EEF blog

The third of our ambitions we want the government to set out in a stronger, clearer growth strategy on Budget Day is to see more companies in the UK bringing new products and services to market.

Why is this important?

There is no such thing as a sustainable competitive advantage. Firms that invest in innovation grow faster and are more productive. This is essential to stay ahead of the competition, especially given the inability of the UK to compete with fast-growing developing countries on relative labour costs.

We have strengths supporting the development of new products and services already. The UK has a good ‘knowledge infrastructure’ (e.g. world-leading universities) and the government has protected its investment in our science base.

However, we are weak in other parts of the innovation chain, in particular commercialising new products and services – taking a design from prototype or proof-of-concept to a commercially produced and sold reality.

How can we measure performance against this ambition?

In common with our other ambitions, we think the government needs to establish a credible set of measures by which progress can be demonstrated. For this ambition we think the measures should be by 2015 that:

• Real business enterprise sector investment in R&D returned to the UK’s pre-recession peak;
• 60% increase in the take-up of the SME R&D tax credit

We’ve chosen these measures quite deliberately – let me explain:

Real business enterprise sector investment in R&D to return to the UK’s pre-recession peak

To see companies bringing new products and services to market in the UK we need to see more basic research capitalised here. This will be driven primarily by businesses. Real business enterprise sector investment in R&D (BERD) is also an internationally comparable metric of business R&D.

National Statistics show that the 2007 figure for BERD in the UK was just under £12 billion. This fell to £11 billion by 2010 (both 2007 and 2010 figures in 2010 prices).

To return to 2007 levels would require 1.5% year on year growth in real business investment in R&D (roughly 8% growth in total). This is below the UK average growth rate from 2002-2007 – but BERD has fallen in every year from 2007-2010.

So we think returning BERD to the pre-recession 2007 peak is a stretching but realistic target.

60% increase in the take-up of the SME R&D tax credit

While the BERD target captures the overall level of business spending on R&D it doesn’t tell us about the number of firms, particularly SMEs, which face the greatest barriers to investing in R&D.

A boost in the number of smaller firms investing in R&D would be indicative of more of our SMEs moving into more productive growth cycle.

A 60% increase in the take up of the SME R&D tax credit would be measured from 2014/15 relative to 2009/10.

HMRC statistics show that average growth in claims since 2003/04 has been c7%; but from 2007/08-2009/10 (the latest year available) the annual average growth has been 12%.

60% growth over the five year period would require growth in 2010/11 of 7% but then growth accelerating to 11%pa 2011/12-14/15. Given that the government has increased the generosity of the scheme, we think this is realistic.

However the billions of pounds worth of estimated unclaimed R&D tax credits suggests the government has some work to do to get the word - and benefit - out there about the scheme.

George Osborne has made a major improvement to the UK’s tax environment for R&D today by announcing in his Autumn Statement that the R&D tax credit will become payable ‘above the line’ from 2013/14.

This reform will increase investment from companies already the UK as well as bring additional investment in R&D to the UK.

The change means that rather than large firms accounting for the R&D tax credit in their tax return ‘below the line’, the benefit will be accounted for upfront in R&D budgeting ‘above the line’.

The key benefits of moving to an above the line credit are:

• Creating a simpler system;
• Strengthening the link between the R&D tax credit incentive and the parts of companies where investment decisions on R&D are made;
• Increasing certainty around the timing of the benefit of the R&D credit by decoupling it from a company’s tax profile.

Innovation is crucial for keeping ahead of the competition, generating better balanced growth, and creating high-value jobs.

When the R&D tax credit system was introduced it was a positive development for the UK. But our competitors do not stand still. Many countries have sought to incentivise greater expenditure on innovation and attract mobile R&D investments by introducing reforms to their own schemes to increase the incentive effect.

Today Mr Osborne has responded. He has made clear that the ambition he stated in March, to make the UK ‘the most competitive tax environment in the G20’ means the whole tax system, not just the headline rate. This is welcome news because it corresponds to how companies see the impact of taxes.

PwC has conservatively estimated this reform would deliver £665 million per annum of additional value to the economy at a net cost to the Exchequer of £205 million per annum. These are meaningful numbers at a time when the UK must be doing all it can to support growth.

The government’s Plan for Growth in March set out an ambition of making the UK the most competitive tax regime in the G20.This is a really positive ambition. But the ambition jars a little with the reality of some of the policy changes and some of the rhetoric.

The government used a cut in capital allowances to help pay for its headline corporate tax cut. And in the measures included under its Plan for Growth ambition, the ‘lowest corporate tax rate in the G7’ appears as a measure.

It all seemed to suggest the focus is very much on corporate tax alone.

For manufacturers, indeed for businesses in general, tax is tax no matter what its label might be. Mobile investors will take into account the complete picture including incentives for R&D, capital allowance regimes, and environmental taxes – as well as main rate corporate taxes.

However, recently there does seem to have been a greater acknowledgement by the government of the breadth its ambition for the most competitive tax regime must have to be credible.

For example in recent consultations on modifying the R&D tax credit, HM Treasury explicitly mentions its ambition for creating the most competitive tax regime.

We now want to see the ambition broadened out further to include the full picture on tax faced by businesses. An important part of this would be creating a measure to demonstrate how the overall burden of taxes faced by businesses is changing – and how that compares with our competitors.

This measure is necessary to not only show progress year-on-year as the government rolls forward its tax reforms but also to help define the success we are aiming for.

By creating this framework we then have something we can hang policy proposals off. And this is what leads me to EEF’s recommendations in our submission to the government in advance of the Autumn Statement.

We are looking for reforms that cover a wide span of the tax landscape manufacturers face:

1. We want to see the UK create the most competitive tax regime for innovation

Reforming the R&D tax credit by shifting it ‘above the line’ in corporate accounts thus lowering the pre-tax cost of R&D in the UK and increasing the incentive to invest in innovation

 2. A shift in our capital allowances regime to accounts depreciation

Matching tax treatment of capital depreciation to accounts depreciation will free up cash flow and help drive faster reinvestment

3. Rationalising the carbon tax landscape

There are too many different carbon taxes and we are pushing too far ahead of our competitors, particularly in energy-intensive sectors. We need to recalibrate how far the UK is pushing on carbon reduction and introduce measures for the industries most severely impacted by policies that reduce their competitiveness

Over the weekend, the Prime Minister committed the government to "taking on the enemies of enterprise":

"...for over a decade in this country the enemies of enterprise have had their way.
 
Taxing.  Regulating.  Smothering. Crushing.  Getting in the way.

...

So I can announce today that we are taking on the enemies of enterprise.
 
The bureaucrats in government departments who concoct those ridiculous rules and regulations...The town hall officials who take forever with those planning decisions...The public sector procurement managers who think that the answer to everything is a big contract....
 
There's only one strategy for growth we can have now...

...and that is rolling up our sleeves and doing everything possible to make it easier for people to start a business and to grow a businesses.

While the wags may have focused on the alliterative powers of the PM's speech writer, we support the PM's focus on doing everything to make it easier for people to start and to grow a business in the UK.

That's why we've put together a Manufacturers' Most Wanted - the top ten 'Enemies of Enterprise' for manufacturers planning to grow over the next 5-10 years.

As we said yesterday, the government can't take growth for granted - not all growth is equal and it doesn't have to happen in the UK.

If the PM lives up to his words and tackles these 'Enemies of Enterprise', he can ensure the UK captures all the benefits - the jobs, the investment and the exports - that the right type of long-term, balanced growth in manufactring can generate.

1.        Lower Capital Allowances: Inefficiently taxing investment in the UK.
The UK’s capital allowance regime is inefficient, outdated and uncompetitive, and the government’s plans to lower the level of allowances from 20% will add to the cost of investing in technology and growth in the UK.

2.        Tax Complexity & Uncertainty: Raising risks to long-term investments in the UK.
The government’s departures from its ‘New Approach to Tax Policy Making’, such as the decision to retain revenues from the Carbon Reduction Commitment, have unnecessarily increased uncertainty for firms making long-term investment decisions.

3.        The Carbon Reduction Commitment: Unnecessarily & inefficiently taxing production in the UK.
Combined with the carbon floor price and the CCL, the CRC provides triple taxation of carbon, inefficiently raising the cost of producing in the UK.

4.        The Climate Change Levy: Taxing electricity consumption at 10x EU minimum.
The EU requires the UK to have the CCL, but the UK has unilaterally chosen to impose a levy 10 times the EU minimum.

5.        The Lack of Competition in Lending: Entrenching a risk-averse approach to lending to UK manufacturers.
Not enough competition means it’s harder for growing firms to secure the loans they need on reasonable terms and tougher to switch providers when service standards aren’t up to scratch.

6.        The T&C’s Attached to Bank Lending: Capping the flow of finance to growing UK manufacturers.
From personal guarantees to impossible covenants, the range of T&Cs attached to lending places a cap on manufacturers’ ability – and willingness – to invest in the UK.  

7.        Inadequate Impact Assessments: Consistently underestimating the burden of red tape on UK manufacturing.
Poor Impact Assessments – such as for the Default Retirement Age and the Carbon Floor Price – fail to accurately assess the additional and cumulative impact to business of UK and EU regulations. These assessments need to improve if the government is the scale of the barriers to private sector growth.

8.        The Default Retirement Age: Reducing labour market flexibility.
Rapid introduction leaves firms scrambling to comply with red tape and complicates plans to manage workforce skills.

9.        10 Years of Tinkering with Apprenticeships: Making apprenticeships and funding unstable.
The lack of stable funding and overuse of centrally-planned targets have made good-quality apprenticeships harder to come by for both students and manufacturers.

10.    Failure to Deliver STEM Skills in Schools: Shrinking the future workforce of manufacturing.
Without a solid foundation in STEM skills, students are less likely to have the skills needed to begin an apprenticeship, pursue an engineering degree or even seek a career in manufacturing.

 

How well prepared are UK manufacturers for the next challenge of turning their investments in productivity and competitiveness over the past decade into transformational growth in the next?

To answer this question and to understand the current state of British industry, our new report - The Shape of British Industry - Growing from strong foundations - draws on a survey of 300 manufacturers as well as in-depth discussions with dozens of businesses.

What comes out is a picture of an industry starting from strength, but cautious about growth. Having weathered the recession, UK manufacturing emerges as an innovative, diverse and globally engaged sector. Firms have continued to boost productivity and competitiveness, even if they have struggled to deliver profits or meet their ambitions. According to our new report there's both good and bad news.

Chart 1 - SMEs less likely to turn productivity boost into profits or growth
% balance with increase in productivity, profits and meeting growth objectives

There is, however, one striking feature: the UK, has relatively fewer large manufacturers – those employing more than 250 people – than our closest competitors.

Chart 2 - UK has relatively fewer larger manufacturers,
Number of manufcturers with 250+ employees (US figure is for firms with 500+ employees), and large companies as % of total manufacturers

The twin dynamics that could drive growth in manufacturing are large companies creating markets for a dynamic, diverse supply chain and innovative, agile suppliers attracting large, mobile multinationals to the UK. The danger for manufacturing and the economy is that the lack of larger companies could slow this dynamic, leading to a hollowing out of supply chains and placing a cap on future growth

After a deep recession in which the economy shrunk by 6%, a manufacturing-led recovery has helped drive a year of good economic news. Exports to developing economies are booming and the private sector is slowly creating jobs again. But with public sector cuts looming and a currency war threatening to derail the global economy, we cannot take this growth for granted.

Generating long-term, sustainable growth will require the private sector and government to work together to build on the strengths of sectors – such as manufacturing – that are essential to tackling our future challenges, such as global security, demographic change and climate change. Government, therefore, has a big part to play in providing the right framework that will support and catalyse private sector investment and business growth.

As the Prime Minister stated in his speech on growth, this will mean more than government getting out of the way.

Instead it will need to be clear about what its role is in generating and supporting growth.

The previous government’s preferred approach was overly focused on industrial champions. The current government’s attention to start-ups and young businesses is helpful, but is in danger of swinging too far in the opposite direction.

Yet growth is not a big or small issue. It is about providing sufficient demand to sustain a dynamic and diverse supply network. It is about big businesses with the capacity to drive innovation and productivity down supply chains. And it is about growing bigger businesses with the scale and muscle to invest in tackling our long-term economic challenges.

Prior to the recession, manufacturers’ investments in innovation, their collaboration and their agility were paying dividends. But knocked off their plans for growth during the recession, many companies are now justifiably cautious about investing in growth until they gain greater certainty over the economic and business environment.

Growing more, larger manufacturers is, in part, about continuing to attract new ones to the UK. But it is also about ensuring small and medium-sized manufacturers overcome barriers that constrain them.

The limited availability of affordable finance traps some young and small companies in a Catch-22: unable to get the necessary finance, their ability to plan for growth is constrained, yet unable to demonstrate clear ambitions for growth, some firms find it difficult to get the appropriate finance. If they do manage to grow, these firms would be caught in the thicket of tax and red tape that helps make mid-sized cautious about planning to become truly global in scale.

Chart 13 Tax and regulation are major concerns for mid-size firms
% balance of companies citing UK strengths by company size

The Prime Minister has challenged industry to commit “to create and innovate; to invest and grow; to develop and break boundaries”.

This report shows that manufacturers are already rising to the challenge, but it also sets out where both manufacturers as well as government must make better progress if we are to grow a generation of bigger manufacturers.

Maintaining momentum behind the recovery is crucial. But not all economic growth is equal: imbalanced and unsustainable growth can leave a terrible legacy, as the recent financial crisis and recession have shown.

To ensure our economy can pay its own way in the future, the UK does not need a handful of bigger manufacturers, we need hundreds of them.