Select Committee on Treasury Written Evidence


Memorandum submitted by the CBI

  1.  The CBI welcomes the inquiry undertaken by the Treasury select committee into "Globalisation: Its impact on the real economy" and for the opportunity to comment.

  2.  As the UK's leading business organisation, the CBI speaks for some 240,000 businesses that together employ around a third of the private sector workforce and covering the full spectrum of business interests both by sector and by size.

THE NATURE OF GLOBALISATION AND ITS OVERALL IMPACT ON THE UK ECONOMY

The meaning of globalisation

  3.  "The growing economic interdependence of countries world-wide through the increasing volume and variety of cross-border transactions in goods and services and of international capital flows and also through the more rapid and widespread diffusion of technology." (IMF) This process is the most conducive to growth in living standards via specialisation and comparative advantage. Countries with a high proportion of trade to GDP tend to be highly developed, and vice versa. Open economies tend to be freer and richer; those that are closed tend to be repressed and poorer.

The extent to which the recent phase of globalisation is a new phenomenon for the world economy

  4.  Global economic integration is not new—it was proceeding apace in the 19th century via steamships, railways, telegraphs and foreign exploration. The two world wars and an outbreak of protectionism interrupted this but gave way to greater opening of the world economy since 1950. Some aspects are, however, different. These include:

    —  the scale and speed of capital flows, for example gross private capital flows as a share of GDP increased from 10.3% in 1990 to 24.2% in 1993;

    —  the new trading potential caused by falls in transport costs and better IT systems, exemplified by the export of labour intensive processes to low wage countries—for example, the value of traded goods has risen from 5.5% of global GDP in 1950 to 18.8% in 2000;

    —  dis-intermediation of the production process, whereby various stages of goods' production pass across national boundaries;

    —  the striking growth in flows of foreign direct investment since the mid-1990s, which have increased from $203 billion in 1990 to $746 billion in 2001; and

    —  the increase in competition which encourages specialisation and productivity.

The roles of China and India in the globalisation process

  5.  Despite the hyperbole, both China and India still have very low per capita incomes. China's $1,263 lies between Ukraine and Syria in 115th place globally, while India's $640 is below that of Senegal. (The UK per capita income is $35,421). There remain considerable obstacles to smooth advancement such as India's caste system, infrastructure, China's state owned banks, pollution and land title problems, etc.

  6.  UK trade with India and China is a small share of the total. For external trade in goods, exports to China and India were 2.4% and 1.3% of the total respectively, and imports from them were 4.7% and 1% respectively, in 2005. China is the world's second largest user of petroleum products at 6.5 mbpd in 2004 (USA 20 mbpd is the first), yet imports only 12% of its energy needs due to huge reserves of coal and rapid growth of its nuclear power program.

  7.  Chinese and other developing countries' excess savings and growing official reserves since 1997 have been used to buy Government bonds of developed countries. This has helped to lower borrowing costs in developed countries by exerting downward pressure on bond yields.

The impact of globalisation on UK and global macroeconomic stability

  8.  While globalisation has supported macroeconomic stability, as demonstrated by improved inflation performance, it has also had underlying or structural impacts on the UK economy.

  9.  Globalisation has coincided with a period of exceptionally low inflation (by post World War II standards), and while central bank policies have undoubtedly played a part, enhanced competition from low-cost countries may well have contributed too. The annual average inflation of the G7 group of countries between 1973 and 1983 equalled 10.2%. Since 1995 average inflation within the G7 has averaged just 1.8% per annum. Globalisation has also coincided in the 1990s with exceptional macro-stability, by reducing the amplitude and variability of inflation. Globalisation has been felt most in the prices and production of tradeable goods, which has provided consumers with higher living standards through greater choice and lower price products.

  10.  Competition for labour from other countries has helped to keep inflation low by restraining the growth of wages, both through inward migration, off-shoring and the possibility of off-shoring of production processes. Inward migration alone is estimated to have shaved 0.5% off UK interest rates by holding down the growth of pay and augmenting labour supply.

  11.  Economic growth in developed countries has been supported by a lowering in the cost of capital. Since 1997 excess savings have flowed to developed countries in a reversal of the traditional development process, where funds would flow from rich to poor. Now poor countries send excess savings abroad to subsidise western over-consumption, eg by financing the US current account deficit. This followed the SE Asian currency crises of 1997-98, and their switch to huge current account surpluses, but also reflects under-developed banking systems and capital markets in developing countries.

The opportunities and challenges which globalisation presents for the UK

  12.  Globalisation is likely to bring increased competition and in turn further changes to existing labour market practices and the production process. Increasingly, workers are part of a global pool of labour—expanded by China, India and other rapidly industrialising countries—with production processes located across a number of national frontiers. For the UK some sectors will expand, whilst others will shrink, dislocating some workers, but creating employment opportunities elsewhere within the UK economy.

  13.  There will also be greater competition for natural resources with access and security of resource supply more critical. In order to meet this challenge the UK needs to invest more in refineries, storage terminals and sources of power to avoid (a) an exodus of chemical and manufacturing companies and (b) rationing by price and quantity. Natural resources will have to also be used more efficiently.

  14.  At the same time there will be increased opportunities for trade, which can be enhanced by reducing tariffs and other barriers to trade. Greater opportunities for trade, knowledge transfer and investment should stimulate economic activity, leading to greater specialisation, consumer choice and higher living standards. But in order to fully realise these opportunities the UK must invest in equipping workers with the skills and education as the demand of unskilled labour declines. And greater investment in a number of other areas (see below) in order for the UK to continue to remain an attractive business location.

BUSINESSES

The relevance of globalisation to the Government's policies on:

Business investment

  15.  Globalisation makes it more imperative that government policies be predictable and business friendly if the UK is to continue to be an attractive location to invest—both for domestic and foreign firms. Generally the more open the economy the better it will perform and more attractive it will be as a location to invest, which in turn will support employment, tax revenues and economic growth.

  16.  Companies are increasingly less able to operate under bureaucratic restrictions and/or inflexible social contracts that trap them into outmoded methods under the force of international competition and specialisation. The UK must ensure that it does not hamper companies' flexibility, by burdening business with excessive regulation, taxes (see section on design and level of business taxation) and other barriers to competitiveness. And to ensure the UK remains an attractive place to invest will require greater investment in infrastructure and transport, promoting innovation and R&D as well as increasing the depth and breadth of the skills' base of the workforce.

Promoting innovation and research and development

  17.  Global competition for business investment in R&D and innovation is stronger than ever. The UK will need to demonstrate that it has the skills, funding, infrastructure and opportunities that meet business needs if it is to attract and retain such activity in the UK.

  18.  The R&D tax credit is designed to be simple and attractive to all companies conducting R&D in the UK; it helps to maintain existing business R&D effort while also supporting new growth and inward investment. The tax credit does make the UK an attractive place for R&D in the global market, although it is still operating at sub-optimal levels. For larger companies the credit should be equivalent to a 7.5% reduction in R&D costs, but companies are only realising a 3% reduction. The optimum level for influencing global R&D decision-makers would be 10%. To achieve this, the rate of the tax credit should be increased significantly and/or the range of eligible R&D costs covered by the tax credit should be widened. Otherwise, it is inevitable that new R&D investment by companies in the UK will slowly drip away to other parts of the globe (China is planning to introduce its own R&D tax credit and is investing heavily in science and technology infrastructure and skills).

  19.  The government has done much over the last decade to reverse the decline in investment in the science base infrastructure in the UK. However, it has also introduced Full Economic Costing, which has effectively removed much of the original cost advantages for business working with UK universities. To help re-dress this, government funding for universities must shift to focus more on meeting the skills, research and innovation needs of business.

  20.  On the broader innovation front, the government has correctly identified using public procurement as a major catalyst for business innovation. With sufficient drive, the UK could become a global hot spot for innovation (in particular for the service sectors) with government benefiting as the first customer. But this will require a significant attitude change: at present nearly 80% of companies disagree that government supports innovation by acting as an early adopter of new ideas.

The revised Lisbon Agenda for Europe

  21.  Globalisation makes realisation of the goals of the revised Lisbon Agenda all the more critical. Increased global competition should serve to accelerate the UK Government's efforts to implement policies nationally to achieve these goals and step up lobbying efforts to encourage other Member States to do so too.

Outsourcing by UK businesses

  22.  Outsourcing equals specialisation outside the firm, when the firm buys inputs or services from a specialist rather than makes them in house. Off-shoring is a type of or sub-set of outsourcing involving arms-length or long distance purchase of inputs or services abroad, or the deployment of back office or other service functions in overseas locations. Both parties should see enhanced productivity by being freer to focus on their speciality. The much higher productivity levels in the UK should place a finite upper bound on the "off-shoring" of jobs, as might logistical problems such as scarcity of skilled staff and managers in developing countries, but we should not be afraid of this process. Exposure to it, like competition generally, lifts living standards in both countries. Even when a country has an absolute advantage in the production of every type of good or service over another, it will still make sense to trade in those goods or services where the advantage is least pronounced.

Design and level of business taxation

  23.  Relative to our main trading partners, UK business has seen deterioration in tax competitiveness. This has been a result of the continued rise in the UK tax burden since 1997 (£60 billion of extra business taxes), at a time when our competitors have taken tax competitiveness seriously and reduced the tax burden on business. For example Ireland has reduced its corporation tax rate to 12.5% in 2002 from 38.5% in 1996, whilst the UK rate of 30% is now above the OECD average of 29%.

  24.  With globally mobile capital and businesses increasingly footloose, the UK must ensure that its business tax system remains competitive if it is to sustain high rates of direct investment—both by domestic and foreign businesses. UK business taxation should be kept as simple and transparent as possible, with full regard to the levels charged by competitor economies. In short, the business tax burden should be kept as low as possible in order to stimulate investment, employment and economic activity.

Reducing the burden of business regulation

  25.  According to a CBI/MORI survey, the nature and level of regulation affecting business is one of the most important factors influencing a company's international location investment decisions.

  26.  The CBI is a strong advocate of the benefits of fair competition and open markets and it is the CBI's view that an appropriate regulatory environment is a key factor in ensuring both fair competition and the efficient operation of open markets. An appropriate regulatory environment provides certainty in the functioning of the market and underpins investor confidence in an economy.

  27.  The CBI is pleased that better regulation is a key priority for the Government as the need for regulatory reform is at the top of many companies' agenda. Better regulation should mean ensuring that any new legislation and regulation adheres to the Better Regulation Commission's principles for good regulation. In the end it is the appropriateness of legislation and regulation that will determine the success of a regulatory regime. So, as well as simplification of existing regulations, the CBI supports efforts to improve the process of formulating new regulation.

  28.  This includes encouraging a "culture change" among policy makers and regulators and a move towards a more business-friendly culture with emphasis on light-touch regulation proportionate to risk, clarity of intent to avoid unintended consequences, consistency within and between regulators at different levels and quality information. New regulation should only come forward when absolutely required and consideration has to be given to the cumulative burden of regulations, particularly on small firms. The CBI is also of the view that departments and regulators should undertake more frequent and better post-implementation reviews of regulations.

  29.  Whatever measures are taken by government to deliver "better regulation", it is crucial that the quality of legislation and regulation is not damaged.

HOUSEHOLDS

The relevance of globalisation to the Government's policies on:

Labour market and employment

  30.  Global competitiveness requires a real drive to raise productivity levels—this will depend in large part on achieving stronger skills base and ensuring a flexible labour market. The UK needs skilled and adaptable workers who are able to respond to shifts in demand and take on new roles and responsibilities.

  31.  The challenge for successive governments has been to balance labour market flexibility with security for workers. The UK's current employment rates suggest that the UK has got the balance right. The UK's employment rate is currently 71%—one of only three member states (along with Denmark and the Netherlands) meeting the 70% target set out in the 2000 Lisbon Agenda.[12]

  32.  A flexible labour market is one equally accessible to all workers. Excessive levels of employment protection creates an insider/outsider model, in which insiders (typically men working full-time on permanent contracts) enjoy high levels of employment security, while those on the fringes (typically young people, older workers, women and ethnic minorities) experience difficulties finding employment. A flexible labour market also delivers flexible working patterns—part-time and temporary work, "flexitime" and annual hours—which help employers match supply and demand in a service-driven environment and meet employee demand for work life balance.

Migration

  33.  Mobility is also key to labour market flexibility—the ability to recruit globally is vital if the UK is to maintain its competitive edge and the Home Office's recent plans to introduce a new, streamlined, points-based immigration system is very welcome. Migrants, particularly the highly-skilled, must see the UK as an attractive option in the global labour market, and employers need a system that will make it as easy as possible for them to recruit globally. The economy benefits from this kind of activity—migrants generate 10% of GDP, despite accounting for only 8% of employment.[13]

Training and the acquisition of skills

  34.  Raising skills is also fundamental to a flexible labour market and essential to ensure continued competitiveness. On average, an 8% increase in the proportion of trained workers leads to a 0.6% increase in UK productivity, as measured by the value-added per hour worked.[14] The need to improve skills at all levels will become ever more pressing as employer demand grows. By 2020, 42% of jobs will be at graduate level or above, compared to 30% today. Demand at the lower end of the labour market is also shifting, with service sector jobs, particularly hospitality and personal services, likely to experience significant growth. These occupations require different types of skills, placing greater emphasis on customer care and communication.

  35.  But a third of employers report a serious impact on business performance as a result of skills shortages[15] and many have real concerns about the skill levels of those entering the workforce: only 56% of 16-year olds gain a C or above in GCSE maths and only 60% in English. Seven million adults lack the literacy skills and 17 million the numeracy skills expected of an 11-year old. It is estimated that low basic skills cost the UK economy £10 billion per annum.

RESOURCES

The relevance of globalisation to the Government's policies on:

The supply and pricing of energy

  36.  Economic expansion in both emerging economies such as China and India, and developing countries, will result in increased demand for the world's energy resources, putting upward pressure on prices. As the UK moves towards becoming a major net importer of energy, it will increasingly have to compete internationally for oil and gas supplies, becoming more exposed to global price increases.

  37.  Increased energy import dependence does not automatically undermine UK energy supply security, but does pose new challenges for government which must be managed effectively, for example by:

    (i)  improving energy efficiency, thereby minimising consumers exposure to global energy price rises, while simultaneously contributing toward national security of supply and climate change objectives. While significant progress has already been made by many businesses in this regard (for example, through their actions under the climate change agreements), there is still scope for further cost-effective improvements across the economy, particularly in the residential, commercial, SME and public sectors. Key to realising this significant potential is to ensure that consumers are both better informed and better enabled to make energy efficient purchasing decisions through a combination of regulation (eg extension of product standards), information (eg labelling) and more direct fiscal incentives (eg tax rebate for more efficient housing).

    (ii)  ensuring that the UK remains an attractive environment for energy investment. Over the next 10-15 years, significant investment is required both in replacement generation capacity and in new gas import and storage capacity (eg Oxera estimates that total investment required in the electricity sector will be £4.3-£5.7 billion per annum over the next 15 years, while total planned investment in the UKCS and import and storage facilities over the next few years will be approximately £2.9 billion per annum). With both energy and capital markets now international in scope and outlook and with investment needs simultaneously rising in many other countries (the IEA estimates that OECD countries will need energy investment totalling $6.5 trillion between 2004 and 2030), there is a need to remain committed to the liberalised energy market mode to attract capital market investment.

    (iii)  encouraging full liberalisation of EU energy markets, and adoption of the liberalised energy market model beyond the EU, to remove market barriers to free trade in energy and ensure flows into the UK.

    (iv)  working with the energy industry to ensure that UK is importing energy supplies from a range of sources and countries, to avoid over dependence on specific pieces of infrastructure or exporting countries.

The environment

  38.  Climate change is one of the major environmental dangers facing the world and has the potential to have a significant impact on global economic growth in the long-term. While UK leadership on climate change can serve to spur investment in environmental technologies, allowing businesses to specialise in those areas in which we have a competitive advantage, the case must not be over-stated. Climate change is a global problem, requiring a global solution. Unilateral action by the UK or the EU that raises costs for carbon-intensive industries risks their relocation to areas where there are less stringent environmental regulations, thus having limited impact environmentally. While the UK and other industrialised countries must take a leadership role, to minimise the competitiveness impact on UK and EU businesses, and maximise environmental benefit, we need participation of emerging economies and developing countries in addressing the climate change problem.

May 2006



12   Employment Statistics, Eurostat, 2005 Back

13   HMT Parliamentary Question May 2002. Quoted in A Points-based system: Making managed migration work for Britain, Home Office, 2006 Back

14   Dearden, Reed and Van Reenen, The Impact of Training on Productivity and Wages: Evidence from British Panel Data, Institute for Fiscal Studies (2005) Back

15   CBI Employment Trends Survey (2004 and 2005) Back


 
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