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INVESTMENT AND ECONOMIC GROWTH
Scottish Enterprise
December 2007
Table of Contents
1. Introduction .................................................................................................. 3
2. Why investment is important ........................................................................ 4
3. What we mean by investment ...................................................................... 5
4. Evidence on investment as a driver of economic performance .................... 5
5. Measuring investment .................................................................................. 7
5.1 Capital stock ........................................................................................... 7
5.2 Capital Services ...................................................................................... 8
5.3 Gross Fixed Capital Formation (GFCF) ................................................ 10
5.3 Business investment ............................................................................. 13
5.3.1 Information and communication technology (ICT) investm ................ 14
5.3.2 Scottish business investment ............................................................. 15
5.3.3 Why is business investment in the UK lower than other countries? ... 16
5.4 Government investment ........................................................................ 17
6. Conclusions ............................................................................................... 19
Data Appendix ............................................................................................... 20
2
INVESTMENT AND ECONOMIC GROWTH
Summary

Investment, defined as the physical capital available to workers, is an important driver of
productivity growth.

The UK has one of the lowest levels of capital stock (measured per worker or as a
proportion of GDP) among OECD countries, although latest data is for 2001. No capital
stock data is available for Scotland.

Scotland’s rate of annual investment (gross fixed capital formation) is estimated to be
slightly below the UK average. The UK’s rate, however, lags most other OECD economies
– and has done so for a number of years.

Scotland’s investment rate lags each of the Arc of Prosperity countries (equivalent to
between £2 billion and £7 billion less investment a year).

Business investment accounts for the majority of overall investment. The UK’s rate
business of business investment lags all other OECD countries, although it is unclear why
this is. No robust data exists for Scotland, although performance is likely to be similar to
the UK’s.

Government investment rates in the UK also lag most other OECD economies, leading to
a relatively poor infrastructure.

There is a lack of robust data on capital stock and annual investment (total and business
investment) for Scotland. This is a significant evidence gap in the understanding of
Scotland’s relative productivity performance.
1. Introduction
Economic growth is dependent on labour utilisation (how many people are employed) and
labour productivity (how much output labour is able to produce). In recent years employment
has been growing strongly in both the UK and Scotland, with employment rates amongst the
highest in the OECD. However, both the UK’s and Scotland’s productivity rates fail to match
the top OECD performers and this has resulted in lower economic growth and prosperity
(GDP per head) than could potentially be achieved.
The UK’s relatively poor growth performance has prompted a large programme of economic
research by the UK government on the factors influencing productivity. This analysis has
identified five drivers (outlined in Figure 1 below):

Investment

Skills

Enterprise

Innovation

Competition
This review considers the first of these, investment. The analysis draws on existing research,
for example the HM Treasury’s ‘Productivity in the UK’ series 1, and outlines what is meant by
investment, why it is an important driver of growth, what the potential measures/indicators of
investment are and how the UK and Scottish economies perform. Where available,
1
HM Treasury (various reports, 2000 to 2007) http://www.hmtreasury.gov.uk/documents/enterprise_and_productivity/the_evidence/ent_prod_index.cfm
3
performance is compared to the ‘Arc of Prosperity’ countries outlined in the Government
Economic Strategy2.
Figure 1: Growth accounting and the five drivers of productivity growth (HM Treasury 3)
TFP = Total factor productivity (how efficiently labour and capital are combined using
technology, organisation, etc)
2. Why investment is important
HM Treasury productivity research series of reports notes that the amount and quality of
physical capital associated with a job is a key determinant of workers’ labour productivity.
Investment in plant, machinery and infrastructure can increase the productive capacity of an
economy by raising the capital stock available to workers. Specifically, raising the capital
stock can drive productivity growth in two ways:

‘Capital deepening’ increases the amount of plant and machinery workers have to work
with

New technologies embodied in investment can introduce more efficient plant and
machinery into the production process and boost productivity.
It is important to note that increased capital investment alone may not lead to productivity
gains and depends on, among other things, the skills of workers to use capital assets, the
skills of management to invest in the appropriate types of capital assets and the right goods
and services being produced to meet or create market demand (an indicator of enterprise).
This highlights the inter-relationships between the five drivers of productivity outlined in Figure
1 above.
2
The Scottish Government Economic Strategy (2007) has identified five small European
countries as broad benchmarks for Scotland – Denmark, Finland, Iceland, Ireland and
Norway http://www.scotland.gov.uk/Publications/2007/11/12115041/0
3
Productivity in the UK 6: Progress and new evidence (2007) HM Treasury http://www.hmtreasury.gov.uk/media/6/B/bud06_productivity_513.pdf
4
3. What we mean by investment
There are various types of investment that have are important to economic growth4:

physical capital – refers to the overall level of physical assets (plant, machinery, buildings),
that directly influences how much a unit of labour can produce.

ICT investment – is a specific component of physical capital and is the most recent
example of technological change that can influence production processes across a wide
range of sectors.

infrastructure – refers to investment that provides a base to support other economic
activities. This is often publicly funded due to its wide public benefits, for example
transport.

public sector capital investment – includes government investment in physical assets that
support productivity growth by contributing to a healthy and skilled workforce (investment
in school and hospital buildings, medical equipment, etc).
4. Evidence on investment as a driver of economic performance
The Scottish Government Economic Strategy, quoting research into the reasons why UK
productivity lags behind other countries, notes that different levels of investment in physical
capital stock accounts for 51% of the productivity gap with the United States, 80% of the gap
with France and 81% with Germany5.
Other empirical studies also show that levels of overall physical capital stock are closely
correlated with productivity performance. A study in 1991 looking at the relationship between
investment in machinery and equipment and economic growth in selected developed
countries found that increasing investment by 1% would increase GDP per capita by 0.7%6.
At the firm level, a study in 2000 looking at labour productivity gaps in the UK between foreign
and domestic-owned firms found that the former operated with 50% more capital per worker,
and that this explained a large part of the differences in labour productivity between the two
types of firm. This result was consistent across most manufacturing and service sectors7.
Data produced by the IMF8 also suggests a positive relationship between the capital stock
available to workers (capital stock per unit of labour) and productivity in eighteen OECD
countries over the 1996-2000 period (Figure 2). This data also suggests that the UK has low
levels of both capital stock and productivity and is out performed by each of the Arc of
Prosperity countries.
4
Productivity in the UK 6: Progress and new evidence (2007) HM Treasury http://www.hmtreasury.gov.uk/media/6/B/bud06_productivity_513.pdf
O’Mahoney, M., and de Boer, W., (2002), Britain’s relative productivity performance: Has
anything changed? National Institute Economic Review.
5
6
HM Treasury Productivity Series http://www.hmtreasury.gov.uk/documents/enterprise_and_productivity/the_evidence/ent_prod_index.cfm
7
Nicholas Oulton: Why do foreign-owned firms in the UK have higher labour productivity?
(2000)
8
IMF Country Report: United Kingdom: Selected Issues (2003)
http://www.imf.org/external/pubs/ft/scr/2003/cr0347.pdf
5
Figure 2
Output (productivity) per
unit of labour
Capital stock per unit of labour and GDP per unit of labour (productivity),
1996-2000 Index UK=100
180
Ireland
160
140
Norway
Iceland
120
Denmark
Finland
100
Germany
UK
80
80
100
120
140
160
180
Capital per unit of labour
Source: IMF
Note: See data appendix for full data
Data for UK regions also suggests a positive correlation between investment (defined as net
capital expenditure) and productivity9. Scotland though appears to be a slight ‘outlier’, with
low GVA per worker relative to net capital expenditure (Figure 3).
Figure 3
GVA per worker £
GVA and net capital expenditure per worker in UK
regions, 2004 (£)
90,000
80,000
70,000
60,000
50,000
40,000
WM
30,000
20,000
Wa
10,000
0
3,000
Lon
SE
East EM NW
Sco
NI
SW NE
4,000
Yor
5,000
6,000
7,000
8,000
9,000
Net capital expenditure per worker £
Source: Regional Competitiveness Indicators (excludes financial services and public sector)
Note: See data appendix for full data
9
The Five Drivers of Productivity. How much does each one contribute? Causal Analysis of Regional
Labour Productivity in the UK (2006) ENRI http://www.erini.ac.uk/Publications/PDF/EriniMon14.pdf
6
5. Measuring investment
There are a number of potential measures of investment:

Capital stock

Capital services

Gross fixed capital formation

Net capital expenditure per employee
5.1 Capital stock
Capital stock is defined as the value of the assets used as inputs into the production
process10. This includes, for example, plant and machinery that produce goods and services
(including software), the buildings these are produced in and vehicles used to transport them.
Measuring the capital stock in an economy is not straight forward. There are challenges in
trying to estimate the value of the current stock of machinery, equipment and buildings and
how these depreciate over time. Also, there are issues around measuring the value of
software and other intangible assets, as well how ‘quality’ is used to assess values (this is a
particular issue for ICT - in recent years the cost of buying ICT has declined significantly at
the same time as its quality or productive potential has risen. Using just a monetary value
would suggest declining ICT investment).
Approaches have been developed, however, to attempt to provide internationally comparable
indicators of capital stock. This involves measuring an economy’s annual investment
spending over a number of years and using standard depreciation rates for different types of
asset.
There are no capital stock data for Scotland (or the other UK regions) due to a lack of time
series capital investment data for service sector businesses 11. Data, though, does exist at the
UK level and for a number of OECD countries, although it is a few years old now. The Keil
Institute12 has estimated capital stock relative to GDP for 2001 and the IMF has estimated
capital stock per unit of labour input for the period 1996-2000 (Figures 4 and 5).
Both the IMF data and the Keil Institute data suggest that the UK’s level of capital stock
(per worker or relative to GDP) is lower than most other OCED countries – and each if
the Arc of Prosperity economies (interestingly, though, the Keil Institute data suggests that
Ireland has a low capital stock relative to GDP - this could in part be due to Ireland’s GDP
being artificially boosted by the activities of inward investors).
10
‘Measuring Capital’ (2001) OECD http://www.oecd.org/dataoecd/61/57/1876369.pdf
11
Research on Options for the Development of Better Measures of Scottish Productivity,
(2006) Scottish Government http://www.scotland.gov.uk/Publications/2007/03/scottishproductivty
12
Database on capital Stocks in OECD Countries, Keil Institute http://www.unikiel.de/ifw/forschung/netcap/netcap.htm
7
Figure 4
Capital stock pe r unit of labour, 1996-2000
(inde x, UK=100)
N
et
G
er
m
an
y
h e Ita
rla ly
Be nd
lg s
i
F r um
an
N ce
o
D rw
en ay
m
a
Ja rk
p
Fi an
nl
an
d
U
Ir e S
l
Sw and
ed
Ic e n
el
an
Sp d
C ain
an
ad
a
A
N us UK
ew t
r
Ze alia
al
an
d
180
160
140
120
100
80
60
40
20
0
Source: IMF
Note: See data appendix for full data
Figure 5
%
Business sector capital stock as % GDP, 2001
250
200
150
100
50
Po
rt
N uga
or l
w
Ja a y
A p an
Au ustr
i
D stra a
Sw en lia
itz ma
r
G erla k
er n
m d
Ic an
e y
B e l an
lg d
iu
m
N F Ital
et in y
he l a
rla nd
n
S p ds
Sw a
e in
G de
re n
Fr ece
an
ce
N
Ze U
al K
an
d
C U
an S
a
Ire da
la
nd
0
Source: Keil Institute
Note: See data appendix for full data
5.2 Capital Services
In considering the contribution of capital assets to the production process and productivity
growth, it is now generally accepted that it is the value of the outputs produced by the asset
(called capital services) that is relevant and not the value of the asset itself (measured by the
capital stock)13. Conceptually, capital services reflect a quantity, or physical concept, rather
than a value, or price, concept of capital. This helps to address a disadvantage of the
standard capital stock measure that does not adequately reflect the shift towards shorter life
and more productive investment goods, especially ICT.
13
Measuring Capital, OECD (2001) http://www.oecd.org/dataoecd/61/57/1876369.pdf
8
The difference between capital stock and capital services is demonstrated in Figure 6 below.
In the late 1990s, the growth of capital services was higher than the capital stock, mainly
because ICT started to become a more important part overall investment. The price of ICT fell
at the same time as its quality or productive capacity rose, leading to a faster rise in capital
services then the value of capital stock.
Figure 6
Volume index of net capital stock and capital services, 1980 to 2005,
index 1980=100
240
220
Net capital stock (excluding dwellings)
200
Index
Capital services
180
160
140
120
100
1980
1985
1990
1995
2000
2005
Source: ONS
Note: See data appendix for full data
Capital services data is only currently available for a small number of countries (and not for
Scotland) and shows annual growth rates up to 2001 rather than absolute monetary values.
The latest data available suggests that the UK’s performance in terms of capital services
growth is mid-table compared to other countries (Figure 7).
Figure 7
Volume index of capital services (all assets) 1980=100
350
Canada
300
Japan
250
Italy
US
200
UK
150
France
100
Germany
Australia
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
50
Source OECD
Note: See data appendix for full data
9
5.3 Gross Fixed Capital Formation (GFCF)
GFCF is defined as investment in tangible fixed assets such as plant and machinery, ICT and
software, transport equipment, dwellings/housing and other buildings and structures (housing
is included because it is considered to produce housing services that are consumed by
owners and contributes to GDP). It also includes investment in intangible fixed assets (such
as intellectual property and patents), improvements to land and the costs associated with the
transfer of assets. GFCF data is expressed as an annual expenditure figure and so does not
measure the capital stock.
In 2005, it is estimated that GFCF in the UK was about £210 billion14, equivalent to
approximately 17% of GDP. Data suggests that the UK has the lowest rate of GFCF
(expressed as a proportion of GDP) than all OECD countries (Figure 8), and this pattern has
been evident for a number of years (over the last 20 years, most Arc of Prosperity countries
have outperformed the UK on this measure). As capital stock is built up through
investment over a number of years, the UK’s low level of annual GFCF explains its low
levels of capital stock.
Figure 8
%
Gross fixed capital formation as % GDP, 2005
35
30
25
20
15
10
5
Ko
re
Sp a
Ic ain
el
a
Ire nd
la
Sl nd
Au ova
st k
r
N C alia
ew z
Ze ech
al
G and
re
ec
Ja e
H pa
un n
Po gar
Sw rt y
i tz uga
er l
C lan
an d
D ad
en a
m
ar
k
Ita
Au ly
s
Be tria
lg
i
Lu F r um
xe an
m ce
bo
Tu urg
rk
N M ey
et e
U he xic
ni r l o
te a n
d d
S s
ta
F i te s
nl
a
N nd
or
w
Po ay
G la
er nd
m
U
ni S an
te w y
d e
K de
in n
gd
om
0
Source: OECD
Note: See data appendix for full data
14
Blue Book, National Statistics
http://www.statistics.gov.uk/downloads/theme_economy/Blue_Book_2007_web.pdf
10
Figure 9
%
Annual gross fixed capital formation as % GDP,
UK and Arc of Prosperity Countries
30
28
26
24
Denmark
Finland
Ireland
22
20
18
Norway
UK
Iceland
16
14
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
1989
1988
1987
1986
1985
12
10
Source: OECD
Note: See data appendix for full data
GFCF data is available for each of the UK regions, although the latest analysis is for 200015.
This data suggests that GFCF (expressed as a percentage of GVA) in Scotland was
marginally above the UK level and ranked fifth out of the twelve UK regions (Figure 10). Over
the 1998-2000 period for which data is available, Scotland’s rate of GFCF was consistently
above the UK’s (Figure 11).
Figure 10
Gross fixed capital formation as % GVA, 2000
%
25
20
15
10
5
ot
st land
En
gl
an
d
L
W
o
n
es
t M don
id
la
nd
s
W
a
N
or les
th
W
Yo est
rk
Ea
sh
st
ire
M
U
id
ni
la
te
n
d
Ki ds
ng
do
m
Source: National Statistics
Ea
Sc
W
es
t
t
So
ut
h
Ea
s
st
N
or
th
Ea
ut
h
So
N
Ire
la
n
d
0
Note: See data appendix for full data
15
Regional and sub-regional gross fixed capital formation, (2003) ONS
http://www.statistics.gov.uk/articles/economic_trends/ETDecCope.pdf
11
Figure 11
Gross Fixed Capital Formation as % GVA, 1998-2000
%
25
20
Scotland
15
UK
10
5
0
1998
1999
2000
Source: National Statistics
Note: See data appendix for full data
An alternative and more up-to-date source of GFCF data is available from input output tables
produced for the UK16 and Scotland17. Data from this source, however, suggests that over the
1998-2003 period, GFCF as a % of GVA was slightly lower in Scotland than the UK (Figure
12). In 2003 (latest available), Scottish GFCF was estimated to be £13.5 billion.
Figure 12
%
Gross Fixed Capital Formation as % GVA, 1998-2003
25
20
15
Scotland
10
UK
5
0
1998
1999
2000
2001
2002
2003
Source: Scottish Government, National Statistics
Note: See data appendix for full data
16
UK Input Output: National Accounts (Office for National Statistics)
http://www.statistics.gov.uk/about/methodology_by_theme/inputoutput/
17
Scottish Input Output Tables (Scottish Government)
http://www.scotland.gov.uk/Topics/Statistics/Browse/Economy/Input-Output/Downloads
12
A potential reason for the differences between the data in Figures 11 and 12 is that the data
in the former is based on older estimates of GVA and of net capital expenditure (an element
of overall GFCF).
Regional GFCF data, however, needs to be treated with caution. One of the main data
sources for GFCF is net capital expenditure estimates from the Annual Business Inquiry and
the robustness of these estimates at the UK regional level has been questioned by the ONS.
Capital expenditure is collected at the overall company HQ level, and in the past if a company
had units or outlets across a number of regions, its capital expenditure was allocated to these
units/outlets on the basis of local employment. The ONS now believe that that the relationship
between local employment and local capital expenditure for a company is unreliable, and so
have stopped publishing net capital expenditure figures at the regional level18. It is unclear to
what extent this affects GFCF estimates for UK regions.
If the GFCD data in Figure 12 is accepted as broadly correct, it would appear that the rate of
annual investment (GFCF) in Scotland relative to GVA is roughly one percentage point below
the level of the UK as a whole - and this suggests the level of Scotland’s capital stock (per
worker or relative to GDP) is also likely to be slightly below the UK’s.
Therefore, it is not unreasonable to assume that Scotland’s investment performance, like the
UK’s, lags many other OECD economies and all the Arc of Prosperity economies.
In 2003, Scottish GFCF was £13.5 billion. To match the investment rates (as a percentage of
GDP) of the Arc of Prosperity countries in that year, the table below shows how much higher
Scotland’s GFCF would have to have been:
Table 1: Estimated gap between Scotland’s GFCF rate and the UK/Arc of Prosperity
Countries (2003)
To match:
Required increase in GFCF (£ billion)
Ireland
£7.1 billion
Iceland
£4.2 billion
Denmark
£3.9 billion
Finland
£2.6 billion
Norway
£2.1 billion
UK
£0.9 billion
5.3 Business investment
GFCF is made up of three main components – business, government and housing
investment. The Department of Business Enterprise & Regulatory Reform’s UK Productivity
and Competitiveness Indicators report19 uses business investment as a proportion of GDP to
assess the UK’s performance compared to other countries.
Data suggests that the UK’s level of business investment lags all other OECD countries for
which data is available, a pattern that has been repeated over the last thirty years (Figures 13
and 14).
18
Annual Business Inquiry Background Information (ONS)
http://www.statistics.gov.uk/abi/background_info.asp#rce
19
UK Productivity and Competitiveness Indicators, (2006) BERR
http://www.berr.gov.uk/files/file28173.pdf
13
Figure 13
%
Business investment as % GDP, OECD countries 2005
25
20
15
10
5
0
y
y
nd ea lia in ce nd ria an rk m al nd a da en ce ico ny d S ds UK
la or tra Spa ree rla ust ap ma lgiu It ala orw na ed an ex ma nlan U lan
e
r
i
e
r
K us
J en e
Ic
G i tz A
Ze N Ca Sw F M Ger F
B
he
A
D
w
w
et
e
S
N
N
Source: OECD
Note: See data appendix for full data
Figure 14
%
Business investment as a % GDP,
UK and Arc of Prosperity countries
25
Iceland
20
15
Denmark
Norway
Finland
10
UK
5
05
20
03
20
01
20
99
19
97
19
95
19
93
19
91
19
89
19
87
19
19
85
0
Source: OECD (data for Ireland not available)
Note: See data appendix for full data
5.3.1 Information and communication technology (ICT) investment
ICT investment (defined as IT and communication equipment and software) is a component of
overall business investment and is considered by many economists to be a particularly
important driver of growth. In the early 1990s, productivity in the US grew rapidly with
increased investment in ICT believed to be a major factor. European countries were not able
to match this growth in ICT investment or productivity and this suggests businesses in the US
have been better at exploiting the opportunities offered by ICT to enhance productivity (Figure
15).
14
Figure 15
%
ICT investment as a percentage of GDP, 1980 - 2005
5.0
4.5
4.0
3.5
3.0
2.5
2.0
1.5
1.0
0.5
0.0
USA
Fin
Den
UK
Norway
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
Ireland
Source: OECD (no data for Iceland)
Note: See data appendix for full data
However, the UK’s level of ICT investment may be higher than OECD data suggests. The
ONS have recently introduced changes to the way that investment in software is measured
and this new approach covers both software purchased from external suppliers, and ‘own account
software’ written in-house (the previous approach just included purchases from external suppliers).
This has a significant impact on estimates of software investment, raising the value from £8 billion
to £21 billion in 2003. This increases the UK’s ICT investment rate to a level similar to the US rate
and has the effect of raising the UK’s level of productivity by around 1% (narrowing the UK’s
productivity gap with the rest of the G7 by one percentage point20). This though will only
slightly narrow the overall gap in business investment with other economies.
5.3.2 Scottish business investment
The HM Treasury has used net business capital expenditure as a proportion of GVA to
assess business investment performance across UK regions. As noted above, though, these
estimates should be treated with caution due to difficulties in allocating capital expenditure
within companies which have multiple units/outlets across regions. Also, large, one-off
investment decisions by companies can make significant differences to total investment
figures in a particular region or year.
To go some way towards overcoming the second of these problems, average net capital
expenditure for the years 1998 to 2004 can be used (Figure 16). This suggests that
Scotland’s performance is on a par with the UK average, but lags in particular the North East,
North West (both of which have higher than average manufacturing investment rates) and the
South East (with a higher than average service sector investment).
20
Productivity in the UK 6: Progress and new evidence (2006) HM Treasury http://www.hmtreasury.gov.uk/media/6/B/bud06_productivity_513.pdf
15
Figure 16
Investment by manufacturing and service sector businesses as %
GVA, average 1998-2004
%
10
8
6
4
2
Lo
nd
U
K
on
Sc
ot
la
nd
W
M
id
la
nd
So
s
ut
h
W
es
t
N
Ire
la
nd
W
al
es
E
M
id
la
nd
s
st
Ea
hi
re
Yo
rk
s
Ea
st
t
ut
h
W
es
So
or
th
N
N
or
th
Ea
s
t
0
Source: BERR Regional Competitiveness and State of the Regions
Note: See data appendix for full data
Data also suggests that business investment as a proportion of GVA has declined across all
regions since 1999 (Figure 17). Its unclear though why this is, although the economic uncertainties
following the dot.com crash in 2000 may have been a factor.
Figure 17
%
Manufacturing and services investment as % GVA,
1999-2001 and 2002-2004
12
Investment (as % GVA)
Average 1999-2001
10
Average 2002-2004
8
6
4
2
UK
W
al
es
Ea
st
Sc
ot
la
nd
N
Ire
la
nd
Yo
rk
sh
Ea
ir e
st
M
id
la
nd
s
Source: Dept BERR
Lo
nd
on
En
gl
an
So
d
ut
h
W
W
es
es
t
tM
id
la
nd
s
es
t
W
Ea
st
No
rth
So
ut
h
No
rth
Ea
st
0
Note: See data appendix for full data
Whilst noting data robustness issues, this suggests that business investment in Scotland is roughly
on a par with UK levels. This further suggests that Scotland’s business investment rates lag most
other OECD economies.
5.3.3 Why is business investment in the UK lower than other countries?
The answer to this is not clear, and there does not appear to be a large body of research
looking into this issue. Potential reasons that have been suggested include:

Economic instability - low levels of business investment in the 1970s and 1980s have been
blamed on instability in the economy (there were big fluctuations in inflation, interest rates,
16
exchange rates and growth over this period which made businesses wary of investing)21.
However, since the early 1990s the economy has been far more stable so the investment
environment should be more conducive.

Data measurement issues - investment data largely cover expenditure on tangible items
(plant, machinery, etc) and only cover some intangibles such as software, IP and patents –
and expenditure on these is thought to be under-recorded. As the UK is a highly service
sector orientated economy, some investment that contributes to value add (such as
spending on design, reputation building and on human and organisational capital) may be
missed in the data. It is estimated that if all spending on intangibles is treated as
investment, business investment in the UK in 2004 would have been double the amount
using the traditional measurement22. However, the same measurement issues are faced in
other countries so this will not account for all the difference in UK versus OECD
investment rates.

Unattractive rates of return – however, there is no evidence that rates of return are lower
in the UK than other countries.

Funding pension deficits - although business profitability has been high in recent years,
some businesses may have been diverting funds away from investment to and into
pension fund to address deficits.

The UK’s capital market - compared to many European countries, a higher proportion of
UK businesses have their shares listed and actively traded on the stock market, and a
higher proportion of these shares are likely to be owned by financial institutions. \it is
suggested that management decisions may be more influenced by actions that maximise
short term shareholder value, rather than looking to longer term investment strategies 23.

Planning regulations - land use issues and planning regulation may be reducing access to
profitable investment opportunities for sectors such as the retail and hotel industry.

Poor management practices and skills - it has been argued that UK managers fail to adopt
best practices and technologies resulting in lower levels of investment24.
Given the importance of business investment as a component of overall investment and as an
important driver of growth, the lack of research on why the UK performs relatively poorly
compared to other countries is a significant evidence gap, as is the lack of robust business
investment data for Scotland.
5.4 Government investment
Government investment is an important element of the overall capital stock and contributes to
productivity principally through the provision of infrastructure. An obvious example is
investment in transport infrastructure which can influence productivity through lowering
transport costs and widening access to labour and product markets. Recent research by the
Centre for Economic Performance suggests that a 10% reduction in average journey times in
UK as a result of transport improvements would increase productivity levels by just over 1%,
21
The Puzzle of UK Business Investment, Bank of England (2006)
http://www.bankofengland.co.uk/publications/speeches/2006/speech282.pdf
22
Intangible investment and Britain's productivity, Treasury Economic Working Paper No. 1
(2007) http://www.hm-treasury.gov.uk/pbr_csr/documents/pbr_csr07_intangible.cfm
23
UK Investment and the Capital Market, HM Treasury http://www.hmtreasury.gov.uk/media/B/8/260.pdf
24
Driving Productivity and Growth in the UK Economy, McKinsey Global Institute (1998)
http://www.mckinsey.com/mgi/reports/pdfs/ukprod/ukprod.pdf
17
and by nearly 2% for areas that enjoy the largest benefits in terms of access to economic
mass25.
Other types of government investment, such as health, education (buildings, equipment, etc)
and housing can affect productivity by contributing to a healthy and skilled workforce – and by
increasing the attractiveness of the UK as a location to live, work and invest. However, it
should be noted that Government investment on its own is not necessarily a sign of potential
productivity growth – any investment needs to efficiently allocated and unsustainable.
Data for OECD countries suggests government investment in the UK as a proportion of GDP
is below that of most other OECD countries (Figure 18). The UK Productivity and
Competitiveness Indicators report concludes that:
‘The relatively low levels of government investment over the last few decades has led to the
UK having poorer infrastructure than would otherwise have been the case. This is likely to
have increased transport costs, for example, and hence raised the overall costs of doing
business in the UK’26.
Figure 18
Government investment (capital formation) as % GDP, 2005
%
7
6
5
4
3
2
1
N
Ko
re
a
ew Cz
e
c
Ze h
al
an
Ja d
pa
M n
ex
i
Tu co
rk
e
Sp y
ai
Fr n
an
ce
N
et
he U S
rla
nd
s
Ita
l
Ic y
el
P o and
rtu
G gal
re
Sw ece
ed
F i en
nl
a
N nd
or
C wa
Sw an y
itz ada
er
A u l an
st d
ra
lia
D U
en K
m
Be ark
l
G gium
er
m
a
A u ny
st
ria
0
Source:OECD (data for Ireland not available)
Note: See data appendix for full data
Directly comparable data on government investment in the UK regions is not available, but
regional data on government capital expenditure as a percentage of regional GVA is available
(Figure 19). This suggests that the rate of capital expenditure in Scotland is above most other
UK regions, and this is likely to be in part due Scotland being geographically larger than other
regions with areas of low population density resulting in larger than average capital spending.
25
UK Productivity and Competitiveness Indicators, (BERR) 2006
http://www.berr.gov.uk/files/file28173.pdf
26
UK Productivity and Competitiveness Indicators, (BERR) 2006
http://www.berr.gov.uk/files/file28173.pdf
18
Figure 19
%
Government capital expenditure as % GVA, 2005/06
K
U
Sc
N
Ire
la
n
d
ot
la
nd
W
al
N
or es
th
E
N
or ast
th
W
es
Lo t
nd
Yo on
rk
sh
W
M ire
id
l
S o and
s
ut
h
W
E
es
M
t
id
la
nd
Ea s
s
So ter
n
ut
h
Ea
st
6
5
4
3
2
1
0
Source: HM Treasury (PESA)
Note: See data appendix for full data
6. Conclusions
The importance of investment as a driver of productivity is evident from the wide range of
research and data. Although investment data is available for the UK and other OECD
economies, there is a lack of data on the level of capital stock for Scotland and the other UK
regions, and there are questions over the robustness of other investment data that is
available. This prevents a robust analysis of Scotland’s performance for this important driver
of economic growth.
From the data that is available, Scotland’s investment performance probably lags the UK by a
slight margin. The UK’s investment performance, though, lags nearly all other OECD
countries across a range of indicators (capital stock, business investment, government
investment). It is therefore fairly safe to assume that Scotland’s performance also lags these
economies.
Scottish Enterprise delivers (or is about to deliver) a range of products and interventions that
can contribute to increased investment either directly or indirectly, including:

Regional selective assistance - discretionary grants scheme for SMEs in designated areas
of Scotland for projects that will create and safeguard employment (in 2006/07 £92 million
of RSA grants were approved related to projects with planned capital expenditure of £416
million in future years)

Scottish co-investment/other SE funds – provides access to investment capital for SMEs.

Innovation support such as SMART and the General R&D Grants – assisting businesses
to invest in R&D equipment and machinery

Strategic investment plan – supporting investment in buildings and associated
infrastructure.
The annual ‘investment gap’ between Scotland and the UK is in the region of £1 billion, and
the gap with the Arc of Prosperity countries ranged from an estimated £2.1 billion to £7.1
billion in 2003. The challenge is to fully understand why Scotland’s investment performance
lags that of other countries, and what organisations such as Scottish Enterprise can do to
narrow the gap.
19
Data Appendix
Data for Figure 2
Capital stock per unit of labour and GDP per unit of labour (productivity),
1996-2000 Index UK=100
Capital per unit of labour
(index, UK=100)
GDP per unit of labour
(index, UK=100)
Australia
99
109
Belgium
154
161
Canada
104
117
Denmark
137
130
Finland
126
119
France
153
142
Germany
171
133
Iceland
114
114
Ireland
124
134
Italy
161
138
Japan
128
101
Netherlands
157
142
New Zealand
94
87
Norway
150
152
Spain
109
102
Sweden
116
116
United Kingdom
100
100
United States
124
142
Note - capital and GDP data are based on 1995 US$ and 1995 purchasing power parities,
one unit of labour defined as 2088 hours of work a year
Source: IMF http://www.imf.org/external/pubs/ft/scr/2003/cr0347.pdf
20
Data for Figure 3
GVA and net capital expenditure per worker in UK regions, 2004
Capital expenditure per
worker (£)
Gross Value Add per
worker (£)
East Midlands
4,681
31,716
East of England
4,344
38,231
London
8,626
84,763
North East
4,538
33,539
North West
5,027
36,950
Northern Ireland
5,007
33,684
Scotland
7,013
35,922
South East
5,655
46,652
South West
4,070
32,736
Wales
3,750
25,988
West Midlands
3,863
36,051
Yorkshire/Humber
4,891
33,629
Source: Dept for Business Enterprise and Regulatory Reform
http://217.154.27.195/sd/rci2007/index.asp
21
Data for Figure 4
Capital per unit of labour, 1996-2000 (Index UK=100)
Capital per unit of labour 1996-2000 (index UK=100)
Germany
171
Italy
161
Netherlands
157
Belgium
154
France
153
Norway
150
Denmark
137
Japan
128
Finland
126
US
124
Ireland
124
Sweden
116
Iceland
114
Spain
109
Canada
104
UK
100
Australia
99
New Zealand
94
Source: IMF http://www.imf.org/external/pubs/ft/scr/2003/cr0347.pdf
Note: data uses 1995 $ and purchasing power parities
22
Data for Figure 5
Business sector net capital stock as % GDP, 2001
Business sector net capital stock as % GDP,
2001
Portugal
198
Norway
172
Japan
159
Austria
143
Australia
143
Denmark
143
Switzerland
136
Germany
131
Iceland
131
Belgium
129
Italy
126
Finland
125
Netherlands
123
Spain
122
Sweden
116
Greece
116
France
115
UK
115
N Zealand
110
US
109
Canada
107
Ireland
84
Source: Kier Institute http://www.uni-kiel.de/ifw/forschung/netcap/netcap.htm
23
Data for Figure 6
Volume index of UK net capital stock and capital services, 1980 to 2005 (1980=100)
1980
1985
1990
1995
2000
2005
Net capital stock
100
106
123
137
165
193
Capital services
100
108
128
147
191
229
Source: National Statistics
http://www.statistics.gov.uk/about/data/guides/productivity/downloads/ProductivityHandbook_
Chapter5.pdf
Data for Figure 7
Volume index of capital services (all assets) 1980-2001 (1980=100)
1980
1985
1990
1995
2000
2001
Canada
100
142
192
234
310
326
Japan
100
131
174
219
267
267
Italy
100
136
186
211
252
262
US
100
120
142
166
219
228
UK
100
118
141
160
201
France
100
116
141
162
184
190
Germany
100
115
132
153
174
179
Australia
100
117
133
144
164
167
Source: OECD
http://www.olis.oecd.org/olis/2003doc.nsf/43bb6130e5e86e5fc12569fa005d004c/8b6d471e77
82b046c1256e01005ab375/$FILE/JT00156193.PDF
24
Data for Figure 8
Gross fixed capital formation as % GDP, 2005
Gross fixed capital formation as % GDP, 2005
Korea
29
Spain
29
Iceland
28
Ireland
27
Slovak
27
Australia
27
Czech
25
New Zealand
24
Greece
23
Japan
23
Hungary
23
Portugal
21
Switzerland
21
Canada
21
Denmark
21
Italy
21
Austria
21
Belgium
20
France
20
Luxembourg
20
Turkey
20
Mexico
19
Netherlands
19
United States
19
Finland
19
Norway
19
Poland
18
Germany
17
Sweden
17
United Kingdom
17
25
Source: OECD
http://caliban.sourceoecd.org/vl=1813397/cl=31/nw=1/rpsv/factbook/02-02-03.htm
Data for Figure 9
Annual gross fixed capital formation as % GDP
1985
1990
1995
2000
2005
Denmark
20
20
18
20
21
Finland
25
28
17
19
19
Ireland
18
19
17
24
27
Norway
25
22
20
19
19
UK
18
21
16
17
17
Iceland
22
20
16
23
28
Source OECD
http://caliban.sourceoecd.org/vl=1813397/cl=31/nw=1/rpsv/factbook/02-02-03.htm
Data for Figure 10
Gross fixed capital formation as % gross value add, UK regions, 2000
Gross fixed capital formation as % GVA, 2000
N Ireland
22.7
South East
21.3
North East
20.8
South West
20.5
Scotland
20.3
East England
19.1
London
18.7
West Midlands
18.2
Wales
18.0
North West
17.6
Yorkshire
17.6
East Midlands
15.4
United Kingdom
19.1
Source: National Statistics
http://www.statistics.gov.uk/articles/economic_trends/ETDecCope.pdf
26
Data for Figure 11
Gross Fixed Capital Formation as % GVA, 1998-2000
1998
1999
2000
Scotland %
20.7
20.2
20.3
UK %
19.8
19.3
19.0
Source: National Statistics
http://www.statistics.gov.uk/pdfdir/gva1003.pdf
Data for Figure 12
Gross Fixed Capital Formation as % GVA, 1998-2003
Scotland %
UK %
1998
18.0
19.8
1999
17.4
19.5
2000
18.2
19.2
2001
17.6
18.7
2002
17.8
18.7
2003
17.1
18.1
Source: National Statistics and Scottish Government
http://www.statistics.gov.uk/downloads/theme_economy/Input_Output_Analyses_2006_editio
n.pdf
http://www.scotland.gov.uk/Topics/Statistics/Browse/Economy/Input-Output
27
Data for Figure 13
Business investment as % GDP in OECD countries, 2005
Business investment as % GDP
2005
Iceland
19.7
Korea
18.1
Australia
17.3
Spain
17.2
Greece
15.7
Switzerland
15.4
Austria
15.2
Japan
14.8
Denmark
13.5
Belgium
13.3
Italy
13.2
New Zealand
12.2
Norway
11.9
Canada
11.7
Sweden
11.5
France
10.9
Mexico
10.9
Germany
10.7
Finland
10.6
US
10.2
Netherlands
9.8
UK
9.5
Source: OECD (Dataset: Economic Outlook No 80 - December 2006 - Annual Projections for
OECD Countries)
28
Data for Figure 14
Business investment as a % GDP
1985
1990
1995
2000
2005
Denmark
13.8
14.1
12.9
13.9
13.5
Finland
15.4
17.2
10.3
11.5
10.6
Iceland
12.6
10.3
7.6
14.7
19.7
Norway
17.0
14.5
13.5
12.7
11.9
United Kingdom
11.9
13.5
10.7
11.9
9.5
Source: OECD (Dataset: Economic Outlook No 80 - December 2006 - Annual Projections for
OECD Countries)
Data for Figure 15
ICT investment as a % of GDP (%)
1980
1985
1990
1995
2000
2003
Denmark
1.5
2.4
2.8
3.1
3.4
3.3
Finland
1.4
2.0
2.6
3.4
3.7
3.5
Ireland
0.7
1.2
0.6
1.2
2.3
1.0
United Kingdom
0.8
1.7
2.4
2.9
3.5
2.7
United States
2.0
2.8
2.9
3.4
4.9
3.7
Norway
1.9
2.2
1.7
1.8
2.0
Source: OECD
http://www.oecd.org/dataoecd/27/37/36396989.xls
29
Data for Figure 16
Investment by manufacturing and service sector businesses as % GVA, average 19982004
Investment by manufacturing and service sector
businesses as % GVA, Average 1998-2004 (%)
North East
9.3
North West
8.7
South East
8.6
Yorkshire
8.0
East
7.7
London
7.7
Scotland
7.7
W Midlands
7.7
South West
7.6
N Ireland
7.2
Wales
7.1
E Midlands
7.0
UK
7.7
Source: Dept for Business Enterprise and Regulatory Reform
http://217.154.27.195/sd/rci2007/rcsor2007.xls
30
Data for Figure 17
Manufacturing and services investment as % GVA in UK regions, 1999-2001 and 20022004
Average 1999-2001 (%)
Average 2002-2004 (%)
North East
10.6
7.1
South East
9.5
7.6
North West
9.1
7.6
London
8.9
5.9
England
8.7
6.7
South West
8.7
6.5
West Midlands
8.5
6.2
East
8.4
6.7
Scotland
8.1
6.6
N Ireland
8.0
5.9
Yorkshire
7.9
7.8
East Midlands
7.6
5.9
Wales
7.6
5.7
UK
8.5
6.5
Source: Dept for Business Enterprise and Regulatory Reform
http://217.154.27.195/sd/rci2007/rcsor2007.xls
31
Data for Figure 18
Government investment as % GDP, OECD countries, 2005
Government investment as % GDP, 2005 (%)
Korea
6.1
Czech
5.0
New Zealand
4.9
Japan
4.8
Mexico
4.3
Turkey
4.2
Spain
3.6
France
3.2
US
3.2
Netherlands
3.2
Italy
3.1
Iceland
2.9
Portugal
2.8
Greece
2.7
Sweden
2.7
Finland
2.7
Norway
2.6
Canada
2.5
Switzerland
2.5
Australia
2.1
UK
2.0
Denmark
1.8
Belgium
1.8
Germany
1.3
Austria
1.1
Source: OECD
32
Data for Figure 19
Government capital expenditure in UK regions as % GVA, 2005/06
Government capital expenditure as
% GVA
N Ireland
5.1
Scotland
4.5
Wales
4.1
North East
3.9
North West
3.8
London
3.5
Yorkshire
3.3
W Midlands
3.1
South West
2.7
E Midlands
2.5
Eastern
2.3
South East
2.3
UK
3.1
Source: HM Treasury (Public Expenditure Statistical Analyses 2007), ONS (Regional GVA)
33