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OVERVIEW OF PERFORMANCE COMMITTEE RESEARCH AUGUST 2006 to AUGUST 2007 The main highlights from research and analysis carried out for the Performance Committee is: 1. Relatively low economic growth in Scotland is due to a weak private sector reflected by a low business stock, low levels of innovation and weak entrepreneurship – all of which contributes to low productivity. Scotland’s ‘supply side’ (skills) performs far better. A smaller business services sector in Scotland, a dynamic growth sector nationally and internationally, is also a factor in explaining lower economic growth. Scottish business innovation and R&D is low due to its industrial structure and the high degree of foreign ownership of manufacturing. Weak management practices may also be an additional factor. There is tentative evidence that competition in Scotland, one of the main drivers of productivity, is low in Scotland. This also affects innovation levels. Small successful economies are characterised by high levels of innovation and the availability of a skilled workforce and the interaction between these. Higher education plays an important role in both innovation and skills provision. Government policy can drive the development of successful innovation systems through overall setting of strategy, providing funding and building consensus. This stimulates strong inter-firm collaboration, and collaboration between firms and high education. Performance Committee economic indicators and MSSS indicators (ongoing) Objectives The Performance Committee has been tasked with monitoring the progress of the Scottish economy using a small number of indicators (a subset of the Measuring Smart, Successful Scotland indicators). Scotland’s performance is compared to OECD countries and UK regions in terms of quartile position and the latest trends are monitored in terms of whether the gap between Scotland’s performance and the top OECD/UK quartile is growing or narrowing. Main findings Compared to OECD comparators, Scotland’s quartile position and trends are: 1. Growth in GDP – Q3, gap closing 2. GDP per head – Q2, gap closing 3. Employment rate – in Q1 and position improving 4. Productivity (GDP per hour) – Q2, no change in gap 5. Entrepreneurial activity – Q3, gap closing 6. Business R&D as % GDP – Q3, gap widening 7. Graduates as % of the population – Q2, gap closing 8. Net migration as a % of the population – Q2, gap closing 9. Export sales per worker – in Q1, but position deteriorating Figure 1 below provides a more detailed overview, and Figure 2 shows Scotland’s quartile position compared to a small number of benchmark economies. Conclusions Despite high employment levels, Scotland’s in GDP growth is relatively low and the level of GDP per head is behind many OECD economies. This is due to relatively low population growth and low productivity levels. Scotland performs relatively well on ‘supply’ side indicators (high skills, improving migration/population) but less well on the ‘business demand’ indicators (business R&D, entrepreneurship). Export performance has been hit by the downturn in electronics manufacturing mainly as a result of competition from low cost economies. Figure 1: Scottish Economy/Scottish Enterprise Performance Indicators June 2007 Update (Benchmark is top international/UK regional quartile) Measure International Quartile Position Trend with 1st OECD quartile To reach OECD 1st quartile, Scotland needs additional UK Region Quartile position (out of 12) Trend with 1st UK regional quartile Growth in GDP 21nd of 31 countries 1.4 % points / annum growth 9th GDP per head 15th / 31 £1,800 per head 4th Employment 7th / 31 In top quartile 5th Entrepreneurship 19th / 23 90,000 entrepreneurially active 10th Business R&D (% GDP) 23rd / 31 £1.1 bn business R&D expenditure 7th Productivity 14th / 27 - £3.10 per hour 4th Graduates (% of Population) 11th / 31 50,000 graduates 2nd Net Migration (% of Population) 8th / 22 6,600 net in-migration 6th Export sales / worker 6th / 30 In top quartile 10th Data: 2004; 2005; 2006 1st Quartile 2nd Quartile 3rd Quartile 4th Quartile Growth indicator and OECD Quarter ranking Sc ot la nd Ire la nd Fi nl an d D en m ar k M as sa ch us Ic el et an ts d N or w ay Figure 2: Economic Performance – Scotland and Benchmark Economies Growth 3 1 2 4 2 1 3 GDP per head 2 1 2 2 1 1 1 Entrepreneurship 3 2 3 3 - 1 1 R&D 3 3 1 1 1 2 2 Productivity 2 1 2 2 1 3 1 Graduates 2 2 3 1 1 1 1 Migration 2 1 4 4 - - 2 Employment 1 3 2 1 1 1 1 Export Sales 1 1 2 1 - 2 1 2. Competition (August 2007) Objectives Competition is one of the drivers of economic growth identified by the HM Treasury, and a number of economic commentators have suggested that competition levels in Scotland are lower than other economies – which in turn may contribute to Scotland’s relatively low economic growth. The paper outlines a range of potential measures of competition and the available data on Scotland’s performance. Main findings Competition is an important source of economic growth and is a principal driver of productivity growth. Competition drives productivity by promoting efficiency, shifting market share to more productive producers and by encouraging innovation. Of all the drivers of productivity, competition though is the hardest to measure and our understanding is least developed in terms of data availability, particularly at the regional (Scottish) level. At a UK level, measures suggest that the broad competitive environment (e.g. legal framework) is conducive to and supports competition. At a Scottish level, proxy measures tentatively suggest that competitive pressures may be relatively weak compared to the UK. Prices for some goods and services in Scotland are higher than the average of some UK regions. Although this could potentially reflect weaker competitive pressures, other factors such as the nature of Scotland’s geography and sparse population may be a cause. Scotland’s business stock and firm entry/exit rates are lower than most other UK regions, potentially resulting in weaker competitive pressures. However, much of the available data for Scotland is at an aggregate level (in terms of industrial sector) and this does not provide a definitive assessment of the competitiveness of sectors in the Scottish economy and how this effects economic growth. More detailed analysis is required to more robustly assess competitive levels within sectors using a wider set of indicators. Scottish Enterprise can indirectly encourage markets to be more competitive through, for example, removing some barriers to new firm formation, encouraging internationalisation and providing assistance for firms to innovate. Conclusions There is some tentative evidence that competitive pressures may be weaker in Scotland than other parts of the UK in some sectors. However, the available data does not allow a definitive assessment of this. More detailed work is required, potentially with the Scottish Executive, to access robust data. 3. The Finnish innovation system (May 2007) Objectives The analysis of the performance of Finland’s economy highlighted the role that the innovation system played in economic growth. A more detailed analysis of Finland’s innovation system was requested to assess its characteristics, the main players and level of investment. Main findings The Finnish innovation system displays the following characteristics: Level of investment/spend high at all levels of the system, particularly business R&D spend (significantly higher than in Scotland). High level commitment to innovation policy at the government level and long term strategic approach taken. Strong consensus at government, education and business level Focus on business research and the need for collaboration between businesses and with HE (driven by, for example, requirements of government funding) Strong technology focus of R&D government funding High degree of co-ordination across the main players (ministries and business organisations) - spreads the innovation message Cultural norms and characteristics an important factor - high trust in government Conclusions Finland’s innovation system is government driven but also characterised by a high degree of co-operation and co-ordination among the main players (government, education and business organisations). A long term view towards policy making has been adopted, and investment is significant across basic, applied and business R&D. 4. Massachusetts (May 2007) Objectives Continuing the series of comparisons between Scotland and similarly sized, successful economies to identify drivers of economic growth and potential lessons for Scotland. Massachusetts was selected as an example of a successful regional economy. Main findings Massachusetts’ GDP per head outperforms all other OECD countries and is ranked 2nd (out of 125 world regions) in the ‘2005 World Knowledge Competitiveness Index World’ High levels of productivity and a high employment rate have both contributed to high GDP per head The Massachusetts economy is strongly dependent on knowledge intensive, high value sectors such as education, IT, lifesciences, healthcare and business/financial services. R&D has been a main driver of productivity growth - Massachusetts outperforms other OECD countries on a range of R&D measures World-class universities and research institutes play an important role in driving R&D performance, attracting significant government R&D funds and business R&D activities Massachusetts has a highly skilled workforce, again outperforming other OECD economies - the state’s higher education sector again plays an important role here. The availability of high value jobs allows the State to retain and attract skilled workers Massachusetts is not an overly entrepreneurial economy, although does perform well for high growth businesses The interaction between the higher education sector, R&D activity, skilled workforce and knowledge intensive industries, which all depend on and influence each other, explain Massachusetts’ economic performance. Conclusions As the review of the Massachusetts, Finnish and Danish economies highlighted, the combination of innovation, R&D, a skilled workforce and the education system are crucial drivers of successful knowledge economies. 5. Innovation in Scotland (March 2007) Objectives Innovation has been identified as one of the key drivers of economic growth and Scotland tends to lag other economies on a range of measures of innovation. The paper summarised how innovation is measured, levels of innovation activity in Scotland and the reasons behind recent performance. Main findings Business R&D expenditure in Scotland is below the levels of most OECD countries – higher education R&D spend, however, is high. Scottish business R&D is concentrated in the pharmaceuticals sector. Compared to the OECD average Scotland has: a high level of economic activity in high tech manufacturing – but low R&D intensity a low level of economic activity in med-high tech manufacturing – and low R&D intensity a high level of activity in services, a sector that has low R&D intensity across all countries These combinations explain Scotland’s relatively weak business R&D performance. Low R&D intensity is in part caused by the large number of overseas companies in Scotland’s manufacturing sector – R&D tends to be carried out in the country of ownership R&D measures do not capture all innovation activity. Taking a wider definition of innovation (including more than just R&D activities), 56% of Scottish businesses are innovation active. This suggests that a significant proportion of Scottish businesses are not involved in innovation activity. Innovation in Scotland occurs across most sectors, including the service sector. Overall most innovation occurs outside manufacturing. Scottish (and UK) innovation levels are low compared to a number of European competitors Most Scottish businesses not involved in innovation state that that the nature of their product does not require any R&D expenditure. Barriers to innovation cited by businesses include the costs associated with R&D, access to finance required for R&D, the risks associated with R&D and lack of qualified R&D staff Conclusions On R&D measures, given the industrial structure and ownership structure of Scotland’s manufacturing base, narrowing the business R&D expenditure gap with other OECD will be challenging. On the wider definition of innovation, a large proportion of Scottish SMEs are not innovation active, with SMEs in other EU countries more likely product or process innovate. Given the important role that innovation plays in productivity and economic growth, this is a gap that needs to be addressed. The Performance Committee noted the importance of innovation within SMEs and asked for further work to be carried out on the link between Scottish Enterprise innovation activities and measures of progress used (see August 2007 outputs). 6. Scotland and Finland (March 2007) Objectives Continuing the series of comparison between Scotland and highly performing small economies to identify differing drivers of growth and lessons. Main findings Finland is regarded as one of the world’s leading knowledge economy and scores highly on a number of international competitiveness and innovation indices - although, GDP per head, productivity and the employment levels are all below Scotland’s Since the early 1990s, though, employment rate, productivity, GDP and GDP per head growth have all been significantly above the Scottish and OECD averages. Growth has been driven by a high skilled workforce, strong innovation performance and a growing ICT sector. Finland’s workforce is one of the highest educated in the OECD, with a particular focus on technology related subjects and polytechnic level education. On a range of innovation measures, such as R&D spending and patenting, Finland outperforms nearly all OECD countries. Finland was the first country to adopt an ‘innovation system’ approach, with a range of government policies to bring together private and public sector players. Co-operation between businesses on R&D activity (driven in part by government policy), the strength of the ICT sector (with Nokia at the heart) and the education system are key features of the innovation system. Finland is successful at converting innovation inputs into outputs – a high proportion of Finland’s SMEs introduce new products and processes to the market. Conclusions Finland’s recent strong economic performance highlights the role of innovation, skills and education combining to drive growth. The role of the Finnish ‘innovation system’, built through government policy and a national consensus has been key to this - providing potential lessons for Scotland. The role of Nokia, a large indigenous technology company, should not be overlooked as a source of innovation spend and activity. Further work on the Finnish innovation system and comparisons with Scotland were requested for the May 2007 Performance Committee meeting. 7. The business services sector in Scotland (November 2006) Objectives An analysis of Scotland’s economic performance compared to other regions of the UK highlighted the importance of business services (BS) in terms of its size and recent growth performance. A more detailed analysis of the business services sector was requested by the Performance Committee. Main findings BS accounts for 19% of Scottish GVA and 13% of employee jobs, although the sector in Scotland is smaller than in most other UK regions BS has been one of Scotland’s fastest growing sectors in recent years, accounting for over a third of all growth - though growth has been below that of all other UK regions. 40% of BS GVA (and 7% of total GVA) is accounted for by the consumption of housing by owner occupiers and renters (due to the way owner occupation is treated by National Statistics) Other important sub sectors include accounting/book-keeping, labour recruitment agencies and industrial cleaning. The sector exports £5.4 billion worth of goods and services (70% of which are to the rest of the UK), accounting for 12% of all Scottish exports The growth of business services is linked to overall growth of the economy. Another important driver is increased outsourcing of activities by other industries. Conclusions The business services sector has been the fastest growing sector in the Scottish economy (and other UK regions) in recent years. However, the size of the sector in Scotland is lower than most other regions as has been the rate of growth. It is not clear why thus is. This has been a significant factor in Scotland’s lower than average economic growth (compared to the UK). 8. Scotland and Denmark (November 2006) Objectives To compare Scotland with a high performing, small European economy to identify drivers of growth and any lessons for Scotland. Main findings: Denmark is considered to be among the world’s most competitive economies and has been among the OECD’s most prosperous countries Denmark’s employment rate is 2nd highest in the OECD due to liberal labour markets and highly educated population – although Danes work fewer hours (due to high personal tax rates) Denmark has relatively high productivity driven by high business R&D and a highly skilled workforce (all higher than in Scotland) Denmark is in the top quartile of OECD economies for business R&D and for graduates as % population Denmark has a large public sector – 2nd highest spending relative to GDP in OECD Conclusions Denmark’s stronger performance compared to Scotland due to higher productivity and a very high employment rate. Productivity driven by a highly skilled workforce and high business spend on R&D. 9. Scotland, the South West and East of England (August 2006) Objectives A comparison of Scotland’s economic performance with the East of England and the South West of England, two regions that have been performing relatively well in recent years in terms of economic growth. Drivers of growth in each region were compared to performance in Scotland. Main findings: Overall economic growth in the East and South West have been significantly higher than in Scotland, but growth of prosperity (GDP per head) has been relatively similar Population growth in the East and South West has far outstripped Scotland’s, resulting in higher economic growth The East has higher productivity than Scotland, but the South West’s is lower The business and financial services sector is larger in the East and South West than in Scotland, and has been growing faster Manufacturing decline in Scotland has been more pronounced than in the East and SW. Scotland’s skills levels higher than both the East and the SW – although only the East is a net recipient of graduates Scotland’s businesses spend less on R&D, and have fewer entrepreneurs R&D in the East is centred on pharmaceuticals, automotive, ICT clusters – in the SW aerospace, electronics, creative industries, marine sector are the main R&D sectors The ‘London effect’ is particularly important for East (transport hubs, commuting, access to high value jobs) Conclusions Reasons for Scotland’s slower growth compared to Eastof England and the South West include population dynamics, industry structure and dynamics (especially business services), lower productivity, weaker R&D and innovation, less entrepreneurship and the lack of a ‘London effect’. Business services identified as an important driver of economic growth. More research was requested carried out on this for November 2006 Performance Committee.