax systems is often used to overcome some of the disadvantages associated with a small domestic market, and can be an important ingredient in the design of overall economic strategy; encourage R&D, savings, or particular types of economic activity.

10.3 Small Country Case Studies In this context, the following discussion describes a few small country case studies. The primary focus is on New Zealand, but the tax policy approaches of Singapore and Ireland – small countries that have used their tax codes aggressively to promote economic growth – are also considered. Some general lessons are drawn at the end. 10.3.1 New Zealand New Zealand commenced tax reform from the mid-1980s, as part of the overall economic reform programme: this programme simplified the tax regime, reduced the top personal and corporate rates, and introduced a comprehensive consumption tax. The top personal income rate reduced from 66% to 48% in 1986 and further to 33% in 1988. In 2000, the Labour Government increased the top rate to 39%, although this was reduced to 33% in 2010 (the personal rate threshold is NZ$70,000 (£35,000), which is a relatively low threshold by international standards). Corporate tax was reduced from 48% to 33% in 1988, and to 30% in 2008 before being reduced to 28% in 2010. A Goods & Services Tax (GST) was introduced in 1986 at 10%, raised to 12.5% in 1989, and then to 15% in 2010: it is comprehensive, with no exemptions. Despite much debate, there is no capital gains tax in New Zealand. And one of the distinctive features about the New Zealand tax system is the dividend imputation system to address double taxation of dividend income: individual (resident) taxpayers receive an ‘imputation credit’ for the New Zealand company tax paid by any company in which they own shares, which they can apply against their personal tax liability. Scotland Means Business: The Strategy

New Zealand’s approach to tax has been based on the low rate, broad-base approach; tax revenue can be raised most efficiently when the tax base is comprehensive (with few exceptions) and low rates of tax are applied. The view over much of the past few decades has been that tax is generally not the most efficient way in which to achieve other economic policy goals (and that specific exceptions and provisions are likely to create economic distortions). The objective of the tax system is to raise revenue in as efficient manner as possible. The administrative features of the New Zealand system are also world-class; there is now no requirement for individuals to file tax returns if they only receive wage and salary income (or income/dividend income) from which tax has been deducted at source. The absence of exemptions also makes it very easy to file returns when this is needed (and much of the form is pre-populated). Although the New Zealand tax system has worked well, has low transaction costs, and raises tax revenue efficiently, the system has some unusual features in the context of a small, open economy. These have been the subject of debate over the past several years, motivated by a concern that New Zealand’s economy has not been performing as well as desired – and by a related concern that a clean, efficient tax system may not be sufficient to encourage the economic behaviour that is required in a small, open economy. In response, several changes have been made over the past several years: •

savings: New Zealand was one of the few developed countries to not provide any preferential tax treatment on savings (interest and dividend income was taxed at normal rates, while capital gains on property were not taxed). This was argued to be one reason why New Zealand’s national savings rate was low, its current account deficit so high, and there was arguably overinvestment in residential property relative to business investment. In 2006, the KiwiSaver scheme was introduced to encourage household saving: this combined automatic enrolment, employer contributions, and some tax advantages (an up-front contribution and a matching contribution). At about the same time, the government introduced preferential tax rates for income from specified investment products to encourage savings.

•

taxation of corporate foreign income: for small countries, international expansion by firms through outward direct investment is important (in addition to exporting). The tax treatment of this overseas income affects both the incentives facing companies to invest, as well as their competitive position overseas. Traditionally New Zealand companies were liable to pay New Zealand corporate tax on their overseas income (with a credit for foreign tax paid). Given that the New Zealand rate is higher than in many high growth markets (e.g. in Asia) this placed New Zealand companies at a competitive disadvantage. Changes were made so that New Zealand companies only paid tax at the prevailing local rate.

•

sector-specific tax treatment: in recent years, the government has demonstrated increased willingness to actively use the tax system to encourage investment in specific sectors. For example, tax concessions and some grants are used to attract large budget screen productions, and specific deals have been struck with film companies (e.g. to produce The Hobbit, Avatar). Concessionary tax treatment has also been used to attract foreign investment into oil and gas exploration. The justification is that these approaches are common in other countries, and that without these tax breaks

Scotland Means Business: The Strategy

New Zealand would lose this investment. The evidence on the benefits of this approach is not yet clear, and it remains controversial in New Zealand. To ensure that the tax system continues to be high-quality, there have been periodic independent reviews of the New Zealand tax system (which generally make public recommendations to Ministers). The most recent of these was the Tax Working Group (comprising academics, tax experts, officials, unions and others) that was convened in 2010. An important part of this process was that it was open and transparent, so that there was an informed public conversation about the issues and trade-offs. Several issues identified in this review: •

there is greater focus on ensuring competitive tax rates with Australia. The personal tax rate has been lower for some time, but further moves have been made. And the corporate tax rate is being set in a way that is deliberately lower: the Australian corporate tax rate is 30%, and the New Zealand rate has now been set at 28%.

•

there was a deliberate shift to encourage rebalancing of the economy through a revenue-neutral shift from direct to indirect taxation (a reduction in the personal tax rate and an increase in GST from 12.5% to 15% in 2010).

•

there was also discussion of introducing a capital gains tax: an issue that has long been on the agenda, but which is politically very challenging.

10.3.2 Singapore Singapore has a small formal government sector, with correspondingly low tax rates. However, there is a compulsory personal savings system, in which people are required to self-fund retirement, health care, and so on – with government subsidies for a relatively small group, or in the event of catastrophic illness. Singapore is very focused on keeping tax rates low, in order to ensure that Singapore remains an attractive, competitive place to be. The corporate tax rate is 17%, which has been reduced over time (it was 26% in 1999); Hong Kong is one of the competitive benchmarks that has been used. The tax rate system is used actively to encourage particular types of activity. For example, a key economic objective is to transition Singapore to a more productivity-led economy. To encourage this, the Singapore Government has introduced various tax incentives for companies to make investments that will strengthen labour productivity. The Productivity and Innovation Credits Scheme53, which is a broad initiative open to all businesses, provides tax benefits to companies that incur expenditure on such things as: •

acquisition and leasing of information technology and automation equipment;

•

training for employees;

•

acquisition and in-licensing of intellectual property rights;

•

a tax deduction of up to 400% of qualifying R&D expenditure is also available as part of the scheme.

The government has used low tax rates (together with other elements of Singapore’s broader national value proposition) as a way of attracting inward FDI. 53

http://www.iras.gov.sg/irasHome/page04.aspx?id=13838

Scotland Means Business: The Strategy

In addition to the low headline rate, the government has the ability to offer specific financial incentives (often with an explicit agreement with respect to investment and job creation in Singapore). These incentives can come in various forms; concessionary tax treatment, other financial incentives (such as subsidised rental), or commitments with respect to relevant infrastructure or human capital. The Economic Development Board (EDB) is the lead agency on this. 54 As part of the response to the international crisis, there are partial tax exemptions on the first SGD$300,000 (£145,000) of taxable income of new companies. In addition, partial government grants are available for approved R&D projects, as well as for targeted kinds of start-ups.55 The government’s various time-limited tax credits, grants and allowances may be extended to continue to support the ongoing restructuring of the economy. The top personal tax rate is 20% (with a high income threshold), with further exemptions for dependent family members, charitable donations and so on. There is no capital gains tax. This makes Singapore an attractive destination for high income earners to locate. GST is set at 7%, which has been gradually raised from 3% (when it was introduced in 1994). This represents a gradual shift in the tax mix towards indirect forms of taxation – although no further increases in GST have been announced. 10.3.3 Ireland One of the key features of the Irish success story has been the low corporate tax rate regime. The introduction of the low headline rate of corporate tax (at 12.5%), combined with other features of the Irish model (such as investment in human capital and innovation), is credited with attracting substantial inward FDI flows. This rate compares very favourably with corporate tax rates in other European countries. Other non-headline features of the Irish corporate tax regime have also attracted some FDI, some aspects of which are currently under scrutiny in the context of concerns about international tax evasion (for example, the OECD has a major programme of work underway on ‘base erosion and profit shifting’). Other than that, the Irish system is fairly similar to other European countries. The top personal rate is 41% (although there are a range of exemptions to allow for different family structures). The general rate of value added taxation is 23%, but there are also reduced rates of 13.5% and 9% and certain areas are exempt. 10.3.4 General Lessons Capital and firms are increasingly mobile across borders, and corporation and personal tax rates are one of the mechanisms that small country governments have used to attract firms (and investment and employment) to their location. This is particularly the case when inward investment is a central part of the economic strategy. That said, a low corporate tax rate is not a prerequisite for success. There are successful small advanced economies, such as those in the Nordics, which have not used the corporate tax rate as a major competitive tool. The corporate tax rate choice needs to fit with the overall economic strategy, and the way in which Scotland wants to distinguish itself from the UK and other competing countries. 54

Further information on EDB programmes and incentives is available at: http://www.edb.gov.sg/content/edb/en/why-singapore/ready-to-invest/incentives-for-businesses.html 55 Tax incentives and other programmes for start-ups are detailed at: http://www.guidemesingapore.com/doing-business/finances/singapore-government-schemes-forstartups

Scotland Means Business: The Strategy

Personal tax rates are also sometimes used as a competitive tool, but less frequently – and also varying this rate tends to have larger revenue consequences, because it accounts for a larger proportion of the tax revenue base. In addition to headline rates, the design of the tax system can have a material impact on both the competitiveness and efficiency of the overall economy, as well as by strengthening the competitive position of specific sectors of the economy. As Scotland seeks to develop competitive strength in certain activities and sectors, the creative use of the tax code – in the way that other small advanced economies have also done – is a source of potential economic value. The final point to note is that there is a constant process of change and reform in many small countries. New Zealand, for example, has a good, clean system – but the challenges of an efficient tax system in a small open economy are many. There is limited margin for policy error, and an efficient tax system is important for the overall competitive strategy.

10.4 Implications for Scotland There are three areas where Scotland can learn lessons from this international experience, in relation to: •

the taxation system: efficiency and competitiveness;

•

taxation strategy: the overall tax rate and headline tax measures; and

•

taxation levers: the use of targeted tax policies to pursue particular objectives (such as supporting particular sectors or research and development).

Each of these is discussed below.

10.5 Taxation System The UK taxation system is one of the most complex in the world. The Scotland Act, which splits decisions on income tax between the UK and Scottish Governments, would mean that the Scottish tax system becomes even more complex than the rest of the UK. Many of the small counties described above have more efficient, competitive tax systems. The benefits of a less complex tax system are savings to the state in administration costs and an increase in the countries’ competitiveness as a business location since compliance costs for business will be less for a less complex tax system. The OECD estimates56 that the cost of collection for the UK tax system was 0.83% of the taxes collected. For Denmark it was 0.71%, Iceland was 0.60% and Sweden was 0.40%. If the system’s efficiency could be increased to match Denmark, the saving would be £64 million for Scotland and, if Sweden’s performance could be matched, the saving would be £229 million. The work of Professor Sir James Mirrlees has set out an agenda for reform, based on the principles of simplicity, neutrality, stability and flexibility. Such reforms would minimise administration and compliance costs, maximise tax-take and boost investment and growth. 56

OECD (2013), Government at a Glance

Scotland Means Business: The Strategy

Reform of the tax system should also take account of the principles of corporative policy making. In particular, there is merit in a requirement to consult on any significant changes to taxes that can impact on business performance. Such a requirement would mean the end of surprise announcements (such as the changes to oil and gas taxation in the 2010 Budget that the industry had not expected or the decision in the same Budget not to proceed with the changes to the tax treatment of computer games companies that had been expected).

10.6 Taxation Strategy The UKâ&#x20AC;&#x2122;s tax take, relative to the size of the economy, is less than the average for advanced economies in Europe, and considerably less than countries such as Denmark, Sweden, Belgium, Italy and France (Figure 10-1). In terms of the level of the various headline tax rates, the tax system that Scotland shares with the UK has some differences from the small countries discussed above. The UK has a top personal rate of 40% (with an additional rate of 45% for very high income earners) and a 24% corporate tax. This is not out of line with European peers, but is not distinctive. Figure 10-1 â&#x20AC;&#x201C; Total Tax as % of GDP for European OECD Countries 50" 45" 40" 35" 30" %" 25" 20" 15" 10" 5"

Slo

Ire la va k"R nd" ep ub Sw lic " itz er la nd " Gr ee ce " Po rtu ga l" Sp ai n" Po la nd " Es Cz to ec ni h" a" R ep Un ub ite lic d" " Ki ng do m " Ice la n Ge d" rm OE an Lu y" xe CD m "E bo ur ur op g" e" Av er ag e" Hu ng ar y" Slo ve Ne ni a" th er la nd s" Au st ria " Fin la nd No " rw ay " Fr an ce " Ita ly" Be lgi um Sw " ed e De n " nm ar k"

Source: OECD Factbook (figures for 2010)

Whatever the outcome of the independence referendum, the overall taxation strategy for Scotland will become an issue of political debate, since the Scotland Act means that the Scottish Parliament will need to make a decision on the level of income tax that should be set in Scotland, and so the overall tax take. The decision that is taken on the total tax take (i.e. the size of government) will be influenced by ideological positions and views on social policy. A cut below the UK position, or an increase by a few percentage points would both be within the range of positions taken by other advanced economies. From an economic strategy perspective, the Scotland Means Business: The Facts and this strategy document have identified a number of strengths in the Scottish economy, including a skilled workforce, a respected innovation system Scotland Means Business: The Strategy

and opportunities in several global growth sectors. Given these strengths, there is a strong case to be made that Scotland should be competing on the basis of a quality proposition as a business location, rather than on the basis of price (i.e. low taxation). The taxation strategy should support the new economic strategy and so a more targeted approach to tax competition may be most appropriate for Scotland. However, in the shorter term, if the independence referendum was to result in a Yes vote, there would be a strong case for reducing one of the headline tax rates, to send a message that Scotland was open for business.

10.7 Taxation Levers The main lessons for Scotland that are relevant to the development of a new economic strategy are those related to the overall approach to taxation. However, there are also specific measures that could support the pursuit of particular objectives or the growth of particular sectors. The measures that have been identified elsewhere in Scotland Means Business: The Strategy include: •

support for research and development using tax credits – but supporting research and development staff, rather than spending (which can be more difficult to classify and monitor);

•

extending research and development support to cover financial services companies so they are encouraged to invest in innovation to responding to rapidly changing customer needs;

•

scrapping innovation related tax measures that do not lead to increases in innovation (such as the special treatment of profits from patents);

•

measures to ensure a return to the public sector where it has invested in innovation, above profit thresholds (using a similar model to student loans);

•

tax incentives for oil and gas exploration, encouraging a corporative approach to identify more undiscovered resources;

•

targeted tax incentives to support research and development in the oil and gas sector, in particular activity that is focused on enhanced recovery and extending asset life;

•

a review of the whole taxation and fiscal regime for the oil and gas sector to ensure that it is both stable and competitive;

•

tax incentives to encourage long-term saving, including the take-up of the proposed Scottish infrastructure bonds;

•

favourable tax treatment of headquarters functions to retain company headquarters in Scotland and to attract new companies to set up European or functional headquarters in Scotland (including growing companies from emerging economies in Asia and elsewhere);

•

tax incentives to encourage long term investment in high growth technology companies;

Scotland Means Business: The Strategy

•

personal tax regime that will help to retain and attract highly skilled individuals in key sectors (for example, in priority technologies or in priority clusters such as fund management);

•

reductions of VAT and scrapping air passenger duty to make the tourism sector more price competitive; and

•

maintain the competitive tax regime for the computer games sector.

The proposals for specific tax measures should emerge from the corporative policy making process and then be subject to an analysis of costs and benefits and, then consultation, before being implemented. The implementation of such policies will depend on the outcome of the independence referendum since that will decide whether the UK or Scottish Government has control of these areas of taxation. However, the above are examples of policies that would help to support the new economic strategy for Scotland. There are further examples below, all of which emerged during the Scotland Means Business research and consultation programme. In some cases, studies of potential economic impacts have already been undertaken and are referenced below. 10.7.1 Integration of Taxation and Other Policies Taxation levers can also be used to support other areas of policy. For example, in 2002 Ireland introduced a scheme that allowed professional sports people to reclaim 40 percent of tax paid over a ten year period, provided they were tax resident in Ireland. This helped Ireland to retain many of its top sports stars, notably in rugby, which has delivered more success at club and international level than might otherwise have been possible. While sport might be the main beneficiary of such a policy, there have also been economic benefits since sporting events can generate significant economic impacts. This is reflected, for example, the turnover of the Irish Rugby Football Union which say its income increase from €21.6 million (£18.0 million) in 2001 to €69.2 million (£57.7 million) in 201157, despite the recession. In the same year the Scottish Rugby Union’s turnover was £35.1 million. 10.7.2 Tourism Taxation Another example of using tax policies for wider policy purpose would be VAT on some tourism-related businesses. A reduction of VAT on restaurants would be expect to reduce prices (as has happened in other countries that have introduced such measures), making eating out more affordable, increasing demand which would help to make marginal businesses more sustainable, improving town centres and quality of life more generally. The main economic benefits from reducing VAT on tourism would be increasing the competitiveness of the sector. Independent analysis58 commissioned by a UK campaign to reduce VAT on tourism has concluded that cutting VAT to 5% would be, “one of the most efficient, if not the most efficient, means of generating GDP gains at low cost to the Exchequer”. The economic gains to the UK from such a policy are quantified at an annual increase in GDP of £4 billion, 80,000 jobs 57 58

Source: Financial Times (23 February 2012), Ireland Invests in Homefield Advantage Research summarised at www.cuttourismvat.co.uk by Professor Adam Blake and by Deloitte.

Scotland Means Business: The Strategy

created over 2-3 years and tax revenues to the Treasury of £2.6 billion over 10 years. Scotland might expect to secure at least 10% of these benefits. An analysis of the Irish Government’s reduction in the VAT rate for tourism sectors found that it delivered a number of benefits including increased employment of around 10,000 and growth in overseas tourism numbers and earnings, at lower cost to the exchequer than had been anticipated. Should such a policy be followed in Scotland and/or the UK as a whole, consideration should be given to following the example of Sweden and France of reducing the VAT rate on visitor attractions to a lower rate than tourism accommodation, and perhaps even zero rating such attractions, in recognition of their role influence decisions of tourists to visit Scotland. The economic impact of Air Passenger Duty has also been assessed in a study for four airlines59, finding that the abolition of APD could increase UK GDP by 0.45% initially and then by 0.3% per annum, boosting economic output by £16 billion and creating 60,000 jobs. The study also found that while abolishing APD would result in lost revenues from APD of £3-4 billion per annum, this would be more than offset by additional revenues from other areas of taxation, associated with the boost to GDP. 10.7.3 Corporate Taxes The Scottish Government’s White Paper proposes a cut in Corporate Tax of up to 3% compared with the UK. The impact of such a change on public finances will depend on the prevailing UK rate at the time the policy was implemented. However, Corporation Tax accounted for just 5.4% of taxation revenues from Scotland in 2011-12 and so even a 13% cut in revenues from Corporation Tax (a worst case scenario associated with a reduction from a 23% rate to a 20% rate, but assuming no increase in profits reported in Scotland) would mean a reduction in revenues of just 0.7% (£375 million). For some of Scotland’s largest companies, the potential for annual savings are significant, based on their latest annual reports: £16 million for Standard Life (on reported profits of £547 million), £10 million for Weir Group (on profits of £336 million) and £42 million for SSE (on profits of £1,411 million). These savings would be available for re-invest each year, generating future growth for these firms – and for the profitable smaller firms that would also benefit. The generation of growth will then generate further tax revenues over time. Analysis for the Scottish Government60 sets out the economic benefits of such a policy after 20 years, resulting from re-investment by existing firms and inward investment attracted, of 27,000 jobs (an increase of 1.1% in employment) and 1.4% in economic output (around £2 billion per annum). While this represents a good return to the exchequer relative to the costs of the policy, this may underestimate the economic impact. As well as the direct impacts, multiplier effects would be expected to add to this impact, including benefits to suppliers and induced impacts as a result of the additional wages in the economy. The policy would also be expected to contribute to retaining and attracting more corporate headquarters, increasing the prospect of new high growth business start-ups by senior managers and directors.

PriceWaterhouseCoopers for British Airways, Virgin Atlantic, Ryanair and easyJet (February 2013), The Economic Impact of Air Passenger Duty 60 Scottish Government (September 2011), Devolving Corporation Tax in the Scotland Bill

Scotland Means Business: The Strategy

While such a policy would mean that Scotland’s corporation tax rates were lower than the rest of the UK, the international experience is that this would not lead to a ‘race to the bottom’ with neighbouring countries repeatedly cutting rates. So for example, Sweden and Finland have both cut corporate tax rates in the last 2-3 years but Norway and Denmark have not reacted by cutting their rates. This is because corporate taxes are just part of any country’s overall proposition to businesses and so cutting rates is a tool that tends to be used as part of a wider strategy, and often as much to remove perceived disadvantages as to seek an advantage over a neighbouring country. 10.7.4 Income Tax Whatever the outcome of the independence referendum, income tax will become an issue of political debate, since the Scotland Act means that the Scottish Parliament will need to make a decision on the level of income tax that should be set in Scotland. The three largest UK parties have also indicated that further devolution of income tax powers is a possibility in the future. As discussed in the section on taxation strategy above, Scotland should compete as a high quality rather than low cost location. However, care needs to be taken when setting income tax rates to benchmark against neighbouring and competing countries. Setting higher basic or upper rates in Scotland when compared to the rest of the UK, may discourage business investment, as much by creating a perception of a high tax location as by the differences it would make to investors and employees. 10.7.5 Incentivising Investment in Business: Technology Companies As discussed in Chapter 9, Scotland has developed an innovation system that other countries have followed, including supporting the commercialisation of university research and incentivising universities to work with business. However, Scotland does not yet have technology-based companies of scale, and further action may be required, including developing a model for providing high growth technology companies with long term, patient funding. This will likely include a mix of public and private sector funding. However, private investors are likely to consider such investment to be higher risk than other investment opportunities and so incentives, using the tax system, may be required to make such investment more attractive. 10.7.6 Incentivising Investment in Business: Family Businesses Family businesses make a substantial contribution to the Scottish economy, as well as providing wider benefits such as stability (since they are often long-term businesses through several generations) and strong links with the communities in which they are based. The Scottish Family Business Association estimates that almost three quarters of Scottish businesses are family businesses, contributing 45% to Scottish GDP and employing over 50% of the private sector workforce. They are particularly prevalent in some sectors (for example, tourism, agriculture, and food and drink) and in rural communities. Family businesses will have access to the same investment sources as other businesses. However, at the start-up stage and when growing, they will often seek more informal funding, including from family members. Given the importance of family businesses to the Scottish economy, investment in family businesses Scotland Means Business: The Strategy

should be incentivised, as part of the broader strategy of encouraging more long term saving and investment. There are also issues related to the tax treatment of family businesses that are inherited or otherwise passed between generations. Research for European Family Businesses61 has found that the UK has the second highest headline rate in Europe, although there are exemptions in some circumstances, up to 100% in some cases. Given that family businesses are particularly important to the Scottish economy, there is a strong case for a competitive tax regime. 10.7.7 Allowance for Corporate Equity Until it was effectively abolished in 1999, the UK had a system of Advance Corporation Tax (ACT) with companies making an advanced payment of tax when dividend payments were made. This usually meant that those receiving dividends were considered to have already paid the tax and pension funds (that were not liable to pay the tax on the dividends) could claim back some tax. As a result of the abolition of ACT in 1999, pension funds became indirectly liable for tax, since corporation tax reduces the profits available for distribution in the form of dividends. Re-introducing ACT would not be compatible with the recommendations made by Mirrlees on simplifying the tax system. However, as discussed in Section 10.3.1, above, New Zealand has a simpler solution, a dividend imputation system to avoid the double taxation of dividend income. This means that New Zealand taxpayers receive a credit for tax paid by New Zealand companies in which they own shares that can be set against personal tax liabilities. There is merit in considering a similar system in Scotland and/or the UK since it would be compatible with the simplification of the tax system and would also increase incentives to invest long term in the domestic economy, increasing the supply of long term, patient funding for companies. One approach to dealing with this issue has been proposed by the Institute for Fiscal Studies62. An allowance for corporate equity (ACE) would remove the tax disadvantages of equity financing compared with debt. This would have a number of advantages and benefits including: •

making Scotland an attractive location for equity providers and other financial institutions;

•

supporting the equity model of long term business finance, so providing long term patient finance;

•

helping to address the impact in pension funds of the removal of advance corporation tax in the UK; and

•

encouraging increased equity investment in growing Scottish businesses.

10.7.8 Taxation Strategy and Levers Overall, care should be taken when introducing targeted taxation measures, to insure that the full costs and benefits have been taken into account (as the Corporation Tax measures discussed above demonstrate) and to ensure that the objective of having a simple tax system is not compromised. 61 62

KPMG for European Family Businesses (April 2014), European Family Business Tax Monitor Institute for Fiscal Studies (October 2013), Taxing in an Independent Scotland

Scotland Means Business: The Strategy

SCOTLAND MEANS BUSINESS: THE STRATEGY PART THREE: IMPLEMENTATION AND IMPACT

Scotland Means Business: The Strategy

CORPORATIVE POLICY MAKING Key Findings • The new economic strategy for Scotland should be at the top of the hierarchy of policy, providing a framework for all other areas of policy and ensuring integration across all areas of policy; • Ensuring that the economic performance of Scotland is central to policy will lead to a different approach to setting priorities and investing public funds. For example, transport infrastructure projects can be assessed and prioritised based on their contribution to strategic objectives, rather than discreet and competing cost benefits analyses; • Integration of policy can also lead to better policy outcomes that take a more holistic and longer term view of the costs and benefits of policy change. For example, an energy policy that was informed by economic development objectives as well as costs, security of supply and environmental impact may prioritise the commercialisation and growth of new sectors with export potential; • A corporative approach to policy making is required, starting with the development of the new economic strategy for Scotland, involving government, businesses and others working on areas of common interest. This should apply to both the formation and implementation of policy; • Business does already get involved in the policy making process; however, it tends to be in the form of responding to formal consultations or lobbying government on specific issues. A more strategic approach is required; • In addition to a more strategic decision making process and the integration of policy, a corporative approach also reduces the chances of policy shocks that businesses had not been expecting (such as the recent policy changes on pensions, which had not been foreseen by the many Scottish providers of annuities); • A corporative approach requires leadership and co-ordination and it is important that senior Ministers, officials, and central agencies own and champion this process. Such strategy functions are commonly located in the centre of government. For Scotland this would be the First Minister’s office; • The development of a new economic strategy for Scotland needs to be informed by a process to develop a clear, well-understood, and over-arching sense of Scotland’s place in the world, the basis on which it will compete and the strategic direction in which it will move. This process needs to be undertaken in an externally-oriented way, looking at the international environment and specific enough to guide a range of decisions and actions. This should be undertaken in collaboration with business and other stakeholder groups to ensure a broad range of perspectives are obtained. • There needs to be clear connection and consistency between the diagnostic phase, the development of a medium-term strategic policy response, and the execution and delivery phase. A coherent strategy needs to integrate all three of these steps and ensure consistency across a wide range of policy areas (rather than having specific policy areas guided by different goals). Institutions and capacity should be built to ensure that this can be delivered on an ongoing basis.

Scotland Means Business: The Strategy

100

This chapter of has been drafted and edited by BiGGAR Economics. However, the sections on international best practice lessons have been based on a paper produced by Landfall Strategy Group, which has been incorporated into the chapter. The lessons from Denmark are based on a paper by DAMVAD, which is included in Appendix E. A corporative approach to policy making means that government, business and other representatives of society work together collaboratively on the development of policies and integrated strategies designed to exploit Scotlandâ&#x20AC;&#x2122;s competitive advantages. This approach is consistent with both Christian Democrat and Social Democrat traditions in European politics.

11.1 Strategy and Policy One of the main lessons from policy making in successful advanced economies is that strategic priorities are identified and all areas of policy support the pursuit of those strategic priorities. A lesson for Scotland is that the new economic strategy should be at the top of the hierarchy of policy, providing a framework for all other areas of policy and ensuring integration across all areas of policy. The current Scottish Government might argue that it has already put economic growth at the centre of policy in Scotland, identifying growth as its purpose in the Government Economic Strategy. However, this is the policy of the current administration rather than a longer term corporative policy (albeit based on an analysis of what is required) and only covers devolved powers. The new economic strategy for Scotland should not be confined to areas of devolved powers. The starting point for the strategy should be to consider what needs to be done with powers. How those policy recommendations are implemented will then depend on which layer of government has responsibility for which powers and a willingness to tailor solutions to Scotland and to collaborate with business and others to develop and implement those solutions. One practical example of the benefits of integrating policy would be in the energy sector. Currently energy policy is the responsibility of the UK Government while planning and economic development policy are both devolved to Scotland. Each of the three policy areas are addressed separately based on different considerations. However, (as Reform Scotland has observed63) an energy policy that was informed by economic development objectives as well as costs, security of supply and environmental impact may prioritise the commercialisation and growth of new sectors with export potential. The development of the wind turbine sector in Denmark is an example of the long term economic benefits that such an approach can deliver, as discussed in Appendix A. An example of the benefits of having a hierarchy of policy with the economic strategy at the top would be transport infrastructure projects, which could be assessed and prioritised based on their contribution to strategic objectives, rather than discreet and competing cost benefits analyses. The need to develop a new economic strategy for Scotland to address economic challenges is an excellent opportunity to develop a new corporative approach to policy making. In addition to a more strategic decision making process and the integration of policy, a corporative approach to policy development and implementation also 63

Reform Scotland (December 2011), Powering Scotland

Scotland Means Business: The Strategy

101

reduces the chances of policy shocks that businesses had not been expecting. Examples include the unexpected tax increasing for the oil and gas sector announced in the 2010 Budget and the policy changes on pensions announced in the 2012 Budget, which had not been foreseen by the many Scottish providers of annuities.

11.2 Partnership in Policy Making in Scotland The experience of devolution in Scotland has improved relationships between businesses and government. Business leaders in Scotland have found that they can access Ministers and other key decision makers if there are issues of concern that might be impeding economic development, to explain problems and discuss solutions. However, these interactions tend to happen on specific issues rather than at a strategic level. Where businesses do become involved in policy formation it is often in one of two ways: •

in response to consultation processes, by which time the policy proposals have already been drafted; or

•

by lobbying government to make a change in policy to remove a disadvantage or enhance the competitiveness of a sector or group of businesses.

In both of these circumstances it is more likely that the contact will be between government and representative business organisations than with individual businesses. N-56 is recommending a more strategic approach, with government, business and other interests working together over the long term to There are examples of good practice in this area in Scotland. One example is the joint work of the Scottish Government and the Scottish Property Federation, where the property industry, the Scottish Government and local government worked together to deal with issues of common concern, including reforms to the planning system. The recommendation of N-56 is to build on these examples of best practice to introduce this corporative approach to the development and implementation of Scotland’s new economic strategy.

11.3 International Best Practice Lessons Small advanced economies have performed strongly on a range of economic, social, and other outcomes over the past few decades. The quality and coherence of strategic policy decision-making by many small country governments has made an important contribution to this performance, enabling small countries to respond effectively to a changing global environment. This strategic coherence – and flexibility in response to changing circumstances – is partly due to trust and social consensus on the way forward that frequently exists in small countries, but it is also due to institutions and processes that have been established. In a rapidly changing environment, strategic capacity in the public sector will become an increasingly important driver of national performance. Governments need to build capacity to better understand the key dynamics in the environment and then respond appropriately. This is particularly true for small countries. Indeed, the experience of the past decade has reinforced the importance of high Scotland Means Business: The Strategy

102

quality strategic decision-making for small country performance. Small countries have responded to structural changes in the global economy, as well as responding quickly and relatively effectively to the global financial crisis. Small country governments seem to approach public sector strategy in a distinctive manner relative to large country governments. Small country governments are much more likely to have national-level strategic conversations that are framed around how to arrange policies to position the country in the global environment. This contrasts with the more domestic, narrowly-focused type of strategy that is common in larger countries. Small countries are not just scaleddown versions of larger countries; they are quite different in how they approach public sector strategy. This discussion examines a series of small country case studies in terms of how countries and governments have approached aspects of the public sector strategy process (in order to develop and deliver a coherent policy approach). This discussion is structured around three elements: •

diagnosis: understanding emerging trends, challenges and opportunities;

•

developing a policy response to a changing world; and

•

delivering the agreed policy agenda.

11.4 Diagnosis As noted above, small countries need to invest in understanding the emerging challenges and opportunities in the environment in which they operate. For small countries, an important element of this is to understand their exposure to international dynamics. Thinking about emerging trends is a difficult thing to do in an uncertain world, but it is important to approach this in a structured way. Two small country case studies are used to illustrate this process: the Singaporean approach to strategic foresight and futures, and the Government Foresight process in Finland. 11.4.1 Singapore One of the distinctive themes of governance in Singapore is the focus on the international environment and trying to detect emerging issues. As a small, highly open economy – very exposed to changes in the regional and international economic and political environment – Singapore invests considerably in developing foresight capacity. Surprises and shocks still occur, but the government is very focused on being well-positioned and informed. This high level of sustained investment is relatively unusual, even among small country governments. Part of this is ingrained into the culture of the government, both Ministers and officials. But Singapore has also developed formal institutions and processes, including engagement platforms with businesses and thinkers, as well as analytic tools and methodologies. Singapore invests heavily in scenario planning and horizon scanning. For example, a Strategic Policy Office (SPO) is located in the Public Service Division (which sits in the Prime Minister’s Office) that has a responsibility for undertaking reviews and analysis of emerging trends that will impact on the policy space in Singapore (demographic trends, the shape of the emerging global economic geography, the possible nature of technological innovation over the Scotland Means Business: The Strategy

103

coming decades, various scenarios regarding Singapore’s future, and so on). Advanced versions of scenario planning tools are commonly used. Also within the SPO is the Centre for Strategic Futures. This Centre was established in 2009, with a view to thinking about longer-term strategic issues (‘a dedicated group of people to think about the future’). It identifies emerging strategic issues, contributes to an integrated risk management framework for the ‘whole of government’, publishes various futures pieces, and engages with thinkers and experts on new issues around the world. Elsewhere in the Singapore Government, there is a sophisticated Risk Assessment and Horizon Scanning (RAHS) programme, located in the National Security Coordination Secretariat (NSCS). In addition, many of the individual policy ministries will have a futures or strategy unit with a mandate to think about policy issues through a longer-term perspective. 11.4.2 Finland Government Foresight process Finland has institutionalised an approach to thinking about the future, with a view to extending the time horizon of the policy debate. Legislation requires that once during each electoral period, the Government submits to Parliament a foresight report containing long-term perspectives on various issues. The focus of each report is on a defined set of strategically significant issues that will impact the Government's key policy priorities over the coming 10-20 years. The foresight report gives the Government's view on the chosen issues and associated policies. This report is prepared in an open, transparent manner, involving citizens, business and various online groups; the aim is to have a real conversation. In addition to the Government, the foresight report process always involves Parliament. The aim is also to encourage broad debate in society. The Prime Minister’s Office is responsible for drawing up the foresight report and, after its completion, for promoting its implementation.

11.5 Developing a Policy Response Governments need to have internal capacity to undertake strategic policy development work, but it is also important to have broader engagement with business and social stakeholders (to draw on a broader range of ideas and perspectives, as well as to achieve a greater degree of buy-in). In small countries, it is valuable – and feasible – to have a national conversation about the strategic policy direction. Two recent small country examples are discussed below: the Globalisation Council in Denmark; and the Economic Strategies Committee process in Singapore. 11.5.1 Denmark: Globalisation Council In April 2005, the Danish Government set up a Globalisation Council to advise the Government on a strategy for Denmark in the global economy. It was motivated by a sense that the global economy was changing in ways that had important implications for Denmark, and that Denmark needed to develop a view on how best to respond. The Council was composed of representatives of trade unions, industrial organisations, companies, the education and research community, and the Government. The Council was chaired by the Prime Minister, and included Scotland Means Business: The Strategy

104

several senior Ministers. “The work of the Council rests on a strong Danish tradition that changes in society are prepared in dialogue and cooperation between the various groups in society”. In mid-2005, the Globalisation Council held three meetings, in which the Council discussed the challenges of globalisation for Denmark. From August 2005 to February 2006, the Council held a total of nine theme-based meetings on topics such as education and training, research, competitive power and innovation. These meetings involved presentations from international and Danish experts, and organisations and individuals were invited to take part in the following discussions. This was the basis for discussions within the Council. During the meetings, the Council heard a total of 48 international and Danish experts and held discussions with 111 representatives of organisations and other specially invited individuals. The Government published the strategy in April 2006, with recommendations clustered around 14 areas. It contained “350 specific initiatives, which together entail extensive reforms of education and training programmes as well as research and entrepreneurship, and also substantial improvements in the framework conditions for growth and innovation in all areas of society”. 11.5.2 Singapore: Economic Strategies Committee The Prime Minister established the Economic Strategies Committee (ESC) in May 2009 to develop strategies for Singapore to maximise its opportunities in a new world environment, by building capabilities and making the best use of its resources, with the aim of achieving sustained and inclusive growth. Members of the ESC were drawn from government, the labour movement, the private sector (including MNCs) and academia. As a small, open economy that is heavily reliant on MNCs, inward investment and exporting, the business engagement was a very important part of this process. Eight sub-committees and several working groups were formed to study the issues. These included areas such as: seizing growth opportunities (identifying new growth areas); developing a vibrant SME sector; attracting MNCs; making Singapore a global leading city; and so on. These groups met and worked intensively over the next several months. The Committee engaged widely with companies, business chambers and associations, universities and think-tanks, unionists, professionals, entrepreneurs and members of the public. In total, more than 1,000 people participated in generating the ideas leading to the proposals. The Committee reported in January 2010. It made recommendations around the broad strategic direction of the economy (towards ‘productivity-led growth’, suggested a new growth target, and identified many new initiatives). The government subsequently adopted the recommendations and approach.

11.6 Execution of Strategic Policy Once strategic policy direction has been set, governments need to have the ability to bring resourcing and processes behind the priorities. Small country governments, which are less complex, are likely to be able to do this in a more efficient, effective manner – marshalling resources, people and agencies behind a clear and common goal. One useful recent example of this process is the ‘NZ Inc’ approach from New Zealand. Scotland Means Business: The Strategy

105

11.6.1 NZ Inc Strategies The strategies are plans of action for strengthening New Zealand’s economic, political and security relationships with key international partners. They target countries and regions where New Zealand has existing or emerging relationships, and there is potential for significant growth. The strategies look at the future possibilities in these markets over the next 10-15 years, set ambitious five-year goals and specify the steps the Government will take, often working with business, to achieve them. The motivation for developing these NZ Inc strategies was to find ways to better deploy government resources in order to grow New Zealand’s relationships with key countries. Many New Zealand public sector agencies are working to develop relationships with these other countries: for example, export promotion, foreign affairs, immigration, tourism, police, customs and defence, education, and so on. An overarching objective for the NZ Inc strategies is to achieve better alignment and coordination among these agencies, so they are more effective and efficient, including in the support services they provide to business. A structured process was developed that involved intensive engagement between all the government agencies that work in and with these countries. This allowed for better understanding of the full range of activities being undertaken, and where there were opportunities to do things more effectively and efficiently. This work was overseen by a permanent steering group of Chief Executives chaired by the Secretary of Foreign Affairs, and aspects of the process also involved the business community. India and China were the first NZ Inc strategies (in 2011), with strategies for the US, Australia, ASEAN and the Gulf Cooperation Council now released. Specific targets for different dimensions of the relationship were specified, such as exports, tourism, and so on. There is also a process for on-going monitoring, in order to assess whether these targets are being achieved – as well as an on-going conversation in order to make adjustments. This process gives operational effect to the government’s strategic goal of developing these key relationships.

11.7 Lessons from Denmark The Danish approach to policy, discussed in more detail in Appendix E, offers a number of lessons from which Scotland can learn. These include: •

implementing change in society and in the economy by dialogue and cooperation requires a cultural change and so it will take some time to set up the structures required to ensure this works well;

•

strategy and policy making needs to have a long term outlook, beyond the 4/5 year political cycle, at least in those (many) areas where there is a high level of political consensus;

•

governments need to work with business organisations (to get an overall or sector view) and with individual businesses (to access real hands-on knowledge);

•

the corporative approach involves not just government and business but also a range of other interests including trade unions, education providers, research institutions and public agencies;

Scotland Means Business: The Strategy

106

•

the development of policy is an intensive and comprehensive process. The development of the Globalisation Strategy took around a year and involved frequent meetings, typically over two days;

•

the process includes international benchmarking and best practice lessons, as well as drawing on domestic interests and experience;

•

policy development processes should be wide ranging rather than focused on specific problems or opportunities. For example, the Globalisation Strategy includes 350 specific initiatives;

•

the corporative approach should be extended to implementation as well as developing policy. It is common in Denmark for initiatives to have Boards with representatives from government, business and others;

•

implementation arrangements should be formal, for example, with framework agreements on mutually binding partnerships; and

•

ensuring that the corporative approach is also taken to implementation allows for continuous review and development of policy initiatives.

However, while Denmark has been identified as a useful comparator to Scotland, it should not be assumed that everything always works well. For example, the implementation of the ambitious sector growth plans has been challenging due to the limited availability of resources for new initiatives. Scotland can learn from what hasn’t worked so well in other countries as well as from best practice.

11.8 Implications for Scotland This analysis contains several implications for Scotland. First, the ability to achieve strategic coherence in policy is central to achieving national outcomes and senior Ministers, officials and central agencies need to own and champion this process. Such strategy functions are commonly located in Prime Minister’s Offices or equivalent. Second, there needs to be a process to develop a clear, well-understood, and over-arching sense of Scotland’s place in the world, the basis on which it will compete and the strategic direction in which it will move. This process needs to be undertaken in an externally-oriented way, looking at the international environment and be specific enough to guide a range of decisions and actions. This should be undertaken in collaboration with business and other stakeholder groups to ensure a broad range of perspectives are obtained. Third, there needs to be clear connection and consistency between the diagnostic phase, the development of a medium-term strategic policy response and the execution and delivery phase. A coherent strategy needs to integrate all three of these steps and ensure consistency across a wide range of policy areas (rather than having specific policy areas guided by different goals). This is why senior, central oversight of this process is vital. Institutions and capacity should be built to ensure that this could be delivered on an on-going basis.

Scotland Means Business: The Strategy

107

IMPACTS OF STRATEGY Key Findings • a new economic strategy for Scotland, based on the corporative approach recommended by N-56 should result in policies more suited to Scotland’s needs, opportunities and preferences; • this should lead to a more competitive, better performing Scottish economy; • based on historic trends of productivity growth, but no change to population trends or the employment rate, Scottish GDP would increase by a third over the next 25 years to £192 billion. However, this means that Scotland will fall further behind faster growing competitors; • however, increasing productivity to match the top quarter of advanced economies, increasing the employment rate to the average of the top five and halving the gap between UK and Scottish population growth, would increase GDP from the baseline of £145 billion in 2012 to £269 billion by 2037, an 86% increase over 25 years; • this would also increase GDP per capita by two-thirds, by more than £18,000, from around £27,000 to more than £45,000; • projections for Scottish public finances, albeit based on pessimistic forecasts on oil revenues, forecast a bigger deficit than for the UK economy as a whole. Whatever the outcome of the independence referendum it is difficult to see a political future where the rest of the UK would fund such a deficit. The only way to deal with the deficit is therefore to accelerate Scottish economic growth; • even using the Treasury’s projected Scottish deficit of £9.5 billion, the faster growth scenario associated with increased productivity, an increased employment rate and additional population could eliminate this deficit within seven years, and generate significant surpluses thereafter. The development and implementation of a new economic strategy for Scotland, based on the corporative approach recommended by N-56 should result in policies more suited to Scotland’s needs, opportunities and preferences. This should lead to a more competitive, better performing Scottish economy. N-56 believes that the overriding objective of Scotland’s new economic strategy should be to increase economic growth so that, over time, Scotland becomes one of the wealthiest five countries in the world, measured in economic output per person (GDP per capita). However, the success of the strategy should not be assessed entirely on Scotland’s GDP per capita growth. Other measures of the economy such as gross national income (GNI) and wider measures such as the Human Development Index and the Gini-coefficient should also be monitored. The transformational strategies set out in this document are based on creating the conditions for growth in the Scottish economy, primarily through two mechanisms: •

increasing economic participation; and

•

export-based growth.

N-56 intends to undertake further research and analysis that considers the potential effects of the transformational strategies on the Scottish economy and on public finances. Scotland Means Business: The Strategy

108

However, this section provides some preliminary analysis, showing the significant impact that a new economic strategy for Scotland can make.

12.1 Scottish Economic Growth Scenarios In 2012-13, the GDP of the Scottish economy was £145 billion and so Scotland accounted for 9.2% of the UK economy (which had a GDP of £1,574 billion). Scotland has 8.3% of the UK population so GDP per capita in Scotland, of £27,227 in 2012-13 was 11% higher than for the UK. However, when compared with more successful advanced economies a number of gaps in performance can be identified: •

participation: while Scotland has a higher employment rate than the UK as a whole, at 69.4% of the 15-64 population, it is only 14th in the OECD. If Scotland was to match the average of the top five (Iceland, Switzerland, Norway, Netherlands and Sweden), that would require 7.5% increase in the rate, requiring a 10% increase in the number of jobs in the economy;

•

productivity: Scotland is currently in the third quartile of OECD countries for productivity, measured by GDP per hour worked (on an index where the United States is 100, Germany is 92.7 and Scotland is 78.4; comparator economies, with higher levels of trade include Norway at 137.8, Luxembourg at 129.7, Ireland at 112.6, Switzerland at 89.1, Denmark at 88.8, Sweden at 85.9, Austria at 85.6 and Finland at 79.8). Scotland would require a 15.5% increase in productivity to be in the top quartile of OECD countries;

•

population: the Scottish population has been static while more successful economies such as Norway and Denmark have experienced population growth. If Scotland had matched UK population trends since 1951 the Scottish population would be 1.3 million higher than it is in 2014. Over the next 25 years, the Scottish population is forecast to grow by less than 9%, compared with a 15% projection for the UK as a whole.

•

trade: even if trade with the rest of the UK is included in Scottish trade figures, Scotland’s trade per capita of $55,800 is well short of the $75,000 average for a small advanced economy. Scotland’s trade volumes would need to increase by a third to match the average for small advanced economies and, if oil and gas exports were excluded, Scottish trade would need to increase by 60% to match competitors, some £94 billion in additional trade.

Population trends and employment rates are also correlated with economic growth. Trends in working age population, productivity and economic participation have a significant combined effect on economic performance over time. Scottish population forecasts show an ageing population with a small drop in the working age population. This means that, with no increase in productivity and no increase in the employment rate, there would be a small decline in GDP in Scotland, by 1%, over the next 25 years and a decline in GDP per capita of 9%. However, even if the Scottish economy continued to underperform relative to competitors, some productivity growth would be expected. Based on trend productivity levels (growth of around 0.6% per annum less than the average for small advanced economies), but no change to population trends or the employment rate, GDP would increase by a third to £192 billion, increasing GDP per capita by 22% to more than £33,000. Scotland Means Business: The Strategy

109

Increasing productivity, population trends and the employment rate would all increase economic growth: •

productivity: increasing productivity to match the top quarter of advanced economies would increase GDP to £222 billion by 2037, a 54% increase over 25 years and GDP per capita by 41%, to more than £38,000 (an increase in output per person of £6,500 more than current trends would achieve);

•

participation: increasing the employment rate to the average of the top five advanced economies (from 71% to 80%) would generate more than half a million jobs in the Scottish economy and increase GDP to £218 billion by 2037, a 51% increase over 25 years and GDP per capita by 38%, to almost £38,000; and

•

population: halving the gap between UK and Scottish population growth (increasing to 6.11 million from 5.31 million in 2012, equivalent to 330,000 more people than current projections predict, mostly of working age people, retained in Scotland and attracted to move to Scotland by a growing economy) would increase GDP to £204 billion by 2037, a 41% increase over 25 years and GDP per capita by 26%, to more than £34,000.

However, the transformational strategies set out in this contribution to a new economic strategy for Scotland would be expected to deliver a mix of productivity growth, population growth and an increase in the economic participation rate. Increasing productivity to match the top quarter of advanced economies, increasing the employment rate to the average of the top five and halving the gap between UK and Scottish population growth, would increase GDP from the baseline of £145 billion in 2012 to £269 billion by 2037, an 86% increase over 25 years. This would also increase GDP per capita by two-thirds, by more than £18,000, from around £27,000 to more than £45,000. These growth scenarios are summarised in Figure 12-1. Figure 12-1 – Impact of Production, Participation & Population on Scottish GDP No#produc)vity,#par)cipa)on#or#popula)on#growth#

Trend#produc)vity,#par)cipa)on#&#popula)on#

Higher#produc)vity#growth#

Higher#employment#rate#

Higher#popula)on#growth#

Higher#produc)vity,#par)cipa)on#&#popula)on#

!300!!

!250!!

!200!!

£bn! !150!!

!100!!

!50!!

20 12 20 ! 13 20 ! 14 20 ! 15 20 ! 16 20 ! 17 20 ! 18 20 ! 19 20 ! 20 20 ! 21 20 ! 22 20 ! 23 20 ! 24 20 ! 25 20 ! 26 20 ! 27 20 ! 28 20 ! 29 20 ! 30 20 ! 31 20 ! 32 20 ! 33 20 ! 34 20 ! 35 20 ! 36 20 ! 37 !

!"!!!!

Scotland Means Business: The Strategy

110

Source: Analysis based on data from OECD, Scottish Government and ONS

12.2 Public Finance Projections A number of projections for UK and Scottish public finances have been made, including by the Office for Budget Responsibility (OBR) and the Institute for Fiscal Studies (IFS). Some of these projections are for 30 or 40 years into the future and should be read with some scepticism, since analysis of the Scottish economy undertaken 30 or 40 years ago did not predict the Scottish economy of today. For example, the growth of the oil and gas sector would not have been anticipated nor would the communications revolution or the development of a knowledge based economy. However, such analysis does tell us something about the implications of the current trajectory of the economy and should be of some concern. The analysis predicts that, based on current policies, albeit based on pessimistic forecasts on oil revenues, that Scotland will have a bigger public sector deficit than for the UK economy as a whole. More detail on the trajectory of public finances is included in Appendix B. These show that, based on OBR forecasts of oil and gas revenues, Scotland could have a public sector deficit of around 5% of GDP, £9 billion in 2016-17, down from £12 billion in 2012-13, but higher than that projected for the UK. Whatever, the outcome of the independence referendum it is difficult to see a political future where the rest of the UK would fund such a deficit. The only way to deal with the deficit is therefore to accelerate Scottish economic growth. The revisions to economic and fiscal projections published by the OBR show the impact that higher economic growth can have on public finances. If the revisions published in December 2013 and March 2014 are compared with the March 2013 projections, which were based on lower economic growth forecasts for the UK, the OBR figures show that each £1 billion marginal increase in nominal GDP increases taxation receipts by £223 million and reduces public sector spending by £46 million and so reduces the borrowing requirement by £269 million. On this basis, a deficit of around £9 billion would require an increase in GDP of around £35 billion. The faster growth scenario associated with increased productivity, an increased employment rate and additional population could eliminate this deficit within seven years, and generate significant surpluses thereafter. If oil revenues are higher than forecast by the Treasury, as the industry currently expects, Scotland’s public finances would be stronger than the UK’s (as they have been over the last three decades), providing an opportunity to eliminate the deficit earlier.

Scotland Means Business: The Strategy

111

SCOTLAND MEANS BUSINESS: THE STRATEGY APPENDICES

Scotland Means Business: The Strategy

112

APPENDIX A: POLICY MAKING IN DENMARK The recommended corporative approach to policy making set out in the Scotland Means Business: The Strategy is one that works well in other countries. Chapter 11 provided an overview of the approach in several successful economies. This appendix provides more detail on how the approach works in Denmark. This has been prepared by DAMVAD, whose consultants have been personally involved in the development of the strategies used as examples.

13.1 Case Study: Economic Policy Making in Denmark Denmark has a long tradition for including business in long-term strategy and policy development. Business is included from early stages and not only as a hearing partner when a new initiative is developed. Both business in the form of business organisations and as representatives from individual companies are involved in the development. This way, both the view from a sector and of the companies who has the real, hands-on knowledge get included. In 2005, the Danish government launched a comprehensive Globalisation Strategy, with the aim to make Denmark ready for the future. The final strategy was launched in 2006, with 350 specific initiatives. All together, these initiatives require extensive reforms of education, research and entrepreneurship and improvements in the framework conditions for growth and innovation in Denmark. In the development of the strategy, views from broad groups of society was incorporated, as business organisation and company leaders were part of the real work and the actual framing of the strategy. In 2012, another initiative focusing on enhancing productivity in key sectors was initiated. This time also with strong inclusion of relevant stakeholder but in a different, more sectorial setup. Again, with business involved both as business organisations and as individual companies. The result of the extensive work is eight sector specific growth plans. Besides differences in the work process in the Globalisation Strategy and the Growth Plans, there is also external differences. First, there is the global economic situation. In 2005, there was a very favourable economic situation with low unemployment, whereas in 2012, countries are still recovering from the economic crisis and there is continuous job loss and higher unemployment. This have an impact also in the amount of funding allocated to implement the initiatives identified in the strategic work, and thus on the expected outcome. Second, there is a difference in government. In 2005, it was the liberal party Venstre and the Conservative People’s Party who had the power, whereas an election in 2011 put the Social Democrats, Danish Social Liberal Party, and Socialist People’s Party in office. Furthermore, the timing of the process differ. In 2005, the government had been ruling for years and ideas had grown over time, whereas in 2012, the government was brand new, and the growth plan was one of the first initiatives they launched. In the following, a short description of the Danish experience on how society can be included in long-term strategic setting is given. Next, two cases, the Globalisation Strategy, and the Growth Plans – “Denmark at work”, is presented.

Scotland Means Business: The Strategy

113

13.2 The role of business in policy development and implementation The Danish parliament has 179 members represent 8-10 parties, depending on the number of small parties. The governing party/parties are most often from either centre left or centre right, with support from other parties in the vicinity. Generally, the Danish state welfare model receives a broad parliamentary support, and no ruling party rejects this model. On many issues, political parties tend to opt for cooperation, and government bills rarely become law without negotiations and compromise with both supporting and opposition parties. This makes a decision more credible for business to act on, as it is less likely to be changed with a change in government. 13.2.1 Dialogue and ownership Denmark has a long history of implementing changes in society through dialogue and cooperation. There is also a long tradition for including business and opposition in the more long-term, strategic development that points the direction for the Danish society. The idea is that in order to succeed, it is important that everyone have an incentive to anchor the transition and innovation locally and in the specific companies. A successful strategy needs broad ownership across Danish society. One of the benefits of having established a working group â&#x20AC;&#x201C; whether it is an appointed council or a strong team with broad participation from society is that is stirs discussion throughout society on the issues discussed. This way the discussion are likely to reach a broader group than would otherwise be the case. When relevant ministries connected to the working group make a commitment to make the developed output happen politically, it creates a strong basis for a constructive working group and active involvement from members become more likely. Figure 13.1 â&#x20AC;&#x201C; Co-operation

educa6on%and% research%demand%for% the%relevant%and% high%level% knowledge% produced%

broadly%agreed% poli6cal%frame%on% what%society%needs% in%the%long%term%

business%and% industry%2% commercial% interests%and% suďŹ&#x192;cient%supply%of% input%

long%term%strategy% based%on%input% and%desired%long% term%goal%2%and%a% plan%on%how%to% get%there%

Source: DAMVAD

Scotland Means Business: The Strategy

114

In such a process, the value of the input should be met by or offset by the value of the output. In most cases this will translate to resources being allocated to implementation – otherwise the transition should have taken place regardless. 13.2.2 Business involvement in permanent framework Besides being included in the ad-hoc strategy and long term planning, business also has permanent representation, in areas with strong commercial interests. The board of directors in strategic, and to some extent commercial bodies, also includes relevant private sector business leaders. This is the case in e.g. Vækstfonden (The Danish Growth Fund), a funding body that aim to assist in creating new growth companies by providing capital and expertise. By promoting growth and innovation in small and medium-sized enterprises they will achieve greater socio-economic returns. It is an independent growth fund with its own Board of Directors. Figure 13.2 - Members of Vækstfonden board of directors Member

rNo

Percent

Private sector/retired from private sector

Public

Source: Danish Growth Fund

The Minister for Business and Growth appoints the board members of the foundation. The chair of the board is Carsten Koch, who most recently had a position in a public foundation, and has a long career in Danish politics in 199400. Two-thirds of the members are from the private sector Another example is EKF, Denmark’s Export Credit Agency. EKF helps Danish companies with export by raising finance and by insuring companies and banks against the potential financial and political risks of trading with other countries. EKF is owned and guaranteed by the Danish state but operated as a financial enterprise. Figure 13.3 - Members of EKF board of directors Member

Percent

Private sector/retired from private sector

Public

Source: EKF

The Minister for Business and Growth appoints the board members. The chair of the board is Bent Pedersen, retired from the positions at various private companies. Representatives from the private sector or a private sector background account for more than 60 per cent of the board. In both these cases, valuable expertise from business is included in the work of the foundation and agency. It is acknowledged that business have more exact experience with and knowledge of how an instrument work in a situation on the real market.

Scotland Means Business: The Strategy

115

13.3 Globalisation Strategy (2006) 13.3.1 Background The idea of making a Globalisation strategy was based on a wish to make Denmark among the most attractive companies in the world to live and work in, in a more globalised future. In order to seize the opportunities in the global development, Danish society had to be transformed. By making investments in Denmark more focused it would generate better opportunities for growth and prosperity in the future. The aim with the initiative was to develop a vision and strategy to make Denmark the leading growth, knowledge and entrepreneurship society. Furthermore, the initiative should address lacking productivity and the fact that growth in productivity had been weak. To tackle this, the idea was to rethink the current framework and create new ideas, to reach a prosperous and full society. 13.3.2 Setup and process In April 2005, the government started this development by establishing a ministerial committee to lead the process, and a Globalisation Council to advise the ministers on a strategy for Denmark in the global economy. The ministerial committee comprised of ministers from five relevant ministries, and the prime minister served as head of both committee and the council. To support the council and the committee there is a secretariat was established. The Globalisation Council included representatives from many parts of society key groups of society across traditional divides â&#x20AC;&#x201C; employers and trade unions, industrial organisations, education and research community and companies worked together. Figure 13.4 - Members of the Danish Globalisation Council Member

Number

Percent

Academia

Minister

Other

Total

100

Company Business organisation

Source: Ministry of Business and Growth

More than 60 percent of the member for the Danish Globalisation Council are from the private sector â&#x20AC;&#x201C; either companies or business organisations. The process ran for a year, with a high meeting frequency, with most meetings running two days. All members of the council prioritised the participation in the meetings, both initial challenge-exploring meetings, and a number of more themebased meetings. National and international expert delivered presentation on the first day and discussions on presented topic the next day. All materials from the meetings were available to the public, and topics were open to discuss in the open.

Scotland Means Business: The Strategy

116

The process is not a hearing, where stakeholders are invited to state the opinion, but a working process where members of the council are also developing policies. 13.3.3 Outcome In the end, the strategy, titled Progress, Innovation and Cohesion â&#x20AC;&#x201C; Strategy for Denmark in the Global Economy, listed 350 specific initiatives calling for extensive reforms. The strategy also had focus on improving efficiency of public spending on education and research by allocating more public funds in open competition and on increasing competition in the Danish economy as a whole. The targets are presented in figure 3.2. below. Afterwards, each member of the Council signed a framework agreement on mutually binding partnerships, in which the companies and organisations are to contribute to the implementation in practice. By signing the partnership agreement, the government involved and engaged large part of society, and gave everyone a responsibility. To support the implementation of the strategy, resources were allocated to carry out some of the initiatives. After completion, the government also committed themselves to monitor the implementation and each year publish a competitiveness report that evaluates and give a status on the areas, with importance to Denmark. This report continues to be published once a year. For such a process, with extensive allocation of time and resources among both business and politicians to be a success it is important that output is visible, and the product is not just another report. An English summary of the strategy can be found here http://www.stm.dk/multimedia/PROGRESS_INNOVATION_AND_COHESION.pdf Figure 13.5 â&#x20AC;&#x201C; Danish Globalisation Strategy Objectives

Source: http://www.stm.dk/multimedia/PROGRESS_INNOVATION_AND_COHESION.pdf

13.4 Growth plans (2012-14) 13.4.1 Background In 2012, the situation was different. Following the economic and financial crisis, job loss and bankruptcies are more common. There has been a change in Scotland Means Business: The Strategy

117

government, now constituted by Social Democrats, Danish Social Liberal Party, and Socialist People’s Party. This government are trying to find ways to get Denmark back on the international scene as a competitive player. To make that happen, the government announced that they would look to create a more result-oriented business policy. The industrial policy should be more focused and the right framework conditions has to be in place – and productivity improvement is still at issue. Increasing Globalisation also increase specialisation and there are a number of areas appointed as Danish key sectors. The sectors were selected based on an assessment of where Danish companies has special competences, and where global demand is expected to rise. This lead to identification of eight areas as Danish key areas; •

Maritime Denmark

•

Creative Business and Design

•

Water, Bio and Environment Solutions

•

Health- and Welfare Solutions

•

Energy and Climate

•

Food

•

Tourism and

•

IKT and Digital Growth.

13.4.2 Setup and process Contrary to the Globalisation Strategy work, this time a ministerial committee is established to look at business and growth. The ministerial committee had members from 14 ministries. Though their task was to develop the actual growth plan, they had to make sure all relevant aspects was covered. To assist and inspire the committee, people, organisations or companies with specific, relevant knowledge was appointed to an area specific growth team. The eight teams had between 8-11 members, and the average composition of the teams is shown in table 18.6 below.

Scotland Means Business: The Strategy

118

Figure 13.6 - Members of Growth Teams Member

Percent

Private sector company Academia

58 9

Public authorities

Other

Total

100

Source: Ministry of Business and Growth Note: Average of Growth Teams. Composition on the single team differ

The representation of private sector companies was very strong in the teams. The task of the teams was then to develop concrete suggestions to the ministerial committee. After the team present their recommendation and initiatives, the ministerial committee used it as in-put in a concrete plan for growth in each issue. The last of the eight teamsâ&#x20AC;&#x2122; conclusions was presented in 2014. 13.4.3 Outcome With the growth plans, the Danish government, in partnership with enterprises and institutions, in-tends to pave the way for Denmark to unlock any commercial potential within each areas. This will also ensure the continuous development of policy initiatives. Despite good recommendations, suggestions and initiatives included in the growth plans, the entire process has been challenged by the fact that there are no resources to carry out new initiatives and thus the possibility for making substantial changes to the framework conditions are limited. The nature of the output is fragmented â&#x20AC;&#x201C; but the ambitions are high. This is not least due to the fact that what was supposed to be a focused growth plan for only key sectors ended up with covering most of the economy. With few resources available for the execution of the plans, prioritisation is crucial. It is still too early to assess the outcome of the comprehensive work. However, with this involvement and allocation of time to develop the plans, it is important that especially directly involved people and organisations can see some form of output.

13.5 Conclusion Business organisations and companies play an important role when new business and growth policies are developed. The two cases provide examples of how the involvement are set up in practice. One of the differences is the focus; one is based on one council, with a broad focus and a wide range of stakeholder put together to identify the needs in order for Den-mark to reach the optimal society. In the other, the task is set beforehand â&#x20AC;&#x201C; to improve the conditions in specific sectors and the teams consist of sector experts. Common is however, the involvement of both organisations and companies and the recognition of the important knowledge, business sector possess.

Scotland Means Business: The Strategy

119

The Globalisation Council has been one of the largest and most ambitious setup with focus on research, knowledge, education and innovation. The work with the Growth Plans are more focused and with business sector development as the sole end goal. Education, research and development and innovation is still important, but is assessed within each sector. Generally, the perception from both sides that it is to the benefit of the society as a whole that business sector and policy makers work together from the early stages and along the way. This way, it is possible to address potential inexpediencies before they are developed and to have the business sector on board when an initiative is launched, creating political successes. Combined with the fact that the important political decisions often are agreed by both government and opposition, give a long-term credibility on strategies and direction.

Scotland Means Business: The Strategy

120

APPENDIX B: PUBLIC FINANCES OUTLOOK

14.1 Public Finance Projections The annual production of the Government Expenditure and Revenue in Scotland (GERS) report64 is generally accompanied by a political debate about the state of public finances in an independent Scotland. However, what the analysis covers is taxation and government spending associated with Scotland, as part of the UK. The Scottish Parliament does not have the power to make decisions about taxation (with the exception of local taxes which account for just 7.5% of taxes) and so the GERS report is as a result of decisions made by the UK Government. The GERS report often stimulates a debate about the state of the Scottish economy. Again, it should be noted that the analysis covers only the public finances, not the Scottish economy as a whole. Total gross domestic product (GDP) in Scotland in 2012-13 was £145 billion, more than £27,000 per person (the comparable figure for the UK was £25,000). The GERS report considers only the public sector, which spent £65 billion in 2012-13 (45% of GDP) and raised taxes of £53 billion (37% of GDP). The GERS report published in March 2014, which covered the 2012-13 fiscal year, showed that Scotland, with 8.4% of the population, received 9.3% of the UK’s public spending (including the spending of the UK Government in and on behalf of Scotland, as well as Scottish Government and local government spending) and accounted for 9.2% of tax revenues. Scotland’s public sector deficit in 2012-13 was £12 billion, equivalent to 8.3% of Scottish GDP. The UK public sector deficit (net borrowing) was £115 billion, 7.3% of UK GDP. In the previous year, 2011-12, the Scottish public sector deficit, at 5.0% of GDP, was smaller than the UK public sector deficit of 7.9%. The difference is as a result of falling oil revenues associated with a decrease in activity in the North Sea following the unexpected £2 billion increase in taxation for the sector in the Budget in 2011 and a decrease in tax revenues from the sector associated with higher investment, some of which can reduce taxation liabilities (although this investment will generate higher revenues in the future). However, 2012-13 can be reasonably described as an unusual year. Data on Scotland’s fiscal balances is available going back to 1980-81. On average, Scotland’s share of UK tax revenues collected has been 10.5% while Scotland’s share of spending has been less, 9.6%. While the detailed analysis of Scotland’s public finances needs to wait for the annual publication of GERS, which are always at least a year out of date, data and forecasts produced by the Office of Budget Responsibility (OBR) provide a basis for projecting what the future budget position of Scotland might be. The Institute of Fiscal Studies has produced some papers on this topic. The starting point for the analysis is the OBR’s projections for the UK economy and the UK public finances, the most recent of which was published in March 2014. These projections predict that the UK will continue to run a deficit until 2017-18, albeit reducing from 6.4% of GDP in 2013-14 to 0.8% of GDP in 201764

The latest Government Expenditure and Revenue in Scotland report, for 2012-13 was published in March 2013. The reports and associated data are available at: http://www.scotland.gov.uk/Topics/Statistics/Browse/Economy/GERS

Scotland Means Business: The Strategy

121

18, before returning to a small surplus of 0.2% of GDP in 2018-19 (Table 14-1). This continuing UK deficit will add some £450 billion to the national debt (that is almost half a trillion pounds). Table 14-1 - Projected UK Fiscal Position 2013-14 to 2018-19 £bn

2013-14

2014-15

2015-16

2016-17

2017-18

2018-19

Current Receipts

607.7

636.5

659.2

708.0

742.9

777.7

Expenditure

715.5

732.0

734.4

752.5

759.4

772.9

Net Borrowing

-107.8

-95.5

-75.2

-44.5

-16.5

+4.8

Net as % GDP

-6.4%

-5.4%

-4.1%

-2.3%

-0.8%

+0.2%

Source: OBR, March 2014

Data from GERS shows that the Scottish share of non-oil taxes does not vary much from year to year; the average for the last 5 years is 8.3%. The share of oil revenues has varied between 84% and 94% in the last five years, the average is just over 90%. These proportions can be applied to OBR forecasts for UK tax revenues, to provide an estimate of tax revenues from Scotland. The GERS data also shows the proportion of spending that is accounted for by Scotland. This has been gradually declining, from 9.9% in the early 1980s to 9.7% in the mid-1990s to 9.3% now; the average for the last five years is 9.3%. The result of applying these assumptions to UK tax and spending projections from the OBR are summarised in Table 14-2 below. These results are similar to those produced by the Institute of Fiscal Studies on 4th March 2014 (of 3.6% deficit in 2017-18 and 2.5% in 2018-19). These results are also similar to those published by the Treasury on 10th April 2014, referencing analysis by the Centre for Public Policy Research’s (CPPR) and Citigroup, which project a fiscal deficit of 5.5% of GDP for Scotland in 2016-17, the equivalent to £9.5 billion. Both the Institute of Fiscal Studies and the Treasury forecast a Scottish deficit that would be proportionately higher than the UK, based on current UK Government fiscal policies. Table 14-2 - Scottish Fiscal Position 2013-14 to 2018-19 (based on OBR projections) £bn

2013-14

2014-15

2015-16

2016-17

2017-18

2018-19

Current Receipts

54.2

55.8

57.8

61.3

64.4

67.3

Expenditure

66.4

68.0

68.2

69.9

70.5

71.8

Net Borrowing

-12.2

-10.4

-8.6

-6.1

-4.4

Net as % GDP

-7.9%

-7.5%

-6.2%

-4.9%

-3.3%

-2.3%

Source: OBR & GERS, March 2014

However, these projections are based on OBR’s forecast of future oil revenues. OBR is forecasting that oil and gas production will be third lower in 2012-13 than in 2011-12 and will stay static at that level until 2018-19. This does not seem to take account of recent record levels of investment in the North Sea. OBR is also forecasting that oil prices fall during this period, unlike most forecasters, including the UK Government’s Department of Energy and Climate Change (DECC). OBR’s track record on oil and gas production is not great, as can be seen from the historic forecasts still available on the OBR website. For example, the June 2010 OBR forecast for oil and gas industry expenditure (from Scotland Means Business: The Strategy

122

which estimates of tax revenues are made) for 2012-13 was £15.1 billion and the actual was £22.1 billion, almost 50% higher than forecast. Industry figures for expected oil prices, production and tax revenues are significantly higher than those of OBR. The OBR projections for the next five years are for UK oil and gas tax revenues of £15.9 billion while the industry estimates (covering three scenarios) are in the range of £24.8 billion and £71.9 billion. The later will require the implementation of the recommendations of the Wood Review and a renewed policy focus on the sector. This is discussed in more detail in a separate Scotland Means Business report on the oil and gas sector (as are the projections for oil prices, production and tax revenues). The Scottish Government has published65 a number of scenarios for higher oil taxation revenues than OBR but all are close to the bottom of the range of industry forecasts. These consider the effects of different assumptions on oil prices, production costs and industry investment projections and show taxation revenues of between £24.0 billion and £38.7 billion over the next five years. Scenario 4 (oil revenues of £34.3 billion over the next five years), Scenario 5 (£36.8 billion) and Scenario 6 (£38.7 billion) would all mean that Scotland’s public sector finances were slightly stronger than those of the UK, as they have generally been for the last three decades for which data is available (Figure 14-1). Figure 14-1 – Public Sector Deficit as % GDP UK#

Scotland#(scenario#1,#OBR)#

Scotland#(scenario#5)#

Scotland#(scenario#6)#

Scotland#(scenario#4)#

3.0%&

Public&Sector&Deﬁcit&as&%&GDP&

1.0%&

2012!13&

2013!14&

2014!15&

2015!16&

2016!17&

2017!18&

2018!19&

!1.0%&

!3.0%&

!5.0%&

!7.0%&

!9.0%&

Source: Calculations based on OBR, GERS and Oil and Gas Analytical Bulletin

Public sector debt interest payments make a significant difference to Scotland’s public sector budget position. The 2012-13 GERS allocated a population share of UK debt interest payments to Scotland, some £4.0 billion. This is forecast to grow, to £6.4 billion by 2018-19. The analysis of public finances in Scotland in Scotland Means Business: The Facts showed that, due to the significant public sectors surpluses associated with oil and gas production in the 1980s, Scotland has not contributed to the build up

Scottish Government (May 2014), Oil and Gas Analytical Bulletin 3

Scotland Means Business: The Strategy

123

of debt by the UK Government. There is therefore a case to exclude debt interest payments from an analysis of government expenditure and revenue in Scotland. Figure 14-2 shows the impact of removing this contribution from the analysis. Even based on the OBR projections, Scotland’s public finances would be healthier than the UK’s, with the public sector deficit eliminated in 2017-18, one year ahead of the UK as a whole. Based on Scenario 4 for oil taxation revenues, Scotland’s public finances would have a surplus from 2016-17, rising to 2.5% of GDP (£4.7 billion) by 2018-19. Figure 14-2 also shows the effect of cutting public spending, in areas that do not impact on economic growth, with a £1 billion reduction cutting the 2016-17 deficit under Scenario 4 from 2.6% of GDP to 2% of GDP. Figure 14-2 – Public Sector Deficit as % GDP (with projections that exclude debt interest and the effect of lower public spending) UK# Scotland#(scenario#4)# Scotland#(scenario#4,#no#debt#i)#

Scotland#(scenario#1,#OBR)# Scotland#(scenario#4,#8£1bn)# Scotland#(OBR,#no#debt#i)#

3.0%&

Public&Sector&Deﬁcit&as&%&GDP&

1.0%&

2012!13&

2013!14&

2014!15&

2015!16&

2016!17&

2017!18&

2018!19&

!1.0%&

!3.0%&

!5.0%&

!7.0%&

!9.0%&

Source: Calculations based on OBR, GERS and Oil and Gas Analytical Bulletin

14.2 Credit Rating Over the last year, the credit worthiness of Scotland has been a matter that has often been raised in political debate and each of the three main ratings agencies (Moodys, Standard & Poors and Fitch) have issued reports looking at the implications for Scotland and the UK if Scotland was to become independent. However, it should be noted that the credit rating of Scotland and/or the UK does not necessarily make a difference to the interest rates that the Government has to pay on public sector debt – and so is unlikely to effect interest rates paid by either businesses and individuals (which in any case will be more effected by competition in the financial services markets than by base rates). The UK’s credit rating was downgraded by two of the three ratings agencies in 2013 but it has not increased the UK’s cost of debt. Ireland currently has a lower interest rate than the UK on bond yields, allowing the Irish government to borrow at a cheaper rate, despite its lower credit rating. Scotland Means Business: The Strategy

124

Other examples, include Denmark and Norway. Both are AAA rated by all three ratings agencies but Denmark’s borrowing rates are much lower than Norway’s. However, this is not a major concern for Norway since it tends to be a net lender throughout the economic cycle rather than a net borrower (due to its sovereign wealth funds). The three tables below show the ratings for selected countries for each of the three ratings agencies for 2006, 2009 and 2014 and Figure 14-3 shows the market interest rates for benchmark 10 year bonds, highlighting the lack of a relationship between credit rating and costs of debt. Table 14-3 – Credit Rating (Moodys) 10-Yr Bond Yield

Ireland

Germany

Denmark

Norway

May 2006

AAA

May 2009

AA1

AAA

May 2014

BAA3

AA1

AAA

Source: Moodys

Table 14-4 – Credit Rating (Standard & Poors) 10-Yr Bond Yield

Ireland

Germany

Denmark

Norway

May 2006

AAA

May 2009

AAA

May 2014

BBB+

AAA

AA+

AAA

Ireland

Germany

Denmark

Norway

May 2006

AAA

May 2009

AA+

AAA

May 2014

BBB+

AA+

AAA

Source: Standard and Poors

Table 14-5 – Credit Rating (Fitch) 10-Yr Bond Yield

Source: Fitch

Scotland Means Business: The Strategy

125

Figure 14-3 – Interest Rates on 10 Year Bonds 2006, 2009 & 2014

Ireland!

10#year#bond#yield#(%)#

US!

5! 4!

UK! Ireland!

Norway! Denmark! Germany!

Norway! Denmark! US! Germany!

UK!

Ireland! UK!

US!

Norway!

Denmark! Germany!

1! 0! May!2006! Ireland!

UK!

May!2009! Germany!

US!

May!2014! Denmark!

Norway!

Source: www.investing.com/rates-bonds

Whilst the three key credit rating agencies have differing methodologies for rating sovereigns, there are several overlapping criteria. The five principal areas are: •

institutional and government effectiveness;

•

economic structure and growth prospects;

•

external liquidity and international investment position;

•

fiscal performance and flexibility (including debt burden);

•

monetary flexibility.

Overall, all three credit rating agencies consider Scotland to be in a relatively strong position. The key reason for this is that Scotland is a wealthy and open economy whose macroeconomic profile matches that of other sovereigns rated in investment-grade categories. However, the reports that have been issued to date have mainly dealt with matters that would be negotiated should Scotland vote for independence, such as the details of a currency union and the arrangements for servicing current UK debt. By definition, those issues would be resolved before the agencies issued sovereign credit ratings for Scotland. For most of the issues that the credit ratings agencies consider, Scotland’s position would be the same as or similar to the UK’s. There are two main exceptions to that, one negative and one positive. An newly independent Scotland would have new institutions and so they would be untested (although some existing institutions would continue to be shared with the rest of the UK. On the other hand, as discussed at Section 14.1 above, Scotland’s public finances are stronger than that of the UK’s and have been consistently since 1980 (the earliest date for which data is available). On that basis it would be reasonable to expect the credit agencies to give and independent Scotland at least as good a credit rating as the rest of the UK. Scotland Means Business: The Strategy

126

N-56 aims to provide a new focus for Scotlandâ&#x20AC;&#x2122;s business community to work with government and others throughout the country, to plan a more prosperous future for the whole of Scottish society. The ultimate aim is to ensure that Scotland attains a position among the top five advanced economies in the world. If you would like to learn more about N-56, its aims and activities, please visit our website www.N-56.org

112 George Street, Edinburgh, EH2 4LH

Scotland Means Business

info@N-56.org / www.N-56.org / Follow Us on