Scotland is a step closer to launching the UK’s first national investment bank after the Scottish parliament passed plans to create this new source of funding for Scottish businesses. The bank, due to open in late 2020, is the SNP administration’s flagship programme to stimulate the Scottish economy to help address its chronic underperformance.

The Scottish government has earmarked £2 billion of capital for the bank’s first ten years – considerable for a nation the size of Scotland. It has also invested significant political capital, with the first minister, Nicola Sturgeon, calling the bank a “truly transformative” project.

State-owned investment banks offer grants, soft loans, credit guarantees and co-investments to companies to drive economic development. Examples include Germany’s KfW bank, the Nordic Investment Bank and Italy’s Cassa Depositi e Prestiti. In this tradition, the Scottish National Investment Bank’s main role will be to provide “innovative, high-growth Scottish firms” with long-term patient finance.

Mission impossible?

The bank will offer funding in pursuit of certain “missions”. It is not entirely clear what these will be, though an advisory report listed three priorities: mitigating climate change, the ageing population and promoting economic inclusion. There has also been reference to the UN Sustainable Development Goals and the Scottish government’s 81 national performance indicators, so those could play a part, too.

The idea of a mission-oriented industrial policy dates back years. The American Apollo space programme, which made huge public funding available, is often cited as one of the earliest examples. The approach has become very fashionable lately, possibly driven by the green agenda and the idea of using enterprise funding to back science and tech companies that have IP that might help tackle climate change.

The evangelist for this approach is the economist Mariana Mazzucato, a professor at University College London, who has been advising everyone from the UK government to the European Investment Bank. She was commissioned by the Scottish government to develop a blueprint for its bank.

It is a very “fuzzy” idea that will appeal to politicians and policymakers, but my research has identified various potential problems in relation to state-owned banks. The Scottish government has said the bank will play a strong role in helping to commercialise university research. This is squarely in line with the whole missions-oriented ethos and sounds laudable, but funding for commercialising academic research is notoriously ineffective at producing new and growing firms – as successive Scottish policy intiatives amply testify.

There are also plenty of instruments to fund university spin-outs in Scotland already. This helps explain why university research and development expenditure across the UK is in the OECD’s top quartile, while corporate R&D is fairly dismal. Better to try to improve the corporate variety to address weak productivity among Scotland’s smaller businesses (SMEs).

The bank also looks likely to prioritise deals where it matches an investment in a company from an angel investor and they both take a shareholding in exchange. This is the traditional funding route for tech companies, so again it’s a good fit for the missions ethos. Yet Scotland does this already through economic development agency Scottish Enterprise. It excludes lots of small businesses in other sectors who want loans and not equity deals - in other words, most SMEs.

I also wonder how viable the bank’s missions are in practice. For example, economic inclusion could be incompatible with tackling the UK’s notorious productivity problem to help economic growth. Suppose you had the opportunity to improve productivity by investing in automation. One recent US study estimated that half of all jobs could be lost to automation in the next decade, so which priority wins out?

The vagueness of the missions is another worry. If you don’t delineate them clearly at the outset, mission drift is highly likely. And since the SNP administration has tended to be quite interventionist, myself and others see a real risk that the bank will become a strategic vehicle for propping up lame ducks. The government has spent more than £40 million since buying Prestwick airport in the west of Scotland, for example.

A different way forward

I have sketched out an alternative approach to avoid some of these pitfalls. Realistically, most Scottish companies are not Silicon Valley-style gazelles waiting to be transformed with publicly matched equity funding. They are solid small businesses in sectors such as food and drink, engineering, textiles and oil and gas. Their productivity could often be greatly improved with relatively small bank loans to modernise production lines or to buy new factory equipment and train staff to use it properly.

So instead of just focusing on high-tech start-ups, the bank should seek established firms with growth potential. It should help them identify ways to become more innovative and productive. This is sometimes known as “diffusion-orientation” in that it focuses on diffusing good practice as widely as possible – similar to how GTS Institutes in Denmark operates, for instance.

It makes more sense to invest smaller amounts of capital in lots of companies than larger amounts into only a few. Plus, while most development agencies tend to offer “blank cheques” to firms, the new bank could attach “competitiveness clauses” to funding. These would require companies to meet innovation or productivity targets to unlock extra money – similar to retail banking covenants that specify what a loan should be spent on.

Other radical ideas the bank should consider include a bespoke new venture capital fund for scale-ups, similar to the world-famous Yozma Fund in Israel. Set up to address the lack of big-ticket venture capital funding available in Israel, Yozma brings in match funding from other parts of the world.

It is easy to be drawn towards fashionable academic concepts, but it’s more important to shape an economic development policy customised for the economy in question. A mission-oriented approach may work well in some areas, such as London or the Cambridge Norwich Tech Corridor in the east of England, but one size definitely doesn’t fit all. And if this is true in Scotland, it may well be true in many other parts of the world, too.