Britain s Quiet Success Story

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1 Britain s Quiet Success Story Business services in the knowledge economy A Knowledge Economy programme report Andrew Sissons May 2011 More than making things 1

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3 Contents Executive summary 5 Introduction 7 1. What are knowledge-based business services? 9 2. How do knowledge-based business services create value? What do knowledge-based business services contribute to the economy? Prospects for growth What action can government take to promote business services? 43 Appendix 46 Britain s quiet success story 3

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5 Executive Summary The UK economy has changed dramatically over the last 30 years. The majority of Britain s growth no longer comes from physical assets machines, buildings and manual labour but from ideas, knowledge and people s skills. While public attention has focused on the rise of financial services and the relative decline of manufacturing, it has been the business services sector that has quietly driven the growth of the UK economy. This sector which comprises lawyers, IT specialists, estate agents and consultants has thrived because it creates value by providing the ideas and knowledge that the British economy needs in order to grow. These knowledge-based business services are the biggest and most important group of activities in the UK economy far more significant than the financial services sector that has overshadowed them in public debate and they play a key role in oiling the wheels of the UK s burgeoning knowledge economy. While the range of activities making up the business services sector may be diverse, they are united by an important theme: they all sell expertise, advice or information to businesses, but do not generally produce anything tangible. This makes it easy to underestimate the role of these business services, but they play a vital role in underpinning the success of all businesses. We may not be able to buy business services off the shelf, but they provide much of the expertise and technology that allows businesses to work effectively, from computer systems to designing and branding products. In many ways, business services act as the infrastructure of the knowledge economy. Just as roads, ports and pipelines help to move people and goods around the country, business services exist to move ideas and expertise from one organisation to another. Most UK businesses rely on these services to function effectively, just as they depend on being able to access energy, water and telecommunications networks. Not only do business services underpin the workings of British business, they are also one of the UK s biggest economic strengths. Britain s business services sector is one of the most competitive in the world, generating large net exports and bringing essential flows of money into the UK. It accounts for over a fifth of UK output, and 1 in 8 jobs, having created 1.8 million jobs since If the UK is to achieve a stable and lasting recovery, it must be led in large part by the business services sector. But the UK s position as a world leader in business services is not guaranteed. The global knowledge economy is becoming ever more competitive, with countries around the world investing in their knowledge bases and education systems on an unprecedented scale. If Britain is to reap the benefits of its most successful sector, the government must act to build on existing strengths and guard against future threats. The business services sector should be viewed alongside manufacturing as a key anchor of the UK economy, which can drive the recovery and the re-balancing of the UK economy. The business services sector relies on businesses continuing to invest in knowledge and innovation, and on the skills of the UK workforce continuing to increase. The government must ensure that changes to higher education funding do not reduce the supply of graduates, that businesses have incentives to invest in knowledge, and that business service firms can export more and more of their services overseas. Britain s quiet success story 5

6 Executive Summary The Table below provides a summary of the action government can take to secure the future of the business services sector. Summary of key action that government can take to strengthen business services Key areas for action 1. Ensure that UK business continue to invest in knowledge and innovation 2. Seek to significantly increase exports of business services 3. Secure the knowledge base of the business services sector What can the government do? Ensure that the tax regime promotes investment in intangible assets Ensure that government cuts do not lead to a lowest cost approach to public procurement, at the expense of innovation Work with UK business services firms to encourage them to be more export-facing Continue to pursue liberalisation of overseas markets in services, including completion of the Services Directive Ensure that immigration controls do not stifle business service exports Protect public funding for non-scientific research that supports business services Ensure that university research is oriented towards commercial success, and building links between universities and business service firms 4. Increase the UK s supply of highly skilled labour Ensure that tuition fees do not reduce the numbers of students going to university Target a steadily increasing pool of graduates in the long term Ensure that graduates and non-graduates have access to the right business skills 6 Britain s quiet success story

7 Introduction Knowledge-based business services are the overwhelming success story of the UK economy, but their role and importance is often underplayed. The UK s prosperity over the last 20 years has been widely attributed to financial services and a booming property market, both of which have turned out to be unsustainable. However, this view only tells a small part of the story. Business services have contributed far more to the growth of the UK economy over this period, and they make a much greater contribution to a balanced UK economy. Knowledge-based business services have been responsible for 38% 1 of all economic growth in the UK since 1970, and have created 1.8 million jobs 2 over that period. By contrast, financial services contributed 15% to economic growth over the same period, and created just 300,000 new jobs. Knowledge-based business services form the core of Britain s strategic advantage within the global economy. On some measures, the UK has the most competitive business services sector in the world: it is the largest net exporter in the G7 3, outperforming many much larger economies. From the UK s place as a destination for legal arbitration, to the architectural and engineering expertise it sells to companies around the world, the UK excels at providing knowledge-based business services to the world. Any strategy for growing the UK economy must start by harnessing the power of its most successful sector. And business services are more than just a key driver of economic growth; they also form a crucial and underappreciated part of the infrastructure of the knowledge economy. All firms in the UK increasingly rely on knowledge-intensive activities to provide products and services, in order to compete in the global economy. Knowledge-based business services help to create and transfer knowledge to these businesses, allowing British firms to compete and succeed in the knowledge economy. Just as roads, cables and pipelines help to transfer the physical assets that people need around the UK, business services play a critical role in enabling the flow of knowledge and intangible assets around the economy. But despite the success and vital importance of knowledge-based business services in the UK, the sector tends to get less attention from commentators and policy makers than other parts of the economy. This may be in part a symptom of the sector s success why seek to change anything in a thriving area? but there is a risk that such an approach fails to capitalise on the UK economy s biggest strategic strength. In this paper, we argue that knowledge-based business services can continue to grow so long as knowledge and intangible assets continue to be the main driver of economic growth. For this to happen, business services must continue to make a significant contribution to innovation and productivity among UK companies, and this contribution must be recognised and invested in by the UK business community. If this can be achieved, knowledge-based business services will be even more important in the 2020 knowledge economy than they are today. 1 ONS Blue Book data for 1979 to Real GVA attributed to renting and business services stood at billion in 2009, equivalent to 23.8% of UK GDP. However, the classification used in these figures does not exactly match the preferred definition of knowledge-based business services used in this paper. 2 ONS Workforce Jobs data for 1979 to UK net exports of Other Business Services were US$37.3 billion in 2008, according to OECD Trade in Services data. This point (but not the figure) is quoted in HM Treasury (March 2011): The Plan for Growth. Britain s quiet success story 7

8 Introduction However, there are risks to the sector s position, with competition from overseas increasing, and many UK businesses focusing on cost control rather than investment in their knowledge base. If the UK is to capitalise on the potential of its outstanding knowledge-based business service sector, government should work with businesses to secure the sector s future. This report sets out the action we believe is necessary to ensure that the UK remains the world leading provider of knowledge-based business services, and to harness the benefits that these services can have for the rest of the UK knowledge economy. Structure of the report This report continues in 5 sections as follows: Section 1 sets out an overview of what knowledge-based business services are, and how they differ from other parts of the UK economy; Section 2 explains why knowledge-based business services exist, and how they operate; Section 3 outlines the business services sector s contribution to the UK economy; Section 4 examines the sector s prospects for growth, and looks at the factors that could accelerate this growth in the future; and Section 5 concludes by setting out the actions government can take to strengthen the UK s business services sector. 8 Britain s quiet success story

9 1. What are knowledge-based business services? Knowledge-based business services provide professional and technological support to other businesses, helping these companies to function effectively. The business services sector covers a wide range of activities, from lawyers and accountants to IT and data specialists. Despite this diversity, knowledge-based business services are united by a key distinguishing feature: they trade primarily in knowledge and information. These services are unique because their outputs are almost exclusively intangible they do not involve any physical processes, but involve the creation, accumulation or dissemination 4 of knowledge or information. This stands in contrast to the rest of the of the UK economy, where companies produce some form of tangible output be it a manufactured good or service. There are many types of knowledge-intensive activity within the knowledge economy from manufacturing to financial services but most use knowledge as an input to produce some form of tangible or monetary output. By contrast, knowledge-based business services produce knowledge and other intangibles as their output and this is what they sell to customers. From professional services such as law, accountancy and architecture to technology-based services including IT services and research knowledge and information are the key commodities that knowledge-based business services produce and sell. Business services also tend to be knowledge-intensive, but they do not have to be per se. The intangible outputs sold by knowledge-based business services normally serve as inputs for other knowledge-intensive companies, who can use this knowledge to make other products and services. This distinction is important, because there are significant differences between trading in knowledge and trading tangible goods and services. Trading in knowledge often requires a different approach from businesses one which involves closer integration between firms, new operational and accounting procedures and different types of worker and it may also need different types of government support. Understanding these differences is not only relevant to the knowledge-based business services sector, it is also key to our wider understanding of the knowledge economy. 4 See Miles et al. (1995) Knowledge-intensive services: users, carriers and sources of innovation Britain s quiet success story 9

10 What are knowledge-based business services? Other labels and definitions for business services Academics and policy makers have looked at the business services sector through a variety of different lenses. There is a considerable body of academic literature on Knowledge-intensive Business Services (KIBS) 5, while the government has referred to Professional and Business Services in policy documents 6. While there are minor differences in how these different labels classify and define business services 7, they rest on broadly similar principles. In this paper, we talk about Knowledge-based Business Services to distinguish them from other knowledge-intensive activities, on the grounds that they produce knowledge as an output, as well as using it as an input. The intention is not to substantially redefine the sector, but to build on existing work as far as possible. Despite their importance to the economy, business services still tend to be treated as residual activities, rather than as sources of value in their own right. Policy makers tend to focus on value-creating activities such as manufacturing, financial services and creative industries assuming that business services derive their demand from these activities. In this paper, we challenge this view, and argue that knowledge-based business services are an important source of value in their own right. Two types of knowledge-based business service: networked and intermediary services Although knowledge-based business services include a broad range of different activities, they can be grouped in a number of ways. Among these groupings, there is one particularly significant distinction that can be made: Networked services services which provide knowledge, advice or technical support directly to other businesses; and Intermediary services services which reduce transaction costs between businesses and customers, by providing targeted information or matching buyers and sellers. 5 See Muller and Doloreux (2008) What should we know about knowledge-intensive business services for a useful summary 6 Professional and Business Services is one of the growth sectors in the government s Plan for Growth (HM Treasury, March 2011); Also see BIS (2010) Professional and Business Services: A 2020 Vision for Growth 7 For instance, the government s definition of Professional and Business Services includes a number of transport and communications activities, while standard classifications of Knowledge-Intensive Business Services tend to omit some intermediary services. 10 Britain s quiet success story

11 What are knowledge-based business services? Even within these two groups, there is a wide diversity of different types of activity. The two groups of services are linked by the fact that they produce intangible outputs, but there are also some significant differences: Networked services provide value directly to the customer, whereas intermediary services add value by bringing together different economic agents; and Networked services mostly trade in tacit knowledge, whereas the outputs of many intermediary activities are information-based (even if they involve extremely knowledge-intensive processes). Networked services are the larger of these groups, and they produce knowledge that is valuable in its own right. Companies buy services such as engineering, design and management consultancy because the knowledge they provide benefits the business directly. By contrast, intermediary services help to bring companies and customers together, to remove inefficiencies that are caused by a lack of information. Services such as price comparison websites, advertising and recruitment agencies do not produce anything valuable in their own right; they make customers better off by giving them access to more targeted information, which helps them to make more informed choices. Distinguishing professional and technology-based services Academics have also divided knowledge-based services into professional and technologybased services 8. Professional services such as legal, accountancy and management consultancy services are based primarily on expertise in particular disciplines, and generally provide advice to clients. Technology-based services including computer consultancy, R & D and technical services derive value by helping clients to use and exploit new technologies, particularly communications technologies. This distinction is helpful for considering growth prospects within different types of knowledge-based business service, particularly as technology-based services rely on the development and uptake of new technologies for their continued growth. 8 See Miles et al. (1995) Knowledge-intensive services: users, carriers and sources of innovation Britain s quiet success story 11

12 What are knowledge-based business services? Networked services Networked knowledge services involve some form of transfer of useful knowledge from one organisation or individual to another. They are made up of five broad categories of services, which we have grouped as follows in Figure 1.1: Figure 1.1: Five groups of networked services Clerical Legal, accountancy and veterinary services 636,000 employment (2.3% of UK total) Technical Architectural, engineering and design services 587,000 employment (2.1% of UK total) IT Computer programming and consultancy services 493,000 employment (1.8% of UK total) Management consultancy Business and management consultancy services 385,000 employment (1.4% of UK total) R & D Specialised research and development services 118,000 employment (0.4% of UK total) Source: The Work Foundation. Employment figures from ONS Business Register and Employment Survey (2009) All of these services involve some form of transfer or useful application of knowledge from one organisation or individual to another. Together they employed 2.2 million people in 2009, around 8% of total UK employment 9. Intermediary services The main purpose of intermediary services is to bring together buyers and sellers of products and services, and to help them make more informed choices about complex transactions. Intermediary services operate across a number of different of markets, including trade between firms, firms selling to consumers, and the labour market. 9 Data from the Business Register and Employment Survey (BRES), Percentage is based on figure for total UK employment given in BRES, not from Labour Market Statistics. 12 Britain s quiet success story

13 What are knowledge-based business services? The key distinguishing feature of intermediary services is that they add value by making exchanges of products and services more efficient, whereas networked services add value to the products and services themselves. This value may be added in a number of different ways: Providing customers with full and complete information about products and prices available in a market, using knowledge to process the information to make it userfriendly (examples include price comparison websites); Acting as agents on behalf of buyers or sellers, helping to secure the most advantageous transactions possible (examples may include some specialised sales agents and recruitment agents); and Providing market research, branding or advertising services, which help sellers to access markets. Figure 1.2 sets out the four key groupings of intermediary services: Figure 1.2: Four groups of intermediary services Recruitment Recruitment agencies 150,000 employment (0.5% of UK total) Leasing Real estate activities and leasing of machinery 595,000 employment (2.1% of UK total) Marketing and advertising Market research and advertising services 149,000 employment (0.5% of UK total) Information services Data processing, hosting and information services 64,000 employment (0.2% of UK total) Source: The Work Foundation. Employment figures from ONS Business Register and Employment Survey (2009) Britain s quiet success story 13

14 What are knowledge-based business services? Taken together, these services employ 960,000 people, equivalent to 3.4% of total UK employment 10. Summary a unique sector of the UK economy Knowledge-based business services play a unique role in the UK s thriving knowledge economy: their purpose is to move knowledge and information around the economy. This role makes them distinct from the rest of the economy, and means that the sector has different drivers and needs. The remainder of this paper explains why this distinction matters, and examines how the sector can continue to make a major contribution to the economy in future. 10 Data from the Business Register and Employment Survey (BRES), Percentage is based on figure for total UK employment given in BRES, not from Labour Market Statistics. 14 Britain s quiet success story

15 2. How do knowledge-based business services create value? Knowledge-based business services are defined by generating and selling intangible outputs, and this makes them fundamentally different to other companies. The knowledge and information sold by knowledge-based business services is not normally valuable in its own right. For the most part, it is used by companies as an input to their own activities. However, this does not mean that knowledge-based business services do not generate a significant amount of value; their intangible outputs can benefit firms in a number of ways: Providing platforms or support systems that businesses need to operate such as IT networks or accountancy functions; Acting as direct inputs into a product or service such as engineering or technical services; or Helping to drive innovation, either by developing new products or boosting productivity such as management consultancy or specialist design services. Knowledge and other intangible assets can be bought and sold in the same way as tangible products and services. Knowledge and information are widely transferred within and across industries, and within the UK and around the world. However, there are two key differences between intangible and tangible assets that have important implications for the way they are traded: 1. Knowledge and information are non-rivalrous 11 unlike tangible goods, a single piece of knowledge or information can be used an infinite number of times once created; and 2. Knowledge is difficult to transfer; information is difficult to organise usefully whereas physical goods and raw information can be transferred easily (setting aside geographic constraints), knowledge is difficult to transfer, as it passes through human minds that must be trained to understand it, and it is not easily codifiable. Equally, presenting information in a useful form can be a timeconsuming process. In a sense, the non-rivalrous nature of knowledge makes its creation and dissemination extremely powerful. Knowledge and ideas only need to be invented once, and are often valuable to millions of consumers and businesses around the world. In theory, this should lead to rapid advances in economic growth; a single invention can benefit people the world over. Some economists have speculated that this non-rivalrous nature of knowledge, combined with rapid advances in global communications technology, would make many intermediary jobs redundant. Leadbetter (2000) 12 labelled this the New Economy, while Quah (1996) 13 coined the term Weightless Economy. Both concepts rest on the idea that 11 Paul Romer used the term nonrivalry to describe knowledge in 1990, in Endogenous technological change (1990). 12 Leadbetter (2000): Living on thin air: The New Economy 13 Quah (1996): The Invisible Hand and the Weightless Economy Britain s quiet success story 15

16 How do knowledge-based business services create value? knowledge is infinitely expansible, and can be scaled around the world quickly and cheaply. According to this school of thought, the rise of the knowledge economy would remove the need for many of the jobs associated with the knowledge economy, as ideas can proliferate around the world extremely rapidly. However, this view underestimates the difficulties involved in transferring knowledge between people and organisations. Whereas goods can be moved around the world in lorries and ships, knowledge is much harder to move around effectively. Global communication technologies enable information to be transferred instantaneously around the world, but processing this information into useful knowledge is a labour-intensive process. Because knowledge is a cognitive function, and cannot always be written down or codified, it can only be traded through people with appropriate skills and experience. As a result, the transfer of knowledge between people and organisations is slow, costly and uncertain 14. It also appears to be labour-intensive, which helps to explain why there are so many jobs created in knowledge-based business services. Three building blocks of effective knowledge transfer Transferring knowledge is not as simple as employing skilled individuals to carry it from one organisation to another. Unlike the transfer of goods and tangible services, the process by which knowledge-based services trade knowledge and intangibles is complex. In order to transfer knowledge effectively, business service firms need to be able to combine three key elements, which are outlined in Figure 2.3. Figure 2.3: The three building blocks of effective knowledge transfer General stock of ideas Ideas and areas of research are the basis for most knowledge-based services Expertise Skilled individuals and companies are needed to transfer and apply general knowledge Customer knowledge Service providers need to understand the needs and context of customers to apply knowledge effectively Academic disciplines such as law, economics and scientific disciplines Specific intellectual property such as models, designs and trademarks Specialised workers with knowledge and understanding to apply ideas Firms with organisational capacity to exploit expertise and capability Relationships and understanding of clients Understanding of culture and context Without acquiring all three of these, a firm cannot sell knowledge effectively. A firm which develops extremely valuable intellectual property such as Google cannot exploit it without expert staff to develop and apply it. 14 Kogut and Zander (1992) Knowledge of the firm, combinative capabilities and the replication of technology. Quoted in Grant (1996) Toward a knowledge-based theory of the firm 16 Britain s quiet success story

17 How do knowledge-based business services create value? It is the last of these aspects acquiring knowledge of the context and customer s needs that tends to be neglected most by policy makers. A firm with well-developed intellectual property and highly skilled staff will not be able to sell knowledge if it cannot relate its knowledge to the needs and context of its customers. Each of these building blocks are developed in the following text. 1. Generic knowledge and intellectual property Most business services are based around a body of general knowledge within a particular discipline. This knowledge may be broad and freely available as with disciplines such as law, economics and accountancy or they may be related to specific items of intellectual property, as is common with knowledge relating to new technologies. The stock of generic knowledge is always increasing indeed, some endogenous models of economic growth explain continuous growth in terms of an ever-increasing stock of ideas 15. Knowledge-based business services often play a significant role in creating and refining bodies of generic knowledge. There are three key ways in which the stock of generic knowledge can be increased: 1. Publicly funded research by universities this often results in publicly available knowledge, which is open to all firms; 2. R&D undertaken by firms this is normally captured by firms themselves through intellectual property protection; and 3. Other serendipitous bodies of knowledge that arise unexpectedly from innovation eco-systems. Most knowledge-based business service firms are based around a core area of generic knowledge, from disciplines such as architecture or economics to specialised areas of technology. Most firms also develop and use a certain amount of intellectual property to differentiate themselves from their competitors; for example, management consultancy firms often invest in their own methodologies as a sales point to clients. 2. Skills and expertise The majority of knowledge transfers are carried out by skilled workers, who are specialised in a particular discipline and can apply their tacit knowledge to meet customers needs. It is not sufficient for a firm to possess intellectual property they must also have staff who are capable of putting this to use effectively. 15 The most famous of these is the Romer model. For example, see Romer (1986) Growth Based on Increasing Returns Due to Specialization Britain s quiet success story 17

18 How do knowledge-based business services create value? Some forms of knowledge-based service involve codifying knowledge such as by writing reports to answer specific questions but the majority of activities involve applying and transferring tacit knowledge possessed by skilled workers. A knowledge-based firm s expertise is not just dependent on the skills of its workers. The organisational culture and capacity of a firm also plays a key role in enabling workers to coordinate and use tacit knowledge effectively. There are a variety of factors that affect organisational capacity, from a firm s culture and the incentives offered to staff, to formal processes and support systems available. Codified and tacit knowledge Most forms of knowledge can be written down or codified to some extent; for instance, reports such as this one are attempts to codify areas of knowledge. Codifying knowledge allows knowledge to be turned into a product that can be replicated multiple times, in formats such as a textbook or instruction manual. However, codifying knowledge is an imperfect way of transferring knowledge: it is time-consuming, it can t be applied to specific situations, and it relies on the reader being able to fully access the knowledge without additional support. This explains why teachers are needed in schools and universities: people cannot learn effectively from textbooks alone. Tacit knowledge is knowledge that cannot be codified. It resides in people s minds, and can only be shared and applied through human interactions. Tacit knowledge is usually needed to apply generic knowledge to a specific situation. Without people who possess the right tacit knowledge, it is hard to make effective use of ideas and technologies. Knowledge-based business services are primarily suppliers of tacit knowledge. 3. Knowledge of the customer and context For a knowledge-based service to work effectively, it must be adapted to the specific needs of the customer. Knowledge-based business firms often solve complex problems for firms, and they need to absorb information from the customer to be able to do this. This relies on developing an effective relationship with client organisations, which is based on mutual benefit and a degree of openness. Besides knowledge of the customer, knowledge-based business service providers also need to understand the context and culture within which they work. Key aspects that firms must understand include: Relevant laws and policies affecting the area of work; Macro factors, such as the state of the economy; Ability to cross language barriers with client firms; and Understanding of the business culture within which the customer operates. 18 Britain s quiet success story

19 How do knowledge-based business services create value? Summary Knowledge-intensive business services exist because knowledge and information are valuable to companies, but they are difficult to acquire and use. Individual ideas and technologies can be extremely valuable to society, but the process of disseminating and applying these ideas is challenging and time-consuming. The role of business services is to carry out this the complex and labour-intensive process of transferring knowledge around the economy, helping other firms to capture the benefits of new ideas and technologies. Performing this role is not straightforward; business services firms must be able to combine their intellectual property with appropriately skilled workers, while developing an understanding of their customers needs. Britain s quiet success story 19

20 3. What do knowledge-based business services contribute to the economy? As a result of their vital role in moving knowledge around the economy, knowledge-based business services make a major contribution to the UK economy. Not only do they constitute one of the largest and fastest-growing sectors of the UK economy, they also play a key supporting role in underpinning the operation of the UK s knowledge economy. The contribution of knowledge-based business services to the UK economy can be captured in four areas: They account for over 20% of UK GDP, making them comfortably the largest sector of the UK economy 16 ; They provide more than 11% of employment, much of it high value and knowledgeintensive work 17 ; They provide net exports of over 20 billion, making a significant positive contribution to the UK s balance of payments position 18 ; They form the infrastructure of the knowledge economy, helping knowledge and ideas to move around the economy, and allowing UK businesses to exploit the full potential of new technologies and ideas. Different sources of data on knowledge-based business services Due to differences in the economic data provided by the ONS, it is not always possible to use a consistent definition for knowledge-based business services. Our preferred definition of the sector (detailed in Appendix A) uses 4-digit Standard Industrial Classification 2007 (SIC 2007) codes, but some ONS data does not go down to this level of detail. For each dataset, we have used the closest available approximation to the sector. In most cases, there are broad similarities between the overall characteristics of the different definitions used. A full summary of the different definitions used (Table A.3) can be found in Appendix A. Contribution to GDP Renting and business services 19 accounted for 23.8% of the UK s economic output in 2010, making it the largest sector of the UK economy 20. This sector has grown at an average annual rate of 5.4% since the mid 1980s, more than twice as fast as the economy 16 Source: ONS Blue Book. GDP in Renting and Business Services (Broad Industrial Groups L and M) had a GDP of 299 billion in 2009, equal to 23.8% of UK GDP. 17 Figures derived from the Business Register and Employment Survey, 2009, using our exact definition of knowledge-based business services. 18 Source: ONS Balance of Payments first release data. All figures in 2010 prices 19 The two Broad Industrial Groups L and M roughly correspond to but do not exactly match our definition of knowledge-based business services. Refer to Table A.3 for details. 20 All statistics from ONS Blue Book, with analysis by The Work Foundation 20 Britain s quiet success story

21 What do knowledge-based business services contribute to the economy? overall. As a result, the sector has contributed 38% of all growth in the UK economy since 1979; without this growth, the UK s national income would be 17.5% lower than it is today. Figure 3.1 charts the share of the UK economy attributed to business services since 1970, and compares it with manufacturing and financial services. The chart demonstrates clearly that the UK s supposed dependence on financial services prior to the recession is a myth; business services have been a far more significant driver of the UK economy over the last 30 years. Figure 3.1: Share of UK economy in business services 21, plus manufacturing and finance ( ) 35% 30% 25% 20% 15% Manufacturing Financial services Business services 10% 5% 0% Source: ONS Blue Book, time series data ( ). Figures deflated using HMT GDP deflators Employment in knowledge-based business services Knowledge-based business services employ million people, or 11.4% of the UK total. As detailed above, the majority of this employment (around 2.2 million) is in networked services, with almost a million employed in intermediary services 22 Employment in knowledge-based business services increased by over 800,000 between, over 40%, between 1998 and During this period, employment in the whole UK 21 Definition of business services is Broad Industrial Groups L and M under SIC (2007) 22 Figures derived from the Business Register and Employment Survey, 2009, using our exact definition of knowledge-based business services. Britain s quiet success story 21

22 What do knowledge-based business services contribute to the economy? economy grew by around 3.3 million, or 11% 24. The business services sector contributed around a quarter of all new employment over the 10 years prior to the recession. Workers in knowledge-based business services also tend to be involved in higher value activities, and more highly paid than the UK average. GVA per worker in knowledge-based services was around 60,000 in 2008, compared to 35,000 in the economy as a whole. Employment costs per worker in 2008 (a proxy for wages) stood at around 33,000 per worker in knowledge-based business services, compared to just under 20,000 per worker in the economy as a whole 25. In line with these higher wages, workers within the broader finance and business services sector tend to come from higher-level occupation groups. 59% of workers within the finance and business services sectors come from the top three occupations groups generally associated with professional activities compared to 44% in the economy as a whole 26. Table 3.1 compares occupations within the finance and business services sectors with the economy as a whole. 23 Data derived by comparing Annual Business Inquiry results from 1998 to 2008, using our preferred definition of the sector. This data shows employment growing by 815,000 between 1998 and Similar growth in employment (848,000) is also shown by Labour Market Statistics Data for the broader Renting and Business Services sector. 24 ONS Labour Market Statistics 25 All figures derived from the Annual Business Inquiry for 2008, using our exact definition of the knowledgebased business services sector. 26 Source: ONS Annual Population Inquiry Workplace Analysis. Occupational groups are classified according to Standard Occupational Classification codes. The sector used here is much broader than just the knowledgebased business services sector, and includes financial services it is Broad Industrial Groups K, L, M and N. 22 Britain s quiet success story

23 What do knowledge-based business services contribute to the economy? Table 3.1: Standard Occupational Classifications within the finance and business services sectors Standard Occupational Group Finance and business services (K N) Whole economy 1. Managers and Senior Officials 22.3% 15.8% 2. Professional Occupations 16.8% 13.9% 3. Associate Prof & Tech Occupations 4. Administrative and Secretarial Occupations 19.6% 14.7% 17.1% 11.0% 5. Skilled Trades Occupations 4.3% 10.4% 6. Personal Service Occupations 2.6% 8.9% 7. Sales and Customer Service Occupations 8. Process, Plant and Machine Operatives 5.3% 7.5% 1.6% 6.6% 9. Elementary occupations 10.3% 11.2% Source: ONS Annual Population Survey Workplace Analysis, 2010 Britain s quiet success story 23

24 What do knowledge-based business services contribute to the economy? Uneven growth within the knowledge-based business services sector The rapid growth in knowledge-based business services has not been evenly distributed across the sector. As Figure 3.2 shows, areas such as advertising experienced very little growth in employment over this period, while management consultancy was the fastest growing area of business service activities, more than doubling in size over 10 years. Figure 3.2: Percentage growth in selected business service activities, % 100% 80% 60% 40% 20% 0% Source: Annual Business Inquiry data for 1998 to Analysis and classifications by The Work Foundation The growth in IT- and information-related services is perhaps not surprising, given that this area has capitalised on rapid technological progress over the ten years prior to the recession. Equally, the slower rates of growth within more traditional professional activities, such as law, accountancy and engineering, support the idea that technological progress helps to generate rapid growth within particular sectors of the economy. Although management consultancy grew fastest as a sector, the contribution to overall job growth in the business services sector is more evenly spread, as Figure 3.3 shows. This reflects the fact that management consultancy is relatively small as a proportion of the whole sector, whereas areas such as legal and accountancy services have been growing from a larger base. Cont. 24 Britain s quiet success story

25 What do knowledge-based business services contribute to the economy? Figure 3.3: Contribution of selected business services to overall growth in employment, Architecture, engineering and testing 11% Real estate and leasing 23% Legal and accounting 14% Marketing and advertising 1% R & D 3% Management consultancy 24% IT, data and information services 24% Source: Annual Business Inquiry data for 1998 to Analysis and classifications by The Work Foundation Knowledge-based business services and international trade Knowledge-based services are not easy to trade internationally, but the UK s business services sector is relatively export-facing compared to the rest of the world. In 2010, the business services sector generated exports of around 55 billion, and had a trade surplus of almost 21 billion in business services. In the context of the UK s overall trade position, the exports generated by the sector are relatively small; they make up 13% of the UK s total exports. However, when the UK s overall trade balance is considered, business services make a much more significant contribution; the sector s trade surplus is equivalent to 43% of the UK s overall trade deficit in goods and services. Without the business service sector s strong performance, the UK s trade deficit would be considerably worse 27. The UK s trade in knowledge-based business has also increased rapidly over the last 20 years. Since 1991, exports of business services have increased by over 43 billion, an annual average increase of almost 9%. This makes business services responsible for 27 Source for all data in this paragraph: ONS Balance of Payments first release data. Knowledge-based business services defined as: 3.7 Computer and Information Services; and 3.9 Other Business Services as used in Pink Book. Britain s quiet success story 25

26 What do knowledge-based business services contribute to the economy? 21.5% of growth in UK exports since Equally, the UK s trade surplus has increased by almost 15 billion since Table 3.2 provides a summary of how the knowledge-based business service sector has contributed to the UK s overall trade performance since Table 3.2: Trade in knowledge-based business services Year Exports of business services % of UK service exports % of total UK exports Trade balance in business services ( billion) ( billion) % 5.0% % 9.4% % 12.8% 20.9 % change % % Source: ONS Balance of Payments first release data. All figures in 2010 prices The strong trade performance of the business services sector also reveals how strong and competitive the UK is in this area. Our report Trading in Ideas and Knowledge 29 identified knowledge services as the UK s key economic strength, while the government s Plan for Growth 30 highlighted that the UK is still by far the largest net exporter of business services among advanced economies. However, from the perspective of export performance, business services are not an ideal sector in which to have a decisive comparative advantage, as they are relatively harder to export than manufactured goods. The UK cannot rely on business services alone to close its significant trade gap, but it should actively seek to increase its exports of knowledgebased business services, drawing on its comparative advantage. Business services the infrastructure of the knowledge economy Knowledge-based business services do not just support the UK economy as a sector in their own right; they also perform a key role in facilitating the workings of the knowledge economy. By enabling other firms to access and benefit from knowledge, ideas and technologies, business services help to make British companies more productive and more innovative. In many ways, business services are the infrastructure of the knowledge 28 Source for all data in paragraph: Same as above, with data deflated using HM Treasury GDP Deflators. All prices at 2010 levels. 29 See Brinkley (2007) Trading in Ideas and Knowledge 30 HM Treasury (March 2011) The Plan for Growth 26 Britain s quiet success story

27 What do knowledge-based business services contribute to the economy? economy 31 they enable the flow of knowledge and information around the economy, in the same way as the transport network moves people and goods. Knowledge is the key economic asset driving the UK s economic growth, and we expect this to continue over the next decade. However, securing the economic benefits of knowledge is about more than just creating ideas in the first place. Generating new technologies and intellectual property is of little value unless it can be put to some meaningful use. A big part of exploiting knowledge is the ability to disseminate it around the economy, so that the all businesses and customers that could benefit from it are able to use it. Disseminating knowledge around the economy helps to drive innovation and boost productivity in more companies, which further drives the growth of the UK economy. And the rate at which knowledge is disseminated and exploited depends to a large extent on the output of the knowledge-based business services, since these are the primary traders of knowledge and intangible assets. In this sense, knowledge-based business services are a source of economic growth in their own right. They do not drive growth by creating anything valuable per se, but by helping more agents to exploit the stock of ideas. Knowledge arbitrage The idea that activities can generate economic value without creating anything directly is not new, or unique to knowledge-based business services. Even before the industrial revolution, global trade was a major driver of economic growth. There were discrepancies in the availability and price of goods around the world. For example, spices were abundant in East Asia, but extremely rare and valuable in Europe. By bringing spices from Asia to Europe, merchants were able to make vast profits themselves, but they also facilitated mutually beneficial trades which unlocked economic value. During the industrial revolution, the development of new technologies and mass-market manufactured goods in some countries provided further opportunities for value-unlocking trades around the world. This process of moving goods around the world from lower to higher value places is known as arbitrage. Today, many commodities and basic manufactured goods are traded on global markets, meaning that there is a single global price for each. This means that most of the possible opportunities for mutual beneficial trades have already been taken, and suggests that there is little extra global value to be extracted from these markets. However, the growth of the knowledge economy has created new global markets for knowledge. Because different types of knowledge are generated in different places, there is scope for value-releasing trades in knowledge around the world. And because knowledge is hard to transfer, it is likely that the process of transferring knowledge around the UK and around the world offers a vast source of untapped potential economic growth and employment. Where the merchants and traders that acted as arbitrageurs in the pre-knowledge economy were Cont. 31 Den Hertog referred to knowledge-intensive business services as a second knowledge infrastructure. See Den Hertog (2000) Knowledge-Intensive Business Services as Co-producers of Innovation Britain s quiet success story 27

28 What do knowledge-based business services contribute to the economy? relatively few in number, the knowledge arbitrageurs in today s economy are the large numbers of people who work in knowledge-based business services. Besides the role of knowledge-based business services in helping firms to exploit knowledge, they may also help to create and refine new ideas and technologies. Much of the academic literature on knowledge-intensive business services focuses on their role in driving innovation, both through their own investment in research, and through symbiotic relationships with their clients 32. In addition, the links between public institutions (particularly universities) and business service firms are significant in helping to develop and disseminate ideas and knowledge. Despite the pivotal role played by business services in supporting the UK s knowledge economy, this aspect of the sector tends to be overlooked by policy makers. In the Plan for Growth 33, the government set out an aspiration for the UK to become one of the best places in Europe to start, finance and grow a business. Under this banner, the plan considers access to finance, regulatory burdens and planning restrictions for new businesses; it does not mention the role of knowledge-based business services (despite including a review of growth prospects for the sector later in the plan). Knowledge-based business services, from legal services to management consultants, play a key role in supporting the growth of UK businesses. If British companies are to grow, they need access to effective business services in a range of areas, just as they need access to finance and physical infrastructure. Summary business services as an anchor for the UK economy Knowledge-based business services are vital to the today s UK economy, and they will be even more important in the 2020 knowledge economy. The sector makes up a significant portion of output and employment in the UK economy, and has been the most significant driver of growth over the last 30 years. The sector also makes a major contribution to UK s exports, and helps to control the UK s serious trade deficit. And besides its direct contribution to the economy, the sector plays a key role in supporting other UK businesses and underpinning the workings of the knowledge economy. Knowledge-based business services should continue to grow in importance over the next decade. If the UK is to have a balanced and sustainable knowledge economy by 2020, the business services sector will need to continue driving growth, while acting as a vital knowledge infrastructure. The sector must continue to help more British firms benefit from new ideas, and adapt to new technologies and business models over the coming decade. 32 See Den Hertog (2000) Knowledge-Intensive Business Services as Co-producers of Innovation 33 HM Treasury (March 2011) The Plan for Growth 28 Britain s quiet success story

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