Responses on Export Innovation Credits

A well informed respondent has rasied some concerns about Export Innovation Credits.

Let's start by reminding ourselves of the economic context. With consumer spending necessarily restrained as consumers pay down debt, and given the need to constrain government expenditure, the only way to achieve growth is through business investment and improving our balance of payments.  Businesses are currently hoarding cash (about £617bn I believe) because we are uncertain about the future and don’t trust the banks. The latest export figures are very encouraging and the consumer slowdown should reduce imports, but it is unlikely that the 1-month trends in Oct can be maintained and much more needs to be done to encourage exports especially to China, India and other Emerging Markets.  This is not a matter of a few £00M here and there but tens of £bn over the course of the next couple of years.

Meanwhile the banks are required to hold extra capital and are simply not transmitting the cash they are receiving from central banks to the real economy – indeed their funding costs are going up and they are seen as very expensive and unreliable sources of funds. This recent ONS survey paints a depressing picture in this respect.

Now let’s look at the points my respondent raised:

1. Adding extra tasks to the VAT system could reduce the flexibility to make future improvements. The proposed adjustments are wholly orthogonal to any changes in the underlying VAT mechanism. And the problems of recession, cash hoarding and insufficient export innovation are much more serious than hypothetical VAT improvements.
2. Contrary to VAT Directive. Given the serious economic situation I’m sure HMG would live with this. The fact that it would as a side-effect reduce the amount we paid to the EU from “own resources” in 2012 would not necessarily be seen as a disadvantage either.
3. Extra Admin. Certainly there would have to be a very simple supplementary declaration.  However this scheme would only be open to exporters so only a small fraction of VAT-registered business would be eligible. It would be reasonable at least in the first instance to limit the scheme to firms whose exports over the last 12 months exceeded £100k and to claims of over £20k. I cannot find published data about how many businesses are in this category, but probably fewer than 50,000.
4. Extra Training and Systems. I appreciate that outsiders will always tend to underestimate these requirements. But HMRC staff are financially literate and have reasonable common sense. Because these are loans and not grants the incentive for false claims is greatly reduced. And except in the most egregious cases (which could be caught by simple safeguards) it should be sufficient to take claims made in the first 2 quarters at face value, allowing time for training. The fact that false claims can be caught retrospectively would provide sufficient deterrent for almost all businesses, and frankly it is more important to get credit to the companies that need it than to avoid any possibility of VAT fraud – which is already sadly fairly easy.
5. Definitions. This certainly needs some further work, but in principle it should be something like: “any expenditure which in the reasonable opinion of the Directors is intended to lead to innovation in the firm’s products, services or markets for export” This would include but would not be limited to R&D, Engineering, Market Research, market and customer visits, preparation of marketing materials, specialist staff, training or consultancy for the development of new markets (eg hiring native Chinese speakers). I think the only major relevant expenditure that would be disallowed would be sales and marketing activity that was wholly or mainly in the UK and commissions paid to agents. If a company was exporting its goods/services then all the R&D and Engineering on those good/services would be allowed.
The reasons for being relatively relaxed and having a wide definition are:
1. It’s a loan. Within reason the more they borrow the better the UK Public Finances will be in 2015.
2. Anything that encourages business investment in 2012 will be helpful to the UK economy. These things all have positive externalities.
3. Allowing a wide definition ensures that the scheme is non-distortive. Essentially firms can make their own plans secure in the knowledge that HMG will lend them 50% of the cost at essentially zero real interest. This essentially doubles the expected return and thus greatly encourages extra profitable investment.
6. Some of the effect might simply be to bring forward investment that would otherwise occur in 2013/14. This would in my view be a good effect of this scheme. The sooner investments are made the sooner there will be a return in terms of increased exports. And as noted any effect on the public finances in 2012-13 will be more than compensated for in repayments by April 2015. Furthermore although they may increase gross public borrowing they will not increase net public borrowing, and should if anything have a positive effect on market sentiment.
7. Other government schemes already support R&D and Exports. R&D Tax Credits are a very good thing and should certainly be continued and probably increased. But of course R&D is a very small proportion of total innovation spend. UKTI does great work but these schemes are pretty small beer, and won’t make a measurable difference if we are faced with a recession next year. I fully accept that HMG can’t afford to spend much more in the way of grants, but these loans are eminently affordable (Gilt yields have dropped even more since my initial suggestion).

I can see no other way of getting a substantial stimulus into the economy in Q2 in a way that improves the public finances and the UK’s productive potential. At the very least it should be held in readiness as a contingency plan if it looks as though we are faced with recession in 2012, of which I fear the probability is roughly 40%.

Any other comments would be very much welcomed.