Productivity – the micro dimension
Over the past 18 months, the RSE has explored the slowdown of Scotland’s productivity. With key partners like Prosper and leading experts, we’ve been asking why has productivity stalled and what can we do about it – at the business and governmental level.
Download the report – Productivity – the micro dimension (311KB, PDF)
Introduction
Over the past 18 months, the RSE’s Economy and Enterprise Committee has been examining issues related to productivity in Scotland – focusing on the poor level of performance in recent decades.
We started the process with an overarching seminar on macro-level productivity issues in Scotland and the UK, led by Professor Bart Van Ark, the Director of the UK’s Productivity Institute. His seminar was followed by a business breakfast discussion, with Prof Van Ark and chaired by Professor Graeme Roy FRSE, Chair of the Scottish Fiscal Commission. These activities were both highly illuminating and produced the power of productivity report.
Following this macro-level discussion we agreed to examine issues at (1) the micro-enterprise level and (2) in the public sector. The preparations for the public sector event, to be held in 2025 in collaboration with the Office for National Statistics and the Scottish Leaders Forum, are well underway.
The purpose of this note is to report on our first discussion of micro issues, then identify key points of policy, etc. meriting attention in Scotland and discuss the way forward given that excellent first discussion. It is not intended to be a straightforward note of the first meeting, but rather an attempt to identify what happens next given what we have already learned.
This first discussion was held on Wednesday 13 November 2024 and organised jointly with Prosper (is the trading name for the Scottish Council for Development and Industry, SCDI) – who have frontline experience in this area given their Peer Works programme (formerly Productivity Club Scotland) which they have been running since 2019. We are very grateful to Arup for providing an excellent location for our seminar. The key presenters were Professor Graeme Roy FRSE, Professor Stephen Roper, University of Warwick and Director of ERC, Clare Reid, Prosper and Amanda Inglis (Due North Creatives). The session was chaired by Jo Armstrong from the RSE Economy and Enterprise Committee.
What’s the state of Scotland’s productivity (recap)?
During previous discussions, Professor van Ark and other participants highlighted Scotland’s key challenges for businesses:
- leadership and management
- knowledge diffusion, and communication at the firm level
- lower rates of innovative businesses with a lack of investment in research and development
- Lower than average rates of new business establishments
- Political uncertainty and red tape
- Health and wellbeing
Business-level insights
Key influences on business-level productivity
Within the current productivity landscape, firms within the top 10% of labour productivity distribution are termed ‘frontier firms.’ The other 90% of firms are categorised as ‘middle firms’ (50-90th percentile) and laggard firms (those in the lowest part of the productivity distribution). This has led to the view that Nick Oulton commented at the TPI Productivity Commission:
“The UK is distinctive in having a particularly long tail of low productivity companies which drags down the overall average. This morphs into the view that large British companies are excellent but are let down by their smaller counterparts, unlike in competitor countries like Germany.”
Prof. van Ark noted in previous discussions that there is a growing productivity gap between frontier firms and middle firms, adding that the UK productivity slowdown is largely due to the firms in the middle. This led to the conclusion that these firms are a key focus for boosting productivity in the UK.
When researchers think about productivity and productivity drivers within a firm, they tend to look at two elements;
- Structural: Structural factors including firm size, sector, and ownership.
- Organisational: intangible factors including, innovation and digitisation (although this factor is questionable). Increasingly, there is also consideration of management/leadership, training and workplace wellbeing.
As noted in our previous roundtable, until recently structural factors were seen as significant influencers of productivity at the firm level. However, recent studies have shown that organisational factors have become more important for firms behind the frontier. For example, findings suggest that there was no strong relationship between productivity growth, the size of the firm, its age, its number of subsidiaries, or fixed investments. It was suggested that this could be linked to the move away from a manufacturing economy to a service-based economy.
For smaller firms, important drivers of productivity are:
- inspirational leadership, people management, and data-driven operational management.
- strategic investment, particularly in innovation and productivity improvements.
- Market development and exporting.
Concerningly, alongside the widening productivity gap (between frontier firms and those behind the frontier), there is also a growing ‘innovation gap.’ However, the data also suggests, very worryingly, that all firms within the UK are facing a downward trajectory in innovation activity. This is despite increased government support for innovative companies.
The key determinants of productivity in Scottish businesses – key points
- Foreign-owned (EU and non-EU) firms in Scotland have higher productivity per worker (around 25-32%) than Scotland’s indigenous businesses.
- Trading services or goods (importing and/or exporting) increase productivity by 14-24%
- IT intensity did not impact the productivity findings – despite being noted as a key driver, it’s not showing within the Scottish data.
- Age and scale effects disappear when we allow for trading, particularly importing and exporting, which seems to be a critical factor.
Organisations working on the ground supporting Scottish small and medium-sized enterprises (SMEs) to adopt practices that are important to improving firm-level productivity have identified the following challenges for SMEs:
Management and leadership
Within Scottish SMEs there is often a narrow focus on day-to-day operations with limited strategic thinking. One example of this is SMEs are struggling with the implementation of systems and processes to convert growth in sales into profitability.
Innovation
SMEs are hesitant to innovate due to uncertainties around cost-benefit outcomes, I.e., will the revenue gains from innovation justify the costs?
Given these uncertainties, there is a reluctance to adopt new digital technologies as they are often associated with further costs such as reskilling.
More recently, businesses have emphasised the current financial pressure – with tax changes in relation to National insurance contributions – as a barrier.
Knowledge diffusion
A siloed business environment. Many SMEs attempt to address their own challenges without consulting with knowledge-sharing networks in part as they are unsure where to go – it was felt that some traditional business networking events were often a waste of time as they seemed to be a place to ‘promote’ your business rather than sharing challenges and coming up with solutions.
Investment opportunities
Many have also cited difficulties accessing grants due to high eligibility thresholds (e.g., cybersecurity requirements). There was also a feeling that there is more support for start-ups in Scotland but little support for businesses who wish to scale.
The link between productivity and job growth
The ONS has looked at the links between increased productivity and job growth and found that there seems to be a weakening link between them. This is particularly true for Scotland, where the productivity-to-jobs link is the weakest of any UK region; a 1% productivity increase is associated with only a 0.087% increase in employment.
Only a small number of firms achieve both employment and productivity growth, referred to as “productivity heroes.” Analysis for 2021-22, of 1.22m firms with employees across the UK, shows only 36,000 productivity heroes. This means that achieving productivity growth will not create many jobs but can help to boost earnings.
The importance of a robust and diversified economy
In previous discussions, we highlighted the disparities between sectors and the regional implications across Scotland. High-performing sectors are disproportionately clustered in cities like Edinburgh (finance) and Aberdeen (oil and gas). These sectors and regions bolster Scotland’s productivity figures, but this presents two key issues:
- Regional disparity: outlined in our previous report, there are clear imbalances in economic performance across regions.
- Economic vulnerability: Scotland’s reliance on a few dominant sectors creates a risk if some of these sectors faces a productivity downturn.
Recent income tax data illustrates the impact of such a decline. Over the past 5 years, Northeast Scotland has had the lowest growth in productivity compared to the rest of Scotland. It is highly likely that this is largely due to the decline in the oil and gas sector. Tax data from Aberdeen shows that this decline has led to a significant fall in income tax revenue. The loss of revenue presents a challenge for Scotland’s economy, with the loss of high-paid jobs and less revenue for the public finances, making it difficult for governments to invest in public services and infrastructure that would support a thriving population and economy.
Additionally, a significant proportion of the Scottish economy is influenced by businesses from outside of Scotland. While only 3.5% of our businesses are owned outside the region (in the rUK or abroad), these account for 55.3% of turnover and slightly over one-third of employment. Inevitably decisions made by these firms, driven by national and international factors, have a substantial impact on Scotland’s productivity and economic stability. This reliance on a small number of firms makes Scotland vulnerable to shifts in their operations or investments.
To address these vulnerabilities, Scotland requires distinct strategies for its domestic SMEs and foreign direct investments (FDIs):
- For FDIs: efforts should focus on attracting highly productive foreign firms to enhance economic diversification and productivity via knowledge transfer.
- For SMEs supporting firms within the middle category of productivity performance is crucial. As noted above, it is the firms in the middle category where we have seen a slowdown in UK productivity. One issue highlighted was the lack of integration into the supply chain and international ties. To maximise the benefit from increased innovation inward investment, we need to encourage their development of linkages with domestic SMEs; and encourage domestic SMEs to look for opportunities to join the supply chains of innovative and high-productivity incomers. Supporting these firms to integrate into the supply chain and increase their absorptive capacity to adopt new technologies and efficiency processes should help to bolster their productivity, and in due course bolster productivity in Scotland as a whole.
FDI which is leveraged successfully can also have the benefit of effective knowledge transfer. The case in Ireland was cited as a positive example during the roundtable, with people there gaining experience in multinational firms and subsequently applying this knowledge and experience to their own newly established ventures or other domestically owned businesses. This mechanism of knowledge transfer is known as ‘movement of labour.’ Another mechanism for knowledge transfer is the ‘demonstration’ effect where local firms imitate multinational processes.
Workforce and skills development
Scotland’s skills policy over the past 20 years have shifted between emphasising the importance of skills or knowledge economies when what we need is a ‘competency economy.’ The competency economy is characterised by a blend of knowledge, skills, behaviours, and experiences that underpin a healthy economy. This relates to the question of how we match the competency supply coming through our education and skills system with future demands, whether they are economic, social, or environmental. Scotland’s current approach to skills policy planning is predicated on a trend analysis of what has come before. There is thus a risk that we are gearing our system to address yesterday’s challenges and not anticipating sufficiency the future labour market. This would include taking account of the skills utilised by innovative inward investors and required by them from companies within their supply chains. The RSE has previously called for a coherent long-term national strategy for skills and education that supports Scotland’s national objectives.
Furthermore, there is a push for school-aged children to pursue the ‘golden pathway’ favouring the university route over other forms of tertiary education which often misaligns with national and industry needs. Young people require more exposure to the career options available and the different pathways they can select to achieve their career goals. This implies revisiting the benefits of high-level higher education participation for young people, as compared to other forms of post-school learning, including further education apprenticeships and more generally on-the-job learning – in appropriate environments.
Linked to the one driver of productivity – innovation, there is also a need to establish school curricula that build an entrepreneurial mindset amongst young people. As highlighted in earlier sections, there is a lack of innovative thinking among Scottish business owners and fostering education and skills policies that help to address this by incorporating innovative thinking in our education system could help achieve this (we accept that this a tough ask).
Practical solutions and policy recommendations
How peer works is helping to address SME productivity
During the roundtable discussion, we heard from Prosper and a business that has benefited from their support via the Peer Works initiative which is helping to tackle the key productivity challenges outlined above (Above section: The key determinants of productivity in Scottish businesses – key points).
In management and leadership, it was noted that Peers Works helps SMEs move beyond a narrow focus on day-to-day operations by providing structured peer-learning opportunities and expert-led sessions that emphasise long-term strategic business planning. Through shared experiences, SMEs gain insights into implementing systems and processes that can lead to growth and profitability.
To address innovation challenges, Peers Works is a platform for SMEs to discuss cost-benefit uncertainties with peers who have successfully navigated similar decisions. By showcasing real-world examples of how digital technologies, management and process improvements lead to measurable gains, the network helps reduce hesitation around innovation. It also connects SMEs with resources for managing reskilling costs and adapting to financial pressures and economic factors.
A significant strength of Peers Works lies in knowledge diffusion via Peer-to-Peer learning. Unlike traditional business networking events that often feel overly promotional, Peers Works fosters an environment of genuine problem-solving and collaboration. It offers a space where business owners can openly discuss challenges, share experiences, and co-develop practical solutions – helping to break down the siloed nature of the SME business environment.
Peer Works supports SMEs to access investment opportunities by demystifying funding eligibility criteria and advocating for better support structures for scaling businesses. By connecting SMEs with experts and peers who have successfully navigated grant applications and alternative funding options.
Through these targeted initiatives, Peers Works provides an excellent example of the crucial role of business support incentives in equipping Scottish SMEs with the tools, knowledge, and networks necessary to drive sustainable productivity improvements.
Peer Works has been independently evaluated and has been demonstrated to provide good value for money in terms of the percentage of businesses (c50%) who action what they have heard after an event versus the relatively modest investment of public money per interaction. The network is established around the country and has scope to scale further for greater impact.
Peer Works 2023-24 external evaluation shows that 47% of respondents had made improvements or changes to their business as a result of applying learning and new ideas gained at the events. As a rough calculation based on membership, over 1,200 members in the latest year have made improvements or changes to their business as a result of attending Peer Works activities for a relatively modest annual programme investment of c£161 per member.
Evaluation evidence shows the impact of these actions can vary from £6,000 to £600,000 alongside non-monetary benefits such as confidence to make changes and new connections.
However, to enhance the impact of Peer Works, scaling up the programme is essential. This can only be achieved with increased financial support and multi-year funding.
Policy considerations
- Support for businesses that can innovate (e.g., through leadership and operational strategies) should be expanded beyond current programs.
- Create further support mechanisms to help SMEs scale in Scotland.
- Simplify entry requirements for grants to make them accessible to smaller businesses. A “Get Grant Ready” program could address these barriers and help SMEs engage with funding opportunities.
- Improve business support through multiyear funding for networks like Peer Works – one of the key challenges for Peer Works has been the lack of multiyear government funding limiting their ability to expand support.
- Tailor unique policy strategies for SMEs and larger foreign direct investment (FDI) driven firms.
- Foster better coordination between education policies and economic, social, and environmental objectives. Enhanced communication between economists, businesses, and educators could bridge the gap between education and workforce requirements.
However, attendees reflected that in the past 20 years, most of the strategies for economic development have broadly tackled the same questions: how do we boost our innovation? How do we commercialise research and development from universities? How do we maximise our innovation encouraging infrastructure? How do we grow businesses of scale, and embed them within the local economy? And many agree with the solutions that have been raised so far – but we still haven’t moved the dial on productivity, leading to the question of how we execute these solutions.
So, the key questions for those driving economic change:
- How do we better determine and articulate means of encouraging enhanced innovation and high productivity across the broad swathe of relatively low-productivity, and SMEs in Scotland?
- How do we, including governments and their agencies, create an environment in which these SMEs are able to achieve these ends to the benefit of themselves and our economy as a whole?
Additional information
Any enquiries about this policy advice should be addressed to Stephanie Webb, Policy Advice Officer (swebb@theRSE.org.uk).
Download the report
Download the report – Productivity – the micro dimension (311KB, PDF)
