‘In the fight for net zero, Labour cannot ignore SMEs’ potential to drive change’

The role of small and medium-sized enterprises (SMEs) in delivering net zero deserves a mea culpa from those of us working on climate policy – and indeed from politicians.

A focus on government, industry and consumers has meant an ignorance of how SMEs have the potential to accelerate progress, rather than just manage change. This is short-sighted. SMEs account for 50% of UK business emissions and yet 76% don’t have a decarbonisation strategy. 

This is the reality that the Labour Party simply must get to grips with when in government if it is to deliver its green targets.

While awareness of net zero is improving, notably the benefits in reducing energy bills, it is focused on direct operations – so-called Scope one and two emissions. As (or perhaps more) important are SME’s business models – how they will succeed in a net zero economy and remove emissions across their value chain (Scope three). 

Energy costs are impacting SMEs

The focus on direct operations is understandable. SMEs are highly exposed to volatile energy prices. Producing their own energy or reducing waste has big implications for margins. 

To help SME’s do this, government must first look at responsibilities between landlords and tenants. Landlords often impede progressive businesses from reducing costs. While Labour has promised to scrap business rates, any new system should exempt energy improvements from assessments, a current barrier to investment.

But cost reduction is just part of the puzzle. According to the office for national statistics(ONS), the pandemic prompted more SMEs to innovate than before. This is vital, as the Bank of England pointed out in its climate stress test, many current business models will become unprofitable in a net zero economy. SMEs need to be an engine of green innovation. 

New technologies can lower emissions

In the UK we are bad at scaling innovation, turning new products into markets. That matters for SMEs trying to expand, but it also matters for emissions. We need to take a huge variety of technologies, to wide scale adoption, incredibly quickly. That might mean the immediate production and installation of heat pumps, or the embryonic production of cultured meats. SMEs will the engine for this.

Germany relies on its ‘mittelstand’ to bring innovations to market. In Britain we need to see a return of regional business support, with a particular focus on the green transition. This could be provided by the UKIB, expanded catapults, or by well-resourced Combined Authorities. At a minimum this would help businesses to adopt green tech but should also help them negotiate green growth opportunities.

The government should also look to SMEs as a place to trial innovation. Innovate UK provides a funding competition for SMEs to test the feasibility of circular economy business models. Labour’s desire to embrace a green industrial strategy should provide further opportunities for private-state collaboration, for example through GB Energy, when the party next enters government.

It’s not just manufacturers. We need innovation in services too, whether that’s challenger banks offering green financial products or lowering resource use through more leasing, renting, and repairing, such as Lime. While the opportunities are bountiful, SMEs will struggle to seize them, for the many of the same reasons they struggle to go green. 

The UK’s low private investment rates are a problem

Changing businesses and technologies costs money. The UK has rock bottom private investment, lagging behind every other G7 country. Our economic model is capital light, and labour intensive – a drag on productivity and tech adoption. Net zero requires productivity and efficiency. 

If investment nationally is poor, it is especially bad for SMEs. SMEs need finance to invest, yet only 2%-4% of business loans go to SMEs, as the Labour Party’s start-up review echoes. SMEs are less likely to seek finance, with a preference for low-growth self-funding over borrowing for faster growth. With debt levels in SMEs growing this is unlikely to change. This has real implications; only around 30% of UK SMEs export, compared to almost 50% in Germany. 

There are ways to increase finance. Any new capital for the British Business Bank and UKIB should be targeted to greening SMEs. Some have proposed adapting the Bank of England’s small business covid financing, the TFSME scheme, to do similar. The FSB argues for the ability to write off investment losses at rates similar to tax on gains. 

Green finance can be a solution

There are clear benefits from a focus on green finance. Venture capital is growing much faster in climate tech than elsewhere. Whilst globally venture capital funding fell 42% last year, climate VC grew 89%. The UK already has eight ‘green unicorns’, helping attract over $7.5 billion investment in 2022. Yet these are concentrated in energy, as the transition gathers pace, we’ll need similar trends in other technologies or face losing out to the US’s Inflation Reduction Act. 

The final missing piece is green skills provision. Green Alliance has written extensively on the challenge of recruiting green skills, which is especially acute for SMEs. Any business support will need to link to local skills programmes which help staff not only understand the nature of the transition and its opportunities but new green technologies, materials or services.

The Conservative government is falling behind its competitors when it comes to keeping SMEs competitive in the green economy, while the opposition and Labour-supporting organisations have been bringing forward creative ideas for doing just that – including the new Fair Competition for Fair Growth project led by Renaissance and Progressive Britain.

If the next Labour government can improve finance and business support, SMEs can and should be central to accelerating the green transition. The benefits of doing this will not just be environmental, but critical in delivering a stronger and more balanced British economy.