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The path to productivity

Boosting the country's abysmally low productivity levels will be a central plank of the Scottish Government's economic strategy if Scotland votes for independence in just over five weeks' time.

But will the Government's plans to lower corporation tax in a bid to boost the country's competitiveness, create jobs and boost revenues be enough for success? According to First Minister Alex Salmond, a cut in corporation tax of 3% will be an independent Scotland's "best available weapon" to improve its competitiveness. And if there is a Yes vote, the Scottish Government said in May that it would aim to boost productivity by 0.3% a year.

"Using the powers of independence to increase productivity by 0.3 percentage points a year, boosting the working-age population, and increasing the employment rate by just over 3% would grow our economy to generate additional tax revenues of £5 billion a year by 2029-30," a Government spokesperson told the Sunday Herald.

But the Scottish Government has so far released little detail on how it will achieve the desired rise in productivity, other than saying that its controversial proposed 3% cut in corporation tax will somehow give the productivity figure the needed boost to take Scotland from the third to the top quartile of the European performance league in this field. Pressed for detail, it has fallen back on formulae on how the 0.3% figure is an "illustration", the language of credit card rates offers.

Even if productivity is improved as part of the Government's "re-industrialisation" policy, this would only bring Scotland's productivity levels up to those of the rest of the UK - which fares poorly in international league tables.

Meanwhile, a recent report by Durham University Business School found that private sector productivity in Scotland, according to the Total Factor Productivity (TFP) indicator (which measures how efficiently a firm uses all inputs, not just labour) rather than official labour productivity figures (which measure output per hour worked), has been on average 11% lower in Scotland than the rest of the UK since the late 1990s.

The main factors for this are an underperforming services sector, poor exporting, a shortage of innovative firms and low investment in research and development.

Defined as the rate at which goods or services are produced, productivity is one of the key measures of a country's economic performance and its ability to improve its standard of living, by raising its output per worker. According to the Nobel laureate economist Paul Krugman, nothing matters more when assessing a nation's prospects.

Annual productivity growth in Scotland averaged 2.2%, 0.3% lower than the rest of the UK between 1998 and 2007, when the economic crisis led to the most severe downturn since the Second World War.

According to STUC assistant secretary Stephen Boyd, the Scottish Government is right to highlight the importance of long-term productivity growth but it has so far been "less than convincing in providing a persuasive and coherent programme for achieving this end".

"Setting ambitious targets may be appropriate but it should also be recognised that even under independence the Scottish Government would not control all the factors which conflate to determine the rate of productivity growth," he said.

"The full impact on Scotland's productive potential of the recent recession and the prolonged period of stagnation that followed will probably not be apparent for some years. The bulk of jobs growth appears to have been in sectors and self-employment where productivity is low."

Despite economic development policy at UK and Scottish levels being targeted with some success at higher-value sectors, large swathes of the economy remain stuck in a "low-pay, low-skill, low-productivity equilibrium".

Boyd also stresses the fact that productivity growth in the manufacturing sector tends to be significantly higher than in most services, particularly labour-intensive personal services largely delivered by the public sector. So increasing the manufacturing sector's share of total output would likely improve the overall rate of productivity growth.

"Increasing the rate of productivity growth is necessarily a slog and pretending that a silver bullet exists in the form of corporation tax cuts is a fantasy.

"Focusing on a measure that will exacerbate short-termism undermines serious efforts to break with Scotland's low productivity business culture through measures such as enhancing long-term patient investment and addressing the antediluvian management practices that exist in too many Scottish workplaces".

Garry Clark, head of policy and research at the Scottish Chambers of Commerce, said that reducing corporation tax would help Scotland attract more inward investment and could help boost productivity levels but was unlikely to do so unless combined with other fiscal measures.

"From the point of view of inward investment, the availability of schools, transport infrastructure and so on is also important. I don't think that lowering corporation tax by itself would be enough to solve everything."

Although investment in R&D is exceptionally high in the oil and gas sector in the north-east of the country, such essential investment is geographically patchy in the rest of the country and varies from sector to sector. Scotland exports less, proportionately, than the rest of the UK so improving exports by growing the country's manufacturing sector ought to be a priority but little is being done to achieve that aim by the Scottish Government, said Clark.

The Government's principal business development agency, Scottish Enterprise, does a good job in helping companies in a limited number of very specific sectors regarded as having high growth potential, but it does not offer any help at all to important sectors such as retail.

According to the husband-and- wife team of economists Jim and Margaret Cuthbert, the Anglo-Saxon capitalist model, with its emphasis on short-term profits and shareholder value, is one of the main stumbling blocks to raising productivity not only in Scotland but in the UK as a whole.

That business culture often leads to companies with surplus cash choosing to put their financial assets into property investments rather than investing in their businesses.

Margaret Cuthbert points to Germany's envied "Mittelstand" of small- to medium-sized companies, often family-owned, where - unlike many UK firms of a similar size - the chief executive is more likely to be an engineer with direct experience and knowledge of innovation and quality.

The German educational system, with its rigorously assessed and highly regulated apprenticeships, is also better geared to serving the needs of manufacturing and industry, according to Margaret Cuthbert.

Jim Cuthbert believes that "intelligently targeted" reductions in corporation tax could help boost productivity to greater effect if companies are given an incentive to invest in research and development.

Productivity levels in the UK are significantly lower than those of most of its main competitors and this is linked to the fact that spending on research and development is also lower than many other advanced countries.

"But this is not a Scottish problem: it is a UK problem," said Margaret Cuthbert. "Scotland's exports in manufacturing are among the best in the UK."

John McLaren, of the recently-launched think-tank Fiscal Studies Scotland, said that cutting corporation tax would likely encourage more companies to set up in Scotland but would have no direct effect on productivity levels - although it could boost productivity if it attracted international companies with high productivity to come to Scotland.

"I think what the Scottish Government is trying to do with corporation tax is increase economic activity not productivity," McLaren said.

Ireland's famously low level of corporation tax (currently 12.5% on a company's trading income) is essentially a means of under-cutting other competitor countries when it comes to attracting foreign investment, McLaren said. What is needed in Scotland - and, for that matter, the whole of the UK with the exception of the south-east of England - is a concerted attempt to boost spending on research and development.

Investment in research and development in Scotland is mostly limited to a few specific industries, such as the pharmaceutical industry. Exports of Scotch whisky are buoyant, "but there are a lot of companies in Scotland that don't export much," said McLaren. "More should be done to encourage firms to export or to attract international companies that do export to come to Scotland."

"Of course, saying we want to improve productivity is harder than actually doing it. There are a lot of companies that want to do that and it is the ideal of every government to improve its productivity because that is the best way to improve the economy."

The economist Andrew Hughes Hallett, who sits on the Scottish Government's Council of Economic Advisers and the Scottish Fiscal Commission, says that the root cause of low productivity levels in Scotland is the poor investment record of English companies with operations in Scotland.

These rest-of-the-UK (rUK) firms present in Scotland typically invest at half the rate of US, European or Scottish-owned firms. More often than not they opt to site their high value operations, such as research and development, in England while their Scottish outposts often fulfil little more than "branch office" functions.

"The fact that the rUK firms and the others have followed such different strategies tells you that the problem lies not in Scotland or the rest of the world, but with rUK," Hallett said.

"It is the unlocking of investment and credit from the banks which has at last improved rUK's dismal productivity record, not anything more fundamental so Scotland has nothing to look forward to under the present arrangements.

"Anything that we can do to improve the investment climate and get credit flowing to firms would help but that is not what is happening at the moment."

Lowering corporation tax is just one of the many tools that independence would put at the disposal of a Scottish Government that wants to raise productivity, Hallett said.

Under the current constitutional arrangements, the Scottish Government is unable to do the things that need to be done to improve productivity as most of the levers "come up against the barrier that the UK government rules them out. Under independence Scotland would be free from those restrictions".

UK immigration policy often doesn't work in Scotland's favour. A good example, cited by the professor, is a scheme, recently shut down by the Home Office in London, which allowed students from some countries outside the EU to stay in Scotland for a limited time following graduation. Demographic factors also need to be considered. According to the Office for National Statistics, there were 3.2 working-age people in Scotland for every pensioner in 2012 but this ratio is expected to drop to 2.6 workers per pensioner by 2037.

But growing anti-immigrant sentiment in England, whipped up by political parties such as Ukip and the BNP, means that this demographic time bomb - with its potential to directly impact government revenues, productivity levels and economic growth - shows no sign at the moment of being addressed in a way that would benefit Scotland.

A reduction in corporation in tax would help "a bit", the professor said, but more radical tweaks to the system - such as introducing exemptions to encourage research and development - could have a greater impact. That is the experience of Europe's largest economy, Germany, which has high levels of corporation tax but also has so many exemptions that many firms pay little or nothing.

Regardless of the outcome of next month's referendum, the onus is now on the SNP government to flesh out exactly how it will improve productivity, boost innovation and the export of high-value manufactured goods.

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