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Developing private investment in the West Midlands – what is the role of government?

Birmingham's industrial heritage

The issue put before us today is the state of private investment in the west midlands economy, and how government, at whatever level, can best encourage it. It's an issue of both local and national significance.

In many ways, this question is especially important in this area. After all, it was here that the Industrial Revolution began, a revolution which both transformed our national fortunes and elevated our international standing.

And it was the endeavour and entrepreneurship of men like William Morris, Michael Bass, Joseph Bamford and George Cadbury which helped create both great wealth and entirely new industries.

The timely combination of emerging technologies, large new markets and the enterprise of a new generation all helped Great Britain become the economic powerhouse of the 19th century.

Now

Today, this area is still home to a diverse range of world leading businesses. Whether it is the brains at Qinetiq, or the brawn of JCB; whether it's a £2 billion construction services business like Tarmac or the iconic status of Aston Martin, this area still nurtures leading enterprises.

Manufacturing remains highly significant to this economy, generating an estimated £45 billion last year. However it is now only part of a wider, more diverse picture. Thus the ICT sector now employs over 57,000 people and turns over some £14 billion, whilst tourism employs some 305,000 people and is worth £4.8 billion per annum.

Of course investors will want to know how competitive a prospect is. They will want to know whether the business can not just survive, but prosper in a tough global market.

Sadly, the UK is struggling. When pitching for export markets we've slipped behind. Germany's exports to China have been growing three times as fast as Britain's, and France's twice as fast. No wonder our trade gap is now one of the largest in living memory.

One of the problems is our inability to become more productive, when compared to the competition. Over the last decade, Britain has slipped from 4th to 10th in the league tables of international competitiveness. Indeed workers from the other G7 countries are now on average 10% more productive than our own British workers.

So there is clearly, much work to be done, locally and nationally. The question is what role - if any - should the state play in backing business and how in reality can it encourage a more prosperous economy here in Birmingham?

The role of Government

I believe that government does have a role to play. But, like most businesses, it should stick to what it can do best and not be drawn into an ever-widening range of well-meant but ill-conceived ventures.

I will come to some micro-economic issues like finance and business support later, but what in macro-economic terms should government do?

Well, the first role is to seek to ensure financial stability, or sound money as Margaret Thatcher called it. Monetary discipline is a vital prerequisite to business and investment, providing relative certainty and so confidence to invest.

If we learnt anything from the 1970s it is that rampant inflation kills businesses and so jobs.

That is why ten years ago Gordon Brown was right to make the Bank of England independent. It was something which I know Ken Clarke had hoped to do, but Brown got the first chance and he was right to take it. I only hope his decision to subsequently switch to a different inflation target hasn't undermined the Bank's ability to do its job.

The second job of Government, when encouraging business, is to tax and regulate as unobtrusively as possible.

For business to prosper, and so investors to earn their reward, a tax system needs to be simple to understand, easy to comply with and cheap to collect.

Sadly, our own tax system is hideously complex, time consuming for taxpayers and increasingly expensive to administer. Indeed our tax code - known as Tolley's Tax Handbook - has doubled in length in just 10 years, to over 9,800 pages of rules and regulations. It is longer than any of our major competitors and KPMG reckon that the compliance costs alone now stand at £5 billion a year. And that's on top of the £52 billion extra tax we actually pay !

The third role for Government is to provide the right environment in which to do business. Conventionally this would include hard infrastructure like efficient roads and railways and a skilled and employable workforce.

However I also extend this role to the essentials needed in today's business environment - ensuring that we have the right technological infrastructure such as mobile telecoms and broadband, as well as the right regulatory framework for IP. After all for many businesses, the know-how and creativity of their staff is often their most important asset.

Business support

These macro-economic roles therefore - sound money, an unobtrusive and efficient tax and regulatory environment and providing the right infrastructure - are the central roles for Government.

You'll have gathered that whilst I believe the current Government has got some things right - such as interest rates - I am also very concerned about its failure to provide the right tax and regulatory regime.

That's why the Shadow Chancellor, George Osborne, has clearly set out our ambition to radically reform the tax system to make it simpler, fairer and in due course lower. Our Tax Reform Commission has set out a range of plans to simplify current business taxes and sharply reduce the cost of compliance. We are evaluating these plans in detail, but the direction for business investment is clear: simpler, fairer and lower.

Business support

Let me now turn to two other inter-related issues which affect investors and business, namely state aid and finance. What role, if any, does Government have in either supporting business or the financing of enterprises?

Let me start with business support. When I began this job in December 2005 I started to enquire how many state business schemes are operating. I had assumed there might be 300, or even 600. In fact there are roughly 3,000 separate schemes, run by 2,000 state bodies and their contractors.

I say 'roughly', because by their own admission Ministers are unsure just how many schemes there are at any one time. The system has become a veritable maze of money, which is no so unclear that it actually deters the very people it's meant to help. And the cost of all this to us as taxpayers is now over £3.9 billion, excluding business tax reliefs.

To better understand the problem, and try and assess what economic benefit these schemes were having, I set up an independent Small Business Task Force. It comprised of both entrepreneurs and VCs and is led by Doug Richard, of Dragon's Den fame, and a Californian serial entrepreneur.

The interim findings of the Task Force were not encouraging. At least one third of the money spent on regional business support is lost in administration. Indeed there were several schemes where the money lost to admin rose to over two thirds of the scheme's budget. Out of a regional budget of over £2 billion that's an unacceptable waste of taxpayers' money.

How could this happen? Let me give you just two of the problems.

First of all, at least a third of local business schemes aren't even assessed to measure what they're achieving. For example, the Task Force found that the NW RDA runs 21 such business schemes in the year 2005-06. However when asked it could provide no analysis of the effectiveness of any of those schemes. Not one.

Secondly, there is considerable duplication. Take, for example, the way inward investment is handled. The RDAs now operate forty five offices abroad. From Newport Beach to Bangalore, from Mumbai to Malmo, from Orange County to San Jose these nine regional agencies are actively competing against each other, to the bemusement of the locals. Thus in Tokyo they have seven separate teams, in Boston and California six, whilst in Paris, New York and Sydney they're running four different teams, all competing to bring investment to our shores.

And all this, when there's another Government agency - UKTI - specifically charged with the task of securing inward investment and with its own £100m budget. It's high time the Government stopped this nonsense, and enabled the UKTI to run a powerful single effort, whilst the RDAs stopped outbidding each other and wasting public money.

These two problems of duplication and waste are just part of a bigger concern, namely that Whitehall's ambitions come before business's needs. This is not to say that those engaged in the system do not mean well. Nor is it right to say that there have not been good individual investments or welcome success stories.

Rather in many of our cities and counties business and investment is succeeding either in spite of or without state intervention, but not because of it.

Doug Richard's team illustrated this when they commissioned a series of fifty independent correlation analyses between Government expenditure per business and a series of key indicators.

They analysed government spending and - the number of registered businesses; the growth in self employment; start-up rates; survival and growth rates and then key measures like profitability and productivity.

In each case no positive correlation could be found between government money spent and the key measure identified. Now, this does not prove that government intervention is not helpful in any individual circumstance. However it does place an onus firmly on Government to prove more robustly that its schemes are working, before it commits any of taxpayer's money.

Business Finance

And what of financial support and investment itself?

The UK actually has remarkably competitive and sophisticated capital markets. It is a vital advantage for the UK, let alone Birmingham, and as new York wrestles with over-regulation, its an advantage we should not cede.

It's why some of the silly, political talk against the private equity market should not distract us from the facts. As the FT recently showed, the 30 biggest private equity deals, have resulted in 36,000 new jobs being created, with a net increase of 25% within those existing employment bases.

So let me be clear today. Conservatives support private equity. Lets us not forget that despite some exceptions, private equity firms increase productivity, increase innovation, and add to employment. It's a success which should be applauded, not decried.

The Government has identified what it believes is an important equity gap, particularly in seed stage funding upto £500,000 and then at the pre-institutional range upto £2m.

For the purposes of our debate today, let me pose two questions to you - is there really an equity gap, and should Government be directly intervening at all?

I mentioned Doug Richard earlier. He is one of several VCs who take the unconventional view here- namely that in fact the so-called equity gap is not as serious as some commentators claim.

Indeed his business, The Library House, which is a leading authority on private high growth companies, researched the UK venture capital market in detail last year.

They found that actually the UK market is alive and well, indeed the latest figures show that over 1,400 companies, were in receipt of £6.6 billion, thus making the UK venture capital portfolio the second largest in the world, behind the US.

Significantly, despite all the fears, the range between £250k and £2m, is in fact the most active, with more deals done than any other range.

So why do growing businesses struggle to get funded? Is there a real, institutional problem, or could it be that - as some suggest that those businesses seeking investment aren't actually ready and need help to prepare.

My second question here, revolves around whether Government should directly intervene? Clearly if the equity gap as been wrongly interpreted it would undermine current policies.

But more specifically what is the evidence as to the effectiveness of the regional Venture Capital Funds, VCTs and early Growth Funds which Government and the RDAs have set up?

Well the NAO recently considered the evidence. In most cases there was again a lack of verifiable evidence which could show the impact of these funds, beyond anecdotal stories. And in recent years take-up has declined sharply, so that for example investment through the Regional VCFs has fallen by 25% over the last full year.

The BBA say that in fact there is plenty of private money in the system and the relative high costs of Government backed schemes like the Small Firms Loan Guarantee Scheme makes them less attractive.

So does this mean that Government should scrap these schemes and replace them, or does it beg the larger question as to exactly what the state should be seeking to, and whether there is in fact a clear market failure which it needs to correct? As both investors and businesses, I should be interested to hear your views, as to how your tax pounds should be spent.

Conservative approach

So what, fundamentally, should government - local or national - do to help the economy of Birmingham, not least its businesses and investors?

Well I believe that we in politics should be clear about the limit of our powers. We should have the sense to focus on those things we can improve, and the wisdom to try and remove the barriers to enterprise. That means beginning with those three macro-economic roles.

First sound money, with interest rate decisions made independent of political interference.

Second, reforming the tax system to make it simpler, fairer and in due course lower. I want - my Party wants - to sharply reduce the burden and costs of tax compliance, not least to let business focus on make profits and creating jobs.

Third, we have to ensure that our workforce is both skilled and employable. In ten years there's been a 40% rise in the number of teenagers not in education, employment, or training. It's a waste of their talent and a terrible indictment of the Government's failed policies.

And what role does Government have in nurturing business and investment?

Doug Richard's team are working on the details, so it would be wrong of me to pre-empt them. However let me try and suggest some important principles.

First, Government should usually intervene only where there is evident market failure. Its role should primarily be to enable market correction and not to tinker and meddle.

Second, business advice and support should by customer-led, not Whitehall-driven. Government's is best left to establish and enforce quality standards.

Third, no scheme or agency should continue unless its effect can be measured, and that measure is meaningful. We must stop making the measurable important and begin to make the important measurable.

Fourth, business support is not a social programme. If there's a social problem, then address it, but don't misuse the business budget. Labelling social schemes 'business support' is misleading and often counterproductive.

And fifth, instead of public servants offering help, advice should by business people for business people. I wouldn't ask a plumber to make tax policy, and we shouldn't ask public employees to try and teach people entrepreneurship.

Conclusion

Continued economic success means continued economic adaptation.

Ten years ago, innovation was something that gave you a competitive edge - now it's a necessity for every business.

Government's most useful support to business is to recognise this and to provide business with a dynamic, quality labour market; a simpler, fairer and lower tax system; a good road and rail network; and an open and robust legal and financial environment in which to invest and trade.

Tinkering and meddling - whether in taxes or regulations - that undermine these aspects should be avoided, whenever possible.

However if there are clear market failures then Government has a role to help correct the reason for that failure. This should be a shared role with business, nationally or regionally.

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