Road to the budget: Reeves sets her sight on a European Silicon Valley

This is the second article in a series. Read the others here.

It was bias in plain sight, he told colleagues and friends alike. One rule for the Tories, who had been allowed kindly forecasts that offered the fiscal room for their unjustified tax and national insurance cuts; another for Labour, which would have to find at least £9bn on top of the many more billions needed to plug the fiscal hole. He was both right and wrong. Right to be incandescent at the implications and the legacy his government had been bequeathed; wrong that the OBR had somehow indulged the Tory party.

The collapse since the financial crisis in UK productivity growth – growing at a third of its former rate for more than 15 years and at the heart of most of our economic and social ills – has confounded more economists than the handful at the OBR. Surely a return to trend was not impossible, the OBR had thought and predicted. But it has finally called optimism a day.

This year’s three Nobel prize winners in economics won because they all argue the alchemy of capitalist growth lies rather in “creative destruction” – letting outworn companies with redundant technologies go to the wall while fostering their rapid replacement by young and innovative companies based on the technologies of today or tomorrow.

Troublingly, most of Britain’s top companies 30 years ago are the same as today, and while we generate a multiplicity of young innovative challenger companies, 19 out of every 20 end up being acquired by either home or foreign buyers. Britain is weak at creative destruction; a meaningful budget must plot a way out.

The economic disaster that is Brexit

The chancellor admitted last week that Brexit has hit productivity and the economy much harder than previously thought, a fact that the budget – courtesy of the OBR – would recognise. In a little-reported speech last week, Bank of England monetary policy committee member Swati Dhingra gave a hint at official thinking, citing recent independent research suggesting that Brexit had lowered Britain’s output by between 6% and 8% and investment by between 12% and 18%, compared with what it would have been had the UK remained in the EU. Worse, these losses are permanent. The devastating numbers, much worse than the OBR’s earlier official estimates, are the single most important cause of weakened productivity. They also mean that the exchequer has lost not £40bn but up to £80bn of tax revenue every year. Outside wartime, no leading country has ever committed so much economic self-harm.

So Rachel Reeves is more than justified in calling Brexit an economic disaster. Not only is she right, the stance promises to pay off politically. Recent extensive polling by Best for Britain shows that 62% of respondents now believe Brexit is a failure, a view held overwhelmingly by Labour, Liberal Democrat and Green supporters, who identify it as the main reason the country is going in the wrong direction; 72% of those who think Brexit a failure blame Nigel Farage. Even a third of Reform supporters think it has failed. There are few votes in championing Brexit.

Looking for growth

Doubtless the chancellor will argue in her speech next month that the government is negotiating hard to improve matters, following through on the May UK-EU summit and the joint “common understanding”. There is certainly progress on lifting some barriers to trade in animal and plant products, and in joining the European “emissions trading scheme”; but on the government’s own projections, these imply perhaps an extra 0.3% to gross domestic product by 2040 – tiny besides the losses, if still worth having.

The government is also keen to collaborate on European defence and security, wanting to join the EU’s proposed €150bn defence and security system as a partner. This would be a huge boost both to British security and the UK defence sector – but French opposition, and EU insistence that only EU countries significantly benefit from EU procurement, is stymying progress. The chancellor needs to use the budget to unblock the stalemate.

Tech to the rescue? 

Reeves holds useful cards. Britain has the largest venture capital industry in Europe, even if dominated by Americans, and boasts two-fifths of all Europe’s young fast-growing tech companies. Britain forms the core of what the industry calls the “new Palo Alto”, an interconnected innovation area spontaneously developing in north-west Europe with the golden triangle of London-Oxford-Cambridge at its heart – but which spikes up to Manchester, Leeds and Glasgow, west to Bristol and also south to Paris, Amsterdam and Antwerp. Only Palo Alto itself creates more successful tech startups, spinouts and scaleups. The budget has to ensure that many more British companies fulfil their promise than do today, staying in the UK rather than being acquired mainly by Americans – then positioned to play a much-needed part in further developing the new Palo Alto as a rival to the US.

How? 

Last week the Sterling 20 initiative was launched. It could be useful. Up to £25bn over the next five years is promised by leading UK-based insurance companies and pension funds to invest in British private assets, including more UK venture capital to support our young tech companies instead of relying so much on US funding. Tax relief should be conditional on investing up to 25% of pension funds’ global share investment in Britain and withdrawn if the proportion falls below, say, 12.5%. But the whole ecosystem needs attention. Tech founders need the tax system to back them when they offer generous shares to their staff, the currency of the tech world; the Enterprise Management Incentive (EMI) programme needs turbocharging to encourage more generosity. Equally, to encourage a good price when tech companies float on the London Stock Exchange, investors should be exempt from stamp duty for up to five years after they are listed. The City, again with allies in No 10, argues stamp duty reform should go much further.

Capital markets

As Starmer’s advisers know, the London stock market is ailing. Young tech companies need the prospect of being quoted on a vibrant stock market to keep them in Britain. No 10 is pressing for the tax relief on cash Isas to be withdrawn and only offered to Isa investors to the extent they buy British shares. Pensions funds have sold a trillion pounds of British shares since 2000 but they still enjoyed tax relief worth £52.5bn last year. Again, influential voices in No 10 argue the same principle could be applied to them.

Some of this will certainly make the budget; measures on Isas, company stock market flotations and the EMI look very probable. But if the chancellor really wants to create a venture capital and stock market boom to entrench Britain’s standing as Europe’s tech leader, driving towards a trillion-pound tech sector, she should go much further. Crucially, the traffic should not be one-way.

Britain should participate in a proposed common template for all European scaleups, of the kind already advocated by Mario Draghi and others, a full-scale innovation partnership with common administrative, financial and regulatory rules for both the EU and UK, giving legal form to the new Palo Alta. The concept is known to be on Europe minister Nick Thomas-Symonds’s radar – a breakthrough initiative that the EU would welcome.