Daniela Glocker
OECD
OECD Economic Surveys: United Kingdom 2024
OECD Economic Surveys: United Kingdom
Abstract
Years of low investment have contributed to sluggish productivity growth in the United Kingdom. Businesses have not sufficiently increased their investment to make labour more efficient partly due to uncertainty from subsequent economic shocks and frequent policy changes. Given fiscal constraints, it is crucial to foster a conducive environment for business investment. While the UK government has taken several steps to support business investment, further changes are required to planning regulation, tax policies, and better access to finance for smaller businesses with policies outlined in a long-term transparent strategy to increase certainty for businesses.
Weak investment has contributed to lacklustre productivity gains since the global financial crisis. Slowing productivity growth was experienced across a range of OECD countries (OECD, 2022[1]), but compared to other countries was driven by a sharper drop in capital accumulation in the United Kingdom (Van Reenen and Yang, 2023[2]). Although business investment has picked up in 2023 and contributed most to aggregate UK investment at around 11% of GDP (Figure 2.1, Panel A), businesses have been lagging their peers for years in investing in physical capital, innovation or new processes that would make labour more productive as discussed in the last OECD Economic Survey (OECD, 2022[1]). Complemented by low housing and public investment, aggregate investment continues to remain low by international comparison (Figure 2.1, Panel B). Public investment can increase the cost-effectiveness of business investment, for example through infrastructure providing better access to markets, but fiscal constraints highlight the necessity of stimulating business investment to increase the supply capacity of the economy.
Note: Panel B: G7* refers to the G7 average excluding the United Kingdom.
Source: OECD Economic Outlook database.
Low business investment in the United Kingdom reflects structural and cyclical barriers. Despite low interest rates and easy financing conditions in the decade between the global financial crisis and the pandemic, the recovery in business investment stalled with the Brexit referendum in 2016 (Figure 2.1, Panel A). The tightening of credit conditions following the energy price crisis (Chapter 1) has made it essential to prevent structural factors from further weakening investment incentives.
Raising private investment is a government priority and the United Kingdom benefits from a regulatory framework that is generally supportive of businesses. This includes lean business regulations, a business-friendly insolvency framework (André and Demmou, 2022[3]) and a comprehensive competition framework, that is being expanded to promote fair competition in the tech industry via the Digital Competition Act UK (UK Parliament, 2024[4]). To boost business investment, the government has reformed the corporate tax system, increased Research and Development (R&D) support, simplified tax arrangements for SMEs, and sought options to unlock the large pool of UK pension and insurance savings, as discussed below. But despite these efforts, high policy uncertainty and lack of policy continuity have weighed on business investment (International Monetary Fund, 2023[5]; Bank of England, 2021[6]).
Since the global financial crisis, the United Kingdom has seen a rise in policy uncertainty (Figure 2.2). Following the Brexit referendum in 2016, elevated levels of uncertainty with respect to regulations reduced the UK’s attractiveness within Europe-wide value chains and raised the cost of exporting (Chapter 1, Bakker et al. (2022[7]), Faccini and Palombo (2021[8]), or Bloom et al (2019[9]). As Brexit related uncertainty declined, the pandemic and the energy price crisis introduced new uncertainties that were amplified by an acute lack of policy consistency (Coyle and Muhtar, 2023[10]; Pabst and Westwood, 2021[11]). From 2017, the government released three major growth strategies, the Industrial Strategy (HM Government, 2017[12]), the Plan for Growth (HM Treasury, 2021[13]) and the Four E’s: Employment, Education, Enterprise and Everywhere (HM Treasury, 2023[14]). These strategies all had a strong focus on supporting the business environment, but a high degree of policy churn hindered their effectiveness in boosting investment. The lack of continuity was not only evident in the development of new strategies, but also in the policy areas they covered (Valero and van Ark, 2023[15]). This prevented the government from learning from experience over time and created uncertainty for businesses. Building on its expertise from previous growth plans the government should establish stable framework conditions and comply to a long-term strategy that ensures policy transparency and allows for continuity of government programmes. A framework with clear rules for review and revision could provide the flexibility to adapt to changing circumstances without compromising predictability.
Note: Panel A: UK Economic Policy Uncertainty (EPU) index based on 11 UK newspapers: The FT, The Times and Sunday Times, The Telegraph, The Daily Mail, The Daily Express, The Guardian, The Mirror, The Northern Echo, The Evening Standard, and The Sun. Panel B: Brexit related uncertainty shows the percentage of firms who reported that Brexit was in the top three current sources of uncertainty for their business.
Source: Economic Policy Uncertainty Index, https://www.policyuncertainty.com/uk_monthly.html; Bank of England, Decision Maker Panel.
Policy can create favourable conditions to invest, as seen with the temporary introduction of the “super-deduction” from April 2021 to end-March 2023, which allowed businesses to deduct 130% of the cost from qualifying assets from taxable income. From April 2023, the super-deduction was replaced with full expensing, which offers 100% capital allowances on qualifying new plant and machinery investments (see below). Businesses increased investment into qualifying assets (Figure 2.3), leading to an overall pick up in investment growth since 2021. Thus investment did not fall despite the disruptions from the pandemic, the energy crisis, Brexit, higher interest rates and the impact of the pre-announced rise in corporation tax, suggesting that the super-deduction worked as intended to support investment (Office of Budget Responsibility, 2023[16]). However, the uptake in investment may reflect businesses bringing forward investment and thereby the policy affecting the timing rather than the investment decision. It remains therefore important to develop policies that reduce structural barriers to sustainably lift business investment.
% point contribution to investment growth
Source: ONS 2024, Business investment database.
This chapter focuses on selected issues that can support business investment, including reforming the planning system, reducing distortions in the corporate tax system and ensuring sufficient access to finance especially for smaller firms. Access to skills is a complementary factor to investment, and measures to alleviate skills shortages and improve the availability of skilled workers should be strengthened as discussed in Chapter 4.
2.2.1. Overhauling the planning system to facilitate investment
An overly stringent and complex planning system creates barriers to investment. Some evidence suggests that the combination of land and building regulations and construction costs creates significantly higher project costs in the United Kingdom than elsewhere (Cheshire, 2018[17]; Brandily et al., 2023[18]). The Competition and Markets Authority (2024[19]) finds that the length, costs and complexity of planning permits have risen over the years as uncertainty due to planning bottlenecks and unpredictable outcomes often take a protracted amount of time for builders to navigate before construction can start. This not only holds back business development, but also developments that are supportive to business investment such as housing for workers and infrastructure (Chapter 1 and 3).
The government has acknowledged that the planning system is “outdated”, and has taken steps to address inefficiencies holding back business investment in particular (HM Treasury, 2023[20]). It plans to strengthen the capacity of the planning system to deliver better services for businesses, including introducing new premium planning services across England with guaranteed accelerated decision dates for major applications and fee refunds wherever these are not met. To ensure effective implementation, the government should provide financial support and capacity building to ensure that local authorities have the necessary resources to adapt to the priority planning system without risking falling behind in other planning areas, as there are significant differences in capacities across regions (OECD, 2022[1]). Local administrations infrequently review and update local plans, which are key for development projects. Local plans should be reviewed and updated once every five years, but only 42% of local authorities have an up-to-date local plan that is less than five years old (HM Government, 2024[21]). The government should support local administrations to update their local plans to reduce high uncertainty around the granting of planning permits.
Greater priority for businesses should not come at the expense of other government objectives, such as increasing residential housing supply (Chapter 1). Speeding up planning decisions for businesses is a welcome development but should only be a first step. The planning system needs to be reformed and aligned with the government’s objectives to not only support investment, but also increase housing supply and speed up infrastructure development. Transitioning from the existing discretionary system, where each planning application faces review and potential opposition from local “not in my backyard” (NIMBY) residents, to a more rule-based system could streamline planning processes. Under this proposed system that is found more commonly in European countries (OECD, 2017[22]) (Box 2.1), developers would have the right to use land for its designated purpose, if they adhere to established rules. This change could enhance planning certainty and speed-up permitting decisions. In 2020, the government proposed reforms to move towards a more rules-based system, but political backlash stopped the advancement of further progress. While changes to the system can be politically difficult as they are usually opposed by existing homeowners, it is vital to consider the long-term gains of better planning procedures.
The government structures of the United Kingdom and Switzerland are at opposite poles of the decentralisation spectrum. Whereas the United Kingdom’s (central) land-use planning system is one of the most rigid in the world and its fiscal system is heavily centralised, Switzerland is an extremely decentralised country, with strong political and fiscal powers allocated at local level.
In contrast to the United Kingdom, Switzerland – a highly decentralised country with fiscal competition both at regional and local level – has a rule- or code-based planning system, where construction projects are automatically approved if they comply with the requirements of the respective code. These requirements usually consist in attributing land-use type (residential, commercial, industrial, or mixed) to plots of land zoned for new construction and in defining the development intensity (in the form, for example, of floor to area ratios). This makes it extremely difficult for local NIMBY residents to successfully oppose new development. Moreover, the Swiss fiscal system provides strong incentives to local municipalities to allocate land for new residential development: local public good provision is financed by levying progressive income taxes and municipalities can choose tax rate levels. Local municipalities thus have strong fiscal incentives to allocate large plots of land at the outskirts of their localities to attract high-income taxpayers.
The combination of a flexible planning system with local fiscal incentives makes the housing supply in Switzerland fairly elastic. Consequently, housing affordability is considered less of an issue in Switzerland, except in major agglomerations – mainly Zurich and Geneva – where physical and geographical supply constraints (lakes, mountains) are quite binding. The main policy concern in Switzerland is thus urban sprawl and preservation of the touristic countryside: Swiss voters are increasingly concerned about urban sprawl as new development in suburban areas is typically quite scattered and low density. Moreover, they are concerned about blighting the most beautiful and touristic Alpine areas. This has recently led Swiss voters to approve an initiative that imposed a ban on the construction of new second homes in touristic areas, with adverse consequences for local residents.
Source: OECD (2017[22]).
The fiscal system in the United Kingdom provides very few fiscal incentives for local authorities to permit new development (OECD, 2017[22]). New business developments increase costs for local authorities, through increased demand for public services, traffic, and pollution amongst other, whereas the benefits of higher employment might not accumulate to the same degree at the same local authority (Brandily et al., 2023[18]). Moreover, local authorities in the United Kingdom transfer half of the property tax revenue from businesses to the central government and over the medium term any increases in revenues are equalised away through the central government grant system. Thus, there are limited incentives to permit local development as the cost could outweigh the financial benefit. In 2015, the government had committed to devolve 100% of the property tax revenue from businesses to local government, but this was later reduced to 75% before being abandoned in 2021. In spring 2023, the government announced its commitment to devolve 100% to Greater Manchester and the West Midlands Combined Authorities (HM Treasury, 2023[14]). The government should consider broadening this commitment and devolve business property tax revenues to all local authorities in the longer term to help align local incentives with the national objective to increase development. The government should set out a clear timeline and conditions for local authorities to keep 100% of property tax revenues from businesses and outline how this will affect transfers from the central government grant system in the longer run.
2.2.2. Moving towards less distortions in the corporate tax system
After a years-long strategy of cutting the main corporate tax rate and broadening the base, the government recently shifted towards higher rates with more generous capital allowances. In April 2023, the main tax rate was increased from 19% to 25% for firms with profits over GBP 250 000 (HM Treasury, 2023[14]). At the same time, the base was narrowed through a “full expensing” policy which comes on top of the annual investment allowance and allows companies to immediately deduct 100% of the cost of qualifying plant and machinery investments. Even though the recent increase in the statutory corporate tax rate is quite substantial, the UK rate remains at the lower end among G7 countries (Figure 2.4, Panel A) and is complemented with generous capital allowances (Figure 2.4, Panel B). Recent OECD research shows that the sensitivity of business investment to the corporate tax rate has fallen since the global financial crisis, while more generous capital allowances can induce strong investment responses (Hanappi, Millot and Turban, 2023[23]). Thus, the new direction is a positive development. However, frequent and often not well communicated changes to the corporate tax system in the recent past increased uncertainties for businesses (Box 2.2). To increase investment durably, the government should set out a transparent strategy for the corporate tax system for the medium term to give businesses more planning certainty.
Note: Panel A: The corporate income tax rate refers to the combined central and sub-central government corporate income tax rate.
Source: OECD Corporate Tax Statistics.
Over the past two decades, the UK corporate tax system underwent frequent changes. Between 2010 and 2017 alone, the main tax rate was gradually reduced from 28% to 19% to enhance international competitiveness while the tax base was broadened, including by making capital allowances less generous (Figure 2.5, Panel A and B). While the shift towards a low corporate tax rate made the United Kingdom an attractive location for profitable, internationally mobile investments, a lower investment allowances disincentivised domestic investment. In March 2021, the government shifted direction and announced to lift the main rate to 25% for firms with profits over GBP 250 000 to take effect from April 2023 (HM Treasury, 2021[24]).
These reforms of the corporate tax system were not always transparent and well communicated. Changes before 2017 were broadly following the 2010 Corporate Tax Roadmap (HM Treasury, 2010[25]), but subsequent announcements lacked a transparent strategy and clear communication. The raise of the main rate to 25% in April 2023 was implemented as announced in April 2021, but the time between announcement and implementation was characterised by uncertainties as the government announced scrapping the raise in the main rate, and then decided to reinstall it (HM Treasury, 2023[14]; HM Treasury, 2022[26]; HM Treasury, 2022[27]). Similarly, the annual investment allowance, allowing businesses to immediately deduct investment for plant and machinery up to a certain limit each year, has not only varied over time in terms of the amount that can be deducted, but the government’s announcements to change the amount have been even more frequent (Figure 2.5, Panel B).
Changes in the key parameters of the corporate tax system, 2010-2025
Source: Institute for Fiscal Studies (2023[28]).
The design of the corporate tax base creates a range of undesired distortions. Investment incentives differ based on the type of asset, how they are financed and the legal structure of the business. The UK’s capital allowance system encompasses two key components: full expensing and the annual investment allowance. The annual investment allowance allows businesses to immediately deduct the full value of qualifying plant and machinery investments up to GBP 1 million from their taxable profits in the year of purchase and is available for all businesses including unincorporated businesses and most partnerships. Above this limit, investments are gradually depreciated for tax purposes over time. Most assets are subject to a writing down allowance with the main rate of 18%, while certain assets (like integral features in a building such as lifts or lighting systems, and assets with an expected life of at least 25 years) are subject to a special rate of 6% for the writing down allowance (Institute for Fiscal Studies, 2023[28]). Since April 2023, incorporated businesses subject to UK corporation tax can immediately deduct the full cost of qualifying new plant and machinery investment under full expensing. First introduced as a temporary scheme, full expensing was made permanent in Autumn 2023 thereby removing the near-term incentive to bring investment forward and increasing certainty for businesses, which is welcome. By facilitating a sustained decrease in the cost of capital, the Office for Budget Responsibility anticipates that business investment will rise by approximately GBP 3 billion annually, subsequently enhancing potential GDP by 0.2% in the long term (Office of Budget Responsibility, 2023[16]). Full expensing only applies to new investments that would qualify for the writing down allowance with the main rate of 18%. Investments in special-rate assets get a 50% allowance in the first year (Institute for Fiscal Studies, 2023[28]). Moreover, capital allowances and full expensing, favour qualifying assets over e.g., buildings or intangibles, hindering the efficient allocation of resources and thereby reducing productivity and economic growth. If fiscal space allows, the government could improve tax neutrality by broadening the range of qualifying assets under full expensing conditional on those assets being expected to be productivity and revenue enhancing in the longer term. However, to move to a better designed tax system, this has to be accompanied with measures that limit the deductibility of interest payments from the corporate tax base.
The UK corporate tax system provides for different treatment of equity and debt financed investment. A distinction between debt and equity is recognised in most other OECD countries’ corporate tax systems by giving deductions for interest as business expense. UK limitations on interest deductions are aligned with BEPS 4 Action, which aims to limit base erosion through the use of interest expense to achieve excessive interest deductions or to finance the production of exempt or deferred income (OECD, 2016[29]). Thus, groups (based on the requirement to prepare consolidated accounts) can deduct interest payments up to GBP 2 million a year against corporation tax, with some restrictions in place above this level. Interest deductibility results in a zero marginal corporate effective tax rate on debt financed investment, and combined with tax depreciation allowances and immediate expensing, creates a mix that results in a cost of capital below the real interest rate and, therefore, a marginal corporate effective tax rate that is negative. Full expensing has increased this large and problematic existing subsidy for debt-financed investment, making even more unprofitable projects viable through the tax system (Institute for Fiscal Studies, 2023[28]). The government should identify and monitor potential overinvestment, evaluate the role of tax in financing decisions and reduce interest rate deductibility accordingly to avoid subsidising unprofitable investment.
Complexities in the corporate tax system can not only raise the administrative burden for firms, but also disincentive investment, especially for small firms. Since April 2023, companies with taxable profit of GBP 50 000 or less are subject to corporation tax at the rate of 19% “small profits rate” (about 88% of firms in 2021-22) and companies with profit levels between GBP 50 000 and GBP 250 000 pay tax at 25%, reduced by marginal relief. This means that an effective marginal tax rate of 26.5% applies on profits over GBP 50 000 and the average tax rate gradually increases until it reaches 25%. The government should review complexities created with the operation of the marginal relief system and the small profit rate, and address potential issues that discourage businesses from increasing their profits for amounts below or above these thresholds (GBP 50 000 and GBP 250 000).
2.2.3. Streamlining investment incentives in business property taxation
Business property taxation can weigh on investment that would improve property values. In the United Kingdom, business property taxes are based on a percentage of the property’s estimated rental value. This system can discourage investment, especially for smaller firms, as increasing property value leads to higher taxes. Although there are several reliefs to support investment, they also create complexity and reduce the tax base. In 2023 alone, the UK government introduced several temporary reforms to lower the business rate on commercial properties, including a 75% relief for the retail, hospitality, and leisure sector (capped at GBP 110 000), a freeze of the business rate multipliers and a three-year transitional relief limiting the tax liability increases when commercial properties are revalued.
To reduce the administrative burden in the short-term, the government should streamline the business property taxation system by evaluating the effectiveness of reliefs and exemptions and ending those that are not fulfilling their purpose as discussed in Chapter 1. In the longer term, the government should evaluate whether a move towards a more efficient land value tax, as for instance, applied in Estonia would be feasible. A land value tax is a recurrent tax on landowners based on the value of undeveloped land and is often considered as economically efficient as it provides incentives to develop the land based on its best use. However, to be successful in practice, it requires a comprehensive up-to-date land registry and forward planning of land use at plot level, the provision of a well-resourced and informed valuation profession, and resources to undertake robust valuations which separate the value of land from the value of improvements for developed plots based on highest and best use (Hughes et al., 2020[30]; Broome, Corlett and Thwaites, 2023[31]).
2.2.4. Increasing transparency to maintain institutional credibility
The United Kingdom has strong institutions that support the business environment. Corruption can discourage business dynamism and thus reduce investment and innovation. While perceived corruption seems to be comparatively low in the United Kingdom, the control of corruption has been deteriorating over the past years (Figure 2.6). The OECD Anti-Corruption and Integrity Outlook (OECD, 2024[32]) identifies areas for improvements, which could not only safeguard against a rise in corruption but also increase more broadly the United Kingdom’s comparable low levels of trust in national government (Figure 2.6, Panel E). While the United Kingdom is one of the top performers in terms of the adequacy of its Anti-Corruption Strategy’s implementation plan, regulatory safeguards on conflict-of-interest prevention could be strengthened. Measured against OECD standards on conflicts of interest, the United Kingdom fulfils 33% of criteria for regulations and 22% for practice, compared to the OECD average of 76% and 40% respectively (OECD, 2024[32]). The United Kingdom has looked into introducing the “deed of undertaking”, which would legally commit ministers to adherence to the rules, for the requirements in the Ministerial Code relating to the Business Appointment Rules that cover the post-public office activities of ministers and senior officials (Cabinet Office, 2023[33]). This legally binding commitment would be signed by ministers on taking office and would mean that civil action could be brought against them if standards in the ministerial code were broken. It should be considered to introduce liability for conflict-of-interest violations more broadly by extending the deed to also cover conflicts of interest during the term of appointment.
The system of transparency around lobbying is more advanced in the United Kingdom than in many OECD countries, but digital tools could be used more effectively (OECD, 2021[34]). In the United Kingdom, the online lobbying register includes instruction on how to register, information on the name and organisation of the lobbyists, the domain of intervention and the type of lobbying activities. Improving the quality of transparency disclosures along with the searchability of the UK’s transparency databases could optimise the potential for transparency and facilitate public scrutiny.
Note: Panel B shows the point estimate and the margin of error. Panel D shows sector-based subcomponents of the “Control of Corruption” indicator by the Varieties of Democracy Project. Panel E does not include Germany, Italy, Spain, and the United States because of data unavailability. Panel F shows ratings from the FATF peer reviews of each member to assess levels of implementation of the FATF Recommendations. The ratings reflect the extent to which a country's measures are effective against 11 immediate outcomes. "Investigation and prosecution¹" refers to money laundering. "Investigation and prosecution²" refers to terrorist financing.
Source: Panel A: Transparency International; Panels B & C: World Bank, Worldwide Governance Indicators; Panel D: Varieties of Democracy Project, V-Dem Dataset v12. Panels E: OECD Government at a glance indicators; Panel F: OECD, Financial Action Task Force (FATF).
2.3.1. Smaller firms have limited access to finance investments in intangibles and new technologies
An investment friendly environment needs to be complemented by sufficient access to finance. In the United Kingdom, public support through direct funding and indirect tax subsidies for Research and Development (R&D) is the highest across major OECD economies, but still firms only invest just above the OECD average in R&D (OECD, 2024[35]). Small and medium-sized firms and high-growth potential firms in particular report being constrained by the difficulty of raising funds for long term investment and to scale up (Department for Business, Energy and Industrial Strategy, 2022[36]; British Business Bank, 2023[37]).
Equity finance in the United Kingdom has grown significantly over the past decade, but it has declined recently in part explained by the cyclical nature of this type of finance, with investors seeking out other types of fixed return investments in response to interest rate hikes (Figure 2.7, Panel A). Moreover, the venture capital market particularly important for young firms is smaller than those of the United States or Canada (Figure 2.7, Panel B). Thus, intangible investments, including R&D, or investment in risky or unproven technologies are particularly hard to finance and firms lack the collateral that are provided by tangible assets. This is not only important as intangible investments are associated with higher productivity growth (Karmakar, Melolinna and Schnattinger, 2024[38]), but also in the context of developing new technology to advance the green transition, as many smaller firms in this field report the lack of financing to be a key barrier (British Business Bank, 2023[37]).
Note: Panel B: Data for the UK is based on the European Data Cooperative (EDC) whose approach is based on a Census of European PE and VC firms identified by Invest Europe and its PE and VC partner associations. As few UK VC fund managers are Invest Europe members, numbers for the UK might be under-estimated.
Source: OECD (2024), Financing SMEs and Entrepreneurs 2024.
Continuous government efforts have improved access to finance by lowering barriers particularly for smaller, high-growth potential firms over the last decade. The British Business Bank, set up with the objective to restructure UK’s finance markets to better serve small businesses in 2014, supported about GBP 12 billion of finance through its programmes, assisting over 96 000 businesses by 2022 (OECD, 2024[39]). The Bank’s subsidiary, British Patient Capital (BPC), launched the Future Fund: Breakthrough in July 2021. This GBP 375 million UK-wide programme encourages private investors to co-invest with government in high-growth, innovative firms. It focuses on R&D-intensive companies and aims to accelerate the deployment of breakthrough technologies that can transform major industries, develop new medicines, and support the UK transition to a net-zero economy. It is welcome that the government announced the extension of the British Patient Capital’s mandate until 2034 at the 2023 Spring Budget and provided the “Future Fund: Breakthrough” programme with at least GBP 50 million additional funding at its Autumn 2023 budget (HM Treasury, 2023[20]; HM Treasury, 2023[14]). To allow the British Business Bank to further scale up its operations, the government could consider allowing the Bank to borrow capital through the issuance of government guaranteed bonds, such as e.g., similar institutions in peer countries like the KfW in Germany (Box 2.3). Separately, the government also provides generous tax reliefs for investors to encourage investments in young, innovative companies. Under the Enterprise Investment scheme, investors can claim a tax relief of 30% on investments up to GBP 2 million if at least GBP 1 million of that is invested in knowledge-intensive companies. Separately, under the Venture Capital Trust, investors can claim 30% on investments up to GBP 200 000 and on income from dividends. In 2021-22, companies raised a total of GBP 2.3 billion of funds under the Enterprise Investment Scheme, and shares issued under the Venture Capital Trusts (VCTs) amounted to the value of GBP 1.1 billion (HM Revenue & Customs, 2023[40]; HM Revenue & Customs, 2023[41]). The announcement to extend both schemes to 2035 is welcome.
The KfW, a German state-owned bank, operates by raising over 90% of its borrowing needs through bonds in the capital markets. These bonds are guaranteed by the federal government, enabling KfW to secure funds under favourable conditions. Its public agency status exempts it from corporate taxes, and it receives unremunerated equity from its public shareholders. This allows KfW to provide loans at lower rates than commercial banks for specific purposes defined by KfW law.
As a subsidiary of KfW Bankengruppe, KfW Capital invests in German and European Venture Capital (VC) and Venture Debt funds. Its goal is to strengthen the capital base of these funds, thereby improving access to capital for technology-oriented growth companies in Germany. KfW Capital has doubled the annual amount of funding to EUR 400 million from 2021 onwards. Funding takes place particularly as part of the European Recovery Programme (ERP)-VC Fund Investments programme as well as of the ERP/Future Fund Growth Facility as a module of the ‘Zukunftsfonds’ (Future Fund). Set up by the Federal Government in 2021, KfW Capital is allocating EUR 10 billion to its’ Future Fund’ by 2030 to boost the German venture capital market for forward-looking technologies.
Source: OECD (2024[39]).
2.3.2. Ensuring high value investments from long-term investors
Unlocking institutional investment can further improve access to finance. The United Kingdom stands out internationally by having one of the biggest pension markets in the OECD, but low domestic investment in equity from Pension Funds (Figure 2.8). According to the British Venture Capital Association, UK pension funds contributed 4% to the GBP 70.2 billion invested in venture capital and private equity in the United Kingdom in 2022, compared to 21% from overseas pension schemes (British Private Equity & Venture Capital Association (BVCA), 2023[42]). As highlighted in previous Surveys (OECD, 2022[1]; OECD, 2020[43]), removing barriers for UK funds to diversify their portfolios in these activities could increase the financing pool available to young innovative firms.
Note: Panel A and B refers to autonomous pension funds. Panel B: The "Other" category includes cash and deposits (including those of mutual funds), land and buildings (including those of mutual funds), loans, hedge funds, structured products, unallocated insurance contracts, derivatives, commodities, trade credits and advances and other accounts receivables and payables.
Source: OECD Funded pensions statistics.
The government considers continuing to change existing investment rules to remove barriers and costs for UK pension funds to make long-term, illiquid investments and to diversify their portfolios, such as the 2022 changes to the regulatory charge cap (Department for Work and Pensions, 2022[44]). The Mansion House reforms include the industry-led Mansion House Compact, which aims to encourage signatories to invest at least 5% of their default funds to unlisted equities by 2030; and measures to increase transparency through the Value for Money framework that will require schemes to disclose their costs and net investment returns, as well their level of investment in the United Kingdom (HM Treasury, 2024[45]). These changes are still subject to consultation by the Financial Conduct Authority. A Growth Fund within the British Business Bank, drawing upon the BBB’s expertise and a permanent capital base of over GBP 7 billion, is planned to give pension funds access to investment opportunities in UK’s most promising businesses. These developments are welcome, and uptake should be monitored to identify further potential barriers for pension funds from channelling investment into the domestic market. Most importantly, it should be ensured that safeguards and appropriate investment regulations remain in place such that pension providers continue acting in the best interest of their members.
Consolidating the fragmented pension market can increase scale and lower cost for savers. Since the introduction of automatic enrolment to occupational defined contribution (DC) schemes in 2012, many small DC pension schemes have emerged. Although the occupational DC pension market has consolidated by nearly 40% between 2011 and 2021 (OECD, 2022[46]), in 2022 there were still about 27 000 schemes in existence, of which only 2 000 were non-micro schemes with more than 12 members (The Pensions Regulator, 2023[47]). Government efforts to consolidate these schemes into fewer larger schemes is welcome as larger schemes can drive down costs for savers and are better placed to invest in innovative companies as part of a balanced portfolio. The new Value for Money framework, where schemes are required to compare themselves against others in the market, including large scale schemes, to ensure they are delivering value for their members is a policy initiative that could help with the consolidation efforts. Funds that fail to meet these could be mandated to transfer assets to the existing number of authorised Master Trusts that already cover 95% of active DC members (Department for Work and Pensions, 2023[48]). However, consolidation should not go too far so that oligopolistic behaviour develops instead (OECD, 2022[46]).
Consolidation is also needed for public sector pension schemes. The Local Government Pension Scheme (LGPS) in England and Wales is administered by 86 separate local pension funds, each with its own pension board and total assets worth of GBP 369 billion (16.2% of GDP) (The Local Government Pension Scheme Advisory Board - England and Wales, 2023[49]). Despite previous government efforts, the consolidation of these funds has been slow (Brandily et al., 2023[18]). To ensure that LGPS can benefit from economies of scale in management and through better investment pooling, the government introduced a March 2025 deadline for the accelerated asset consolidation of LGPS into pools and setting a direction towards fewer pools exceeding GBP 50 billion of assets under management (HM Treasury, 2023[20]). Furthermore, a 10% private equity allocation ambition for the Local Government Pension Scheme (LGPS) in England and Wales was introduced, which the government estimated to unlock around GBP 30 billion (1.3% of GDP). The government should continue to monitor that asset consolidation of pension funds is advancing.
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