Can Scotland invest to diversify growth and increase productivity?

By Nasira Rauf Bradley
Scotland is facing challenging winds from several directions. The slow recovery for the oil and gas sector has impacted the Scottish economy, and potentially government revenues, as evidenced by the recent GERS figures. Furthermore, the Fraser of Allander Institute expect such a potentially adverse influence of UK spending cuts on Scottish budgets, that in their recent report they suggest that ‘the budget challenge facing the Scottish government is arguably the toughest since coming to power in 2007’.

Importantly though, the institute also sees this as a period of unprecedented autonomy with the transfer of tax powers opening up opportunities, as well as challenges, for Scotland. Add to this the headwinds of potential turmoil of Brexit and Scotland indeed would appear to have some heavy sailing ahead. Challenging though as it appears – these can also be days of great opportunity for Scotland.
The challenge and the opportunity facing Scotland is to find diversified growth. To make use of the opportunity in these challenging times, requires an investing mindset, – paraphrasing the famous quote of Warren Buffet: ‘invest when others are fearful’. As Ray Perman alludes to in his blog, this requires more than minor tinkering with tax rates. Scotland needs to find the resources and mindset to lay down the foundations for future diversified and strong growth. Literature is littered with various growth theories and the deeper determinants required for driving growth. Without delving too deeply into the detail, suffice to say that Scotland, indeed UK as whole, has much of the essentials in place. Whilst there is always more to be done and indeed the essentials are not equally spread out across the country, a lot of the foundation is strongly present in the economy. Rather, it is a matter of finding the levers to drive further, pushing innovation across sectors – taking the economy to diversify strengths beyond oil and gas or indeed the financial sectors – that could deliver Scotland a growth boost.
There is talk of revival of UK industrial policy by the Prime Minister, less a form of vertical policy involving picking of winners, more perhaps a push into infrastructure expansion and corporate governance. This perhaps misses the fact that UK has always retained a certain amount of industrial policy in place over successive governments, as outlined by BIS in their report in 2012. This did appear to be translated under the coalition government into some form of support for the automotive, life sciences and advanced manufacturing sectors amongst others. Whilst the new industrial policy is yet to be clarified and how it effects previous initiatives, it may only partially address Scottish challenges – an economy weighed down quite substantially by the struggles in the oil and gas sector and a lower productivity on average than the rest of UK. Scotland may need to find its own specific levers.
Scotland, as pointed out by Fraser of Allander, is gaining control of certain tax and finance powers. It is these levers, which can offer great opportunity for innovation and above all productivity for Scotland. They could be used to deliver a specific Scottish horizontal policy, helping kick-start an ecosystem in which market forces can thrive and hopefully create our own winners. If Scotland could succeed in pushing innovation and creating an ecosystem that delivers the Googles and Apples of tomorrow – we could find one of the drivers of higher productivity. These giants have been found to deliver higher productivity, with small and medium firms with disruptive technologies pushing the boundaries of innovation as well as expanding employment.
What tax incentives could Scotland then put in place to create the ecosystems that would make this happen? One of the answers lies in venture capitalism – not a small push – rather a concentrated boost to upscale the market. Significantly up scaling the number of accelerators or incubators like Code Base in Edinburgh to support innovative start-ups.
As an example, Scotland can look to examples such as Yozma). With less essentials in place, an economy using tax incentives and fiscal investment kick-started a venture capital industry to become now the highest venture capital investment as a percentage of GDP in the world – not US, but Israel. By that metric, in 2013 US ranked 2nd and UK 13th amongst OECD economies. Not a sufficient reason in itself, but perhaps it may be one of the factors that could help explain why UK, despite its brilliant range of start-ups, has not yet created a Google.
To understand where Scotland stands, we need to look at the venture capital figures of today. Over the last few years the UK, as a whole, has shown a remarkable shift in its position. According to BVCA investment activity report in 2015, UK venture capital investment today stands at £5.9 billion, compared to a US figure of £47 billion. The UK has achieved an astonishing growth, but 45% of this was in London alone. Scotland only drew in £138 million of venture capital investment, 2% of the UK total. On a per capita basis this is a fifth of the average UK investment and 25 times lower than London. Can Scotland then find levers specific to its economy?
A lot can be done. On the demand side, increasing knowledge partnerships could help align skills between universities and businesses, concurrently augmenting commercialisation of research. Increasing the number of incubators and accelerators and clustering them with business parks could provide a healthy cocktail of disruptive forces, mixing with best practices needed to create the giants of tomorrow. However, the greater challenge may lie on the supply side. The size of the pool of venture capital investment available in Scotland suggests a shortage of funding – potentially hampering firms from growing beyond the start-up phase. Skyscanner seems to have succeeded against the odds. What Scotland needs is not only more Skyscanners, but also the next DeepMind and the new ARM.
To overcome this funding gap, Scotland could target similar levels of venture capital investment initiated by Israel in 1993 in the Yozma programme. Then the Israeli government invested $100 million (0.1 % of then Israel’s GDP) of public funds to leverage foreign financing from US, Germany and Japan to launch an intensive venture capital in high growth industries. In today’s terms, that would require Scotland to invest in the region of £200 million to draw in comparable venture capital investment. Since the Scottish Investment Bank committed £66 million in 2015 the gap, though significant, seems attainable.
Could Scotland view this as a targeted venture with a time-scale? History would imply yes. Within seven years Israel reached the stage where private sector exceeded public investment and allowed the government to phase out. This venture capital expansion programme could be accompanied by an initiative to bring back Scottish Diaspora similar to the Irish effort, targeted towards attracting back experienced entrepreneurs. Scotland already has a lot of essentials in place to create a similar eco-system as in London today. Expanding the presence of both venture capital and experienced entrepreneurs could prove significant in boosting innovation, spurring growth of firms across sectors.
Nasira Rauf Bradley is a researcher at the Adam Smith Business School, University of Glasgow, with particular interest in innovation, growth and productivity. The views expressed are her own and do not necessarily reflect the views of the David Hume Institute.