SMEs and the Productivity Puzzle

Featured image © patpitchaya / Adobe Stock

The new report published by the Business, Energy and Industrial Strategy Committee focuses on the potential of small business to make a bigger impact on UK productivity. Small businesses – SMEs – represent 99.3% of the UK economy and have, understandably, become the focus of the productivity debate. Unlocking the productivity puzzle demands better understanding of this highly heterogenous group of businesses, and in turn how low productivity might be addressed.

The wide-ranging variations in productivity of UK businesses have given rise to the now infamous long productivity tail, shown in Figure 1. The tail is complex, and while there are examples of more productive businesses of different sizes and in different sectors across the UK the evidence shows that smaller businesses tend to be less productive on average than their larger counterparts.

At the same time, research by the Centre for Cities contends that this is in fact the ‘wrong tail’, and that the cause or cure to the productivity puzzle is unlikely to reside in the long tail, and instead the emphasis should be on exporting, or tradeable businesses. While conclusions drawn from the research differ as to the cause and consequences of the long tail, focusing on small business has the potential to have a meaningful impact on the long tail, and represents an opportunity for more experimental approaches towards the productivity puzzle.

Figure 1: The UK’s productivity distribution (ONS, 2017)

From Policy to Practice

The UK is an attractive place to start a business and has a generally strong business environment. Government policy relating to aspects of business (e.g. export, finance, employment), as well as to different policy areas ranging from transport to energy, and planning to science have undoubtedly contributed to this. While the ongoing work of Productivity Insights Network aims to rethink the experimental approach of Government policy from silos to the system, the BEIS report also highlights the need to consider the support available to SMEs to help them become more productive.

Despite productivity being a political priority, there are not many small businesses that think in terms of productivity. Instead, the focus tends to be on profitability, if they have their sights set beyond their immediate survival. As the BEIS report notes, there is a need to raise the ambition of entrepreneurs to grow and scale their businesses. Another related aspect raised in the BEIS report, that was announced by the Chancellor, Philip Hammond, in the 2018 Budget committed to support leadership, business development and technology adoption for SMEs.

The BEIS report references the nature of and need for business support. However, the What Works Centre for Local Economic Growth found that of 23 evaluations on business advice that met the minimum standards 14 had a positive effect on at least one business outcome, 5 had no effect, and 4 had mixed findings. The evidence from this systematic review offers guidance on how to develop programmes and improve policy effectiveness, while also emphasising the need for clearer objectives against which to assess and evaluate success and value for money.

This is likely to become more pertinent in the preparation of Local Industrial Strategies, which aim to increase regional economic productivity. In order to redress the spatial variations in regional productivity, SME policy typically pursues locally-led approaches to improve growth and productivity. If Local Industrial Strategies are to be effective, they do need to be local in more than name – they will require the requisite autonomy and resources to design and deliver local solutions appropriate to the sectoral and firm profiles of those localities. Moreover, these solutions need to meet the challenges of the small businesses that they seek to support on their own terms if they are to improve both the businesses and ultimately the place where they are based. This means adopting strategies that are sensitive to the diverse needs of firms of different sizes and that incentivise growth across a spectrum of dimensions.

In many respects the BEIS report, and those aspects that relate most prominently to the productivity of small business as oppose to the performance, are not radical. This is for the most part reassuring. However, the next challenge in unlocking the productivity puzzle is developing and implementing effective local responses through the Local Industrial Strategies that are accepted and empowered by Central Government. Achieving this will demand the creation of new governance institutions that are accountable and able to deliver, but given the plateau in productivity more experimental and creative solutions are required if we are to meaningfully address the productivity puzzle…

Tim Vorley and Jen Nelles