Scottish National Investment Bank: implementation plan

The opportunity of a Scottish National Investment Bank

National Investment Banks of scale are successful across the globe

National investment banks (" NIBs") play a key role in the economic development of many countries, with over 90 institutions existing across different countries and regions around the globe ^[7] .

In recent years, the more successful NIBs have taken on a new role as key domestic and global actors driving economic growth and innovation, particularly through addressing contemporary challenges such as climate change. By making strategic investments and nurturing new industrial landscapes, their focus on solving important societal challenges (a "mission-oriented" approach) has helped to rebalance their economies and reinvigorate the industrial base. These institutions act in concert with their governments and help achieve long-term objectives.

A mission-oriented approach to industrial policy has helped to determine the direction of growth by making strategic investments across many different sectors, and improving business expectations about future growth areas. This requires patient, long-term, committed finance – typically over 10-15 years which is beyond the investment horizon for conventional bank lending.

By developing new financial tools and working closely with public and private stakeholders NIBs can, if structured effectively and with the appropriate attitude to risk and return, play a leading role in driving growth, innovation and industrial transformation. By steering the path of innovation towards missions set by government, these NIBs are not just correcting issues in existing markets (a "market failure" approach in the common terminology), but are actively creating and shaping markets. They are enabling activity that otherwise would not take place.

A new cornerstone institution in Scotland's economic landscape

The modern era, with the unprecedented pace of technological change, is having huge economic, societal and environmental impacts across the globe. Governments and capital markets need to respond to these challenges in a new and co-ordinated way at a strategic level, including stimulating investment across sectors to address complex challenges.

There will be opportunities for business to capitalise on these changes, and first-mover advantages to those countries who mobilise resources most efficiently. Scotland is well placed to do this. It has a scale that facilitates collaboration, combined with the human and natural resources required to seize the economic opportunities of the future. Scotland has the potential to demonstrate global leadership on common challenges such as transitioning to a low carbon economy, population health and demographic change, as well as harnessing the powers of rapid technological development to provide benefits to all across society.

The new Scottish National Investment Bank ("the Bank") should be a cornerstone institution in Scotland's economic architecture to help realise these possibilities, building on the success of the Scottish Government's (" SG") current support mechanisms.

It should be set up to be an enduring institution that aligns with SG and its delivery agencies to provide critical economic leadership. By applying robust data analysis and developing evidence, it should respond to well-defined missions that are focused on solving important societal challenges. This will provide policymakers the opportunity to determine the direction of growth by facilitating strategic investments across many different sectors and nurturing new industrial landscapes, which the private sector can further develop.

Close alignment between the Bank, other public sector agencies and government should create a powerful connection between policy, regulation and financing which can be co-ordinated for maximum impact. The direction of policy (both economic and social) together with the activity and support of the Bank, will create confidence in the private sector to invest where previously they would not have done. This will enhance the effectiveness of SG's interventions and allow a longer term view to be taken by business, investor and SG itself.

A vision for the Bank aligned to Scottish economic policy

Scotland has a distinct economic policy environment with Scotland's Economic Strategy establishing four key priorities for growing the economy. These priorities cover investing in people and infrastructure, fostering innovation, promoting Scotland internationally and inclusive growth – the notion that growth which combines increased prosperity with greater equality creates opportunities for all and distributes the benefits of increased prosperity fairly.

Scotland's Programme for Government builds on this. In its own words, it:

"…sets out a bold and forward-looking economic vision – sending a clear message to our people, businesses, schools, colleges and universities, and to the wider world: Scotland's ambition is to be the investor and the producer, not just a consumer, of the innovations that will shape the lives of our children and grandchildren.

We will seize the economic opportunities of tackling climate change, helping existing industries adapt to the future and using developments in data and digital technology to make our economy more competitive, productive, innovative, fair and profitable."

It is apparent that we are now at a critical juncture, with a once in a generation opportunity to grasp Scotland's competitive advantage which can deliver this potential. To unlock such potential, the Bank will need to be an innovative and forward looking institution and, as comparator institutions internationally have shown, will need to have the scope and scale to adapt to local market conditions and needs.

Drawing from this strategic direction, the Bank should adopt the following vision:

"The Scottish National Investment Bank will provide finance and act to catalyse private investment to achieve a step change in growth for the Scottish economy by powering innovation and accelerating the move to a low carbon, high-tech, connected, globally competitive and inclusive economy."

The current economic outlook is challenging

The vision for the Bank is for a long-term cornerstone institution at the heart of the Scottish economy. It is useful to set this in the context of the current economic climate.

The current Scottish Fiscal Commission (" SFC") economic forecasts ^[9] are for modest growth over the period to 2021, below the pre-2008 long-term trend (see Figure 1). The forecast is partially driven by SFC assumptions about productivity growth in the Scottish economy and partly by the modelled impact of the UK leaving the European Union (" EU"). The Office of Budget Responsibility (" OBR") for the UK as a whole show a similar picture although they are more optimistic in their central projection ^[10] .

Figure 1: GDP growth in Scotland: outturn and forecast

The SFC has taken a more pessimistic view of the impact of Brexit than the OBR. The SFC take the view that EU migration will be significantly lower than recent trends and that there will be an adverse impact on trade. At the time of writing, the future relationship with the EU was unclear, but SG analysis published in January 2018 ^[11] provides new evidence of the substantial costs resulting from lower economic growth and lower business investment opportunities in Scotland and the UK that will result from leaving a market in excess of 500 million people. Scotland’s GDP could be as much as 8.5% (or £12.7 billion) lower by 2030 and business investment in Scotland could fall by up to 10.2% by 2030, compared to continued EU membership.

The potential economic benefit of establishing the Bank

SG’s Council of Economic Advisers (" CEA") has previously set out the importance to Scotland’s economic growth of supporting infrastructure development, providing finance for high growth businesses, and supporting strategic investments in innovation through a submission to the consultation on the Green Paper for the UK’s Industrial Strategy ^[12] . The work of the CEA recognised the scale and scope of existing SG investment and intervention in infrastructure and business development, but also identified the potential for a Scottish National Investment Bank to support the delivery of long-term investment to boost economic development.

In particular, the CEA highlight a number of issues around patient capital which are fundamental to long-term growth, and where a NIB could stimulate stronger economic growth across Scotland. These include:

• The need to achieve higher levels of long-term investment in SMEs: High transaction costs and what are termed "information asymmetries" can lead to an under supply of finance for SMEs (a problem traditionally known as the ‘Macmillan gap’). Both debt and equity providers tend to prefer the lower aggregate transaction costs of larger deals, and are reluctant to spend the extra time and cost to support some types of investment. It is also easier to invest in firms with longer track records and where returns are more predictable than newer firms, where returns are less certain and further in the future.

• The need for improved innovation performance: According to the European Commission’s Regional Innovation Scoreboard, Scotland is classed as an innovation ‘Follower’. It ranks around the middle of EU countries across a composite of innovation indicators. Scotland’s overall expenditure on R&D as a percentage of GDP is low relative to comparator countries. Within this, Scotland performs particularly poorly in terms of Business Expenditure on R&D ( BERD), ranking fifth amongst sixth comparator countries.

A further unique feature of the Scottish investment landscape lies in the success and volume of investment by universities and other academic institutions. In 2012, for example, Scotland's higher education R&D expenditure as a percentage of GDP was the fourth highest in the OECD, with half of Scotland's University research being assessed as world-leading or internationally excellent. This makes the relative lack of technology companies based in Scotland starker, and points to a missed opportunity to use the intellectual capital that Scotland has in abundance.

The CEA also focused on the support for patient capital within a devolved Scottish context, and the constraints within the current UK institutional arrangements. They specifically highlighted the persistent gap in the provision of microfinance, debt and early stage equity for small and medium enterprises, and growth capital in amounts up to £10m. In addition, the dependency on European funding sources was noted as significant in Scotland and highlights that Brexit could have significant implications for support for business development funding and infrastructure investment in the coming years.

In order to achieve its full potential and deliver the maximum level of economic benefit to Scotland, the operations of the Bank should be based on a deep and comprehensive understanding of the unique and varied characteristics of the Scottish economy. As with the strongest-performing NIBs elsewhere, it should establish a sharp and dedicated focus on the specific set of conditions which it faces. For example, we know there is significant variation in the industrial composition and productivity performance across – and within – UK regions. Productivity across the whole UK demonstrates significant variation, with London and the South East clearly outstripping other regions’ performance (see Figure 2).

Figure 2: Regional and sub-regional productivity

In addition to this, Scotland’s sub-regional productivity performance is more broadly diverse than all regions other than the North West, South East and London. While four Scottish sub-regions demonstrate productivity levels above the UK average (Aberdeen City & Aberdeenshire; the City of Edinburgh; Inverclyde, East Renfrewshire & Renfrewshire; and South Ayrshire), there are many that continue to lag substantially behind.

This view of sub-regional performance is reinforced by a similar comparison of wider factors that shows the variation between Scotland and the rest of the UK is even more marked. Figure 3 shows the different relative performance of UK regions against OECD regions by a range of measures of well-being.

Figure 3: "Well-being" performance of UK regions against rest of OECD

Scotland scores highest in the UK on Community, Life Satisfaction and Civic Engagement, and poorest on Access to services (as well as Health). But what is equally pertinent is that Scotland is the most extreme (top or bottom of the ranking) in the UK in these five categories, a total that is only surpassed by Greater London (six), which confirms the differences between Scotland and other (regional) parts of the UK.

Coupled with the divergence in the policy environment between Scotland and the rest of the UK – for example in housing, where there are now wide differences in legislation around homelessness and the nature of tenancies as well as a different approach to provision – this variance and specificity of local conditions in Scotland means that local experience, knowledge and focus will be required to deliver the benefits that the Bank can offer.

To give an idea of the macro-economic impact the bank could make, initial economic modelling undertaken by SG on behalf of the Implementation Plan suggests that whilst there will be benefits in the short-term from any additional investment made by the bank, the real prize will be how the bank is able to influence productivity and the overall liquidity of investment in the longer term. To give an idea of the macro-economic impact the bank could make, initial economic modelling undertaken by the Scottish Government on behalf of the Implementation Plan suggests that whilst there will be significant benefits in the short term from any additional investment made by the bank, the real prize will be how the bank is able to influence productivity and the overall liquidity of investment in the longer term. (For further detail see the accompanying Supporting Analysis paper.)

Consultation feedback

The responses received as part of the consultation process were overwhelmingly positive towards the proposition of a national investment bank. Respondents were keen to engage with the development of the Bank’s scope and investment strategy. The responses suggested that there was a broad appetite across Scotland for a wider scope of support within the Scottish investment landscape and a requirement for additional capital. A number of respondents also cited that this was an opportunity to adopt a more ethical, socially just and environmentally aware investment strategy.

Summary

There is a strong and clear argument that the supply of capital to an economy through a NIB can fix market failures and address gaps in the financing markets for companies seeking finance to grow. A NIB can provide strategic leadership to support, create and shape new markets for investment and drive innovation targeted at particular economic, social and environmental objectives.

The strategic and economic cases for establishing a national investment bank in Scotland are compelling, supporting the economic ambitions of SG and the change and growth which will secure the nation’s future. Review of the impact that international comparators have had on their respective economies provides confidence that such a Bank will enhance the performance of the Scottish economy.

Having an institution based in Scotland is important in order to connect its activities to an economy that is distinct from the rest of the UK in terms of geography, sector focus, infrastructure requirements and the supply and demand for capital to finance business growth.

Recommendations

Recommendation 1: A national investment bank should be established for Scotland with a vision to "provide finance and act to catalyse private investment to achieve a step change in growth for the Scottish economy by powering innovation and accelerating the move to a low carbon, high-tech, connected, globally competitive and inclusive economy."

Recommendation 2: The Bank’s strategic priorities for investment should be centred on a core role of helping to address Scotland’s economic priorities in an inclusive and ethical way.