16 November 2017

Government must strengthen the backbone of our economy

By

If you’re trying to explain Britain’s sky-high employment rate, a good place to start is the OECD’s statistics on business creation. The UK, it turns out, creates more “employer enterprises” (ie firms that actually hire people other than their owners) than pretty much any of its European rivals.

But there’s a problem. As Rishi Sunak MP points out in a new report for the Centre for Policy Studies – the first from our New Generation project – Britain is very good indeed at creating new firms, and very bad indeed about scaling them up. The OECD’s statistics show that when it comes to the proportion of new companies that have 10 or more employees after three years, we are lagging well behind. The result is that, unlike countries such as Germany, we have lots of big companies, and lots of small ones, and not so much in between.

So what’s the problem? One of the big ones, as Sunak makes clear, is access to credit. It is the lifeblood of enterprise: without the capital to invest and expand, firms are doomed to stay small. And for small British businesses, the bulk of that comes from the four big banks, which are responsible for 90 per cent of the country’s business lending.

This is in itself problematic: fewer players in the market equals less competition, equals worse terms for SMEs that go to the big banks cap in hand. But it’s even worse than that, because in the wake of the financial crisis, the banks have reined in their lending. In the three years after the crash, new lending to SMEs fell by 23 per cent. In the years after that, the stock of loans fell by a further £30 billion.

Indeed, those business creation figures look all the more impressive when you consider that, according to the British Business Bank, roughly 45 per cent of applications for start-up loans are rejected by the big banks, the equivalent of around 44,000 businesses a year. And yes, many of these would never have become viable businesses. But Britain’s refusal rate is much higher than most other European countries. So either would-be entrepreneurs have been getting too many bad ideas from Dragons’ Den, or there’s a real problem.

As for the scale of that problem – the size of this SME funding gap – estimates vary. But RBS think it could be of the order of anything up to £35 billion. That’s tens of billions of pounds in lending that could be used to grow businesses and create jobs, but isn’t being made.

As Sunak points out, the market is addressing this situation – but too slowly. Even though challenger banks and peer-to-peer services like Funding Circle are growing rapidly, they are still making up about a third of the shortfall in bank lending.

His solution – and it’s a very good one – is for us to copy the model created for AIM, the Alternative Investment Market. This was effectively the Stock Exchange Lite, a place for small firms to get money from adventurous investors without having to go through all the rigmarole you do when you’re a multi-billion-pound company seeking a listing on the FTSE. He proposes a Retail Bond Exchange, on which investors can buy bonds from companies – or groups of companies – that are looking to expand. Such a model has already been enormously successful in Italy.

But for me, the most interesting thing here isn’t Sunak’s solution to the problem – though I do hope Philip Hammond has a good read as he’s writing his Budget – but the problem itself.

There are many problems with the British economy that are universal topics of conversation. Poor productivity. Stagnant real wages. Our grotesque failure to build enough houses.

But with something like the SME funding gap, people seem to fall into two camps. Those I’ve talked to who have already heard of it agree that it is a huge and pressing issue. But many more never even realised there was a problem in the first place.

In fact, as well as the great big hairy issues like productivity, our economy – and the public services – is pockmarked with these kind of problems. Things that are of enormous concern to those in the field, but have yet to seep out into wider awareness.

Off the top of my head, I could think of medical liability bills (about which the CPS published another excellent report recently). The looming threat of the GDPR, which is terrifying anyone – like most charities – who has to deal with issues of data protection and privacy. All the things that people in whatever field start moaning about at dinner parties after a couple of glasses of wine.

The striking thing about all of these is that they often arise not from a lack of cash, but a combination of misguided legislation or regulation from above, and a certain lack of concern about the consequences. The SME funding gap, for example, persists partly because no one in Government seems to have ever sat down and thought: right, this is an absolutely pressing issue, how do we fix it. Instead, things seemed to be motoring on just about OK, at least in terms of job creation, so there were always bigger fish to fry, or louder voices to listen to.

Compared to the Brexit negotiations, or the deficit, or the productivity puzzle, the SME funding gap is an easy problem to overlook. Credit, then, to Rishi Sunak for putting it back on the agenda. Let’s hope we hear a lot more about it – and all those other barriers to growth that are out there, lurking beneath the headlines.

‘A new era for retail bonds’, by Rishi Sunak, is published by the Centre for Policy Studies

Robert Colvile is Director of the Centre for Policy Studies and Editor-in-Chief of CapX