Scottish businesses are suffering from a growing productivity gap, with frontier firms leaving smaller, less innovative peers far behind as costs spiral, according to a new report from the Royal Society of Edinburgh.

In partnership with Prosper, formerly the Scottish Council for Development and Industry, the Royal Society of Edinburgh’s latest research, Productivity – The Micro Dimension, examines issues related to productivity in Scotland, highlighting the particular challenges faced by SMEs.

Drawing on the experience of academic experts, company executives, and business support schemes, the study found that Scottish SMEs have become more hesitant to invest in innovation and digital technologies due to uncertainty about the return on investment after factoring in costs such as reskilling or overhauling systems.

The lack of innovation or digital investment is one facet of a wider problem, according to the report, which found that smaller Scottish businesses are often too narrowly focused on day-to-day operations.

Other recent surveys have shown that rising financial pressures relating to tax changes and labour costs have put Scots firms in survival mode, but according to the Royal Society of Edinburgh, this has limited long-term strategic thinking, leading to SMEs struggling with the implementation of new systems and processes that could translate into more productivity and profits.

According to one academic quoted in the report, Scotland and the UK as a whole have a ‘long-tail’ of low productivity companies dragging down the national average, which ‘morphs into the view that large British companies are excellent but are let down by their smaller counterparts’.

Strangely, this appears to be a problem limited to Scotland’s indigenous businesses, with the study highlighting that foreign-owned firms, both from inside and outside the EU, have around 25-32% higher productivity per worker than homegrown businesses.

Only 3.5% of Scottish businesses are owned outside the region, the report found that these account for more than 55% of turnover and over one-third of employment. 

That is having an impact on the link between productivity and job growth, which until now has gone hand in hand.      

Scotland now has the weakest productivity-to-jobs link of any UK region, with a 1% productivity increase associated with only a 0.087% increase in employment, with only a small number of businesses managing both employment and productivity growth. 

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The report warns that without focusing on this ‘missing middle’ of Scottish businesses, those SMEs lacking official support or connections to higher-performing firms, it will be impossible to unlock national productivity gains.

To close the productivity gap, the report suggests, among other initiatives, that Scottish SMEs should be encouraged to join the supply chains of innovative, high-productivity foreign companies, which could not only bolster their productivity but also support them in adopting new technologies.

Warning that current skills policies are geared up to address yesterday’s challenges, the study also recommends that Scotland’s political and industry leaders take a new approach to create a future-ready workforce, beginning at the school level to build an entrepreneurial mindset amongst young people.