Wednesday, 29 November 2017

What We Talk About When We Talk About Industrial Strategy

All states intervene in the direction and management of industry, whether by providing direct funding, tax-breaks or indirect support through infrastructure and education. A laissez-faire state is no more to be found in the real world than a nightwatchman state. Where states differ is in their institutional structures and their public rhetoric. The fundamental weaknesses of the British economy relate to the former, but this is often obscured by the latter. In the UK, "industrial policy" has traditionally been limited in public discourse to heavy industry and manufacturing, while the language used has tended towards the pathological metaphor of an ailing patient. One result of this was that a dirigiste strategy to support the City of London, from the mid-80s "Big Bang" through the Jubilee Line extension to the bailout of the banks, could be passed off as something else entirely. Likewise, the concept of "innovation" in British political discourse has come to mean invention rather than application, which reflects a social bias towards research embedded within the institutions of elite education. It might seem harsh, but Stephen Hawking is part of the reason why the UK doesn't yet have universal, high-speed broadband.

In the postwar years, the legacy of large scale R&D in business, together with the need for state direction to coordinate the rebuilding of industrial capacity, led to a fashion for "national champions" in most developed countries, often in sectors with a strategic defence dimension such as aerospace or steel-making. In the UK, this gradually gave way to the more pejorative phrase "picking winners", which was both an ideological critique (you can't second-guess the market) and an attack on government competence (you keep picking losers). The incidence of primary research within business then declined, as an expanded higher education sector provided outsourcing opportunities for national firms and globalisation allowed multinationals to consolidate their efforts. This was part of a wider turn that deprecated the concept of firms as institutions, as opposed to financial assets or simple market actors, which had an obvious attraction in the era of privatisations and mega-mergers. While human capital was eulogised by Gary Becker, the firm was reduced to the boundary of administrative efficiency theorised by Ronald Coase.

The classic UK example of this was the car industry. Its prewar firm and brand fragmentation had been preserved by wartime and the seller's market of the immediate postwar years. This meant too many models, antiquated organisation (e.g. the reliance on piece rates), which in turn encouraged craft union fragmentation and poor industrial relations, and self-satisfied management. Though belated efforts were made to rationalise the industry and consolidate production, notably with the creation of BLMC in 1968, this was never pursued aggressively enough. The eventual nationalisation of the industry in the form of British Leyland in 1975 was twenty years too late. Though the political wind then turned against state ownership, government continued to support the sector directly while urging further rationalisation, which laid the foundations for foreign direct investment by the likes of Nissan in the 80s. As the UK's continued success with marquee brands such as Land Rover, Jaguar and Mini proved, the problem wasn't a lack of R&D or skills among the workforce, but a failure to apply these capabilities more widely due to poor organisation and management.

If the industrial strategy of the 60s and 70s tended towards the vertical, focused on particular sectors and the selection of large firms for preferential treatment, the strategy of the 80s and 90s was more horizontal, seeking to create a level playing field for the market to select winners through the free movement of factors of production, not just nationally but internationally, such as in the case of the EU Single Market. Though this shift was successful in many respects, it had two problems. The first was the wrenching effect of the transition, which in the UK saw the disruption of specialist supply chains tied to the old national champions, contributing to the steady decline of manufacturing as a proportion of GDP. The second problem was the tendency for pro-business policies to protect poorly-performing companies that survived the transition. Had the British government been less dogmatic in the early-80s, and less obsessed with lowering the tax burden on business thereafter, the underlying productivity growth of British industry, which was flattered by North Sea oil and financial services between 1988 and 2008, might not have been so weak.

The publication on Monday of the government's industrial strategy white paper comes at a significant time, given both the clear evidence that austerity doesn't work in its own terms, so future deficit reduction must depend on stimulating growth, and the debate over the UK's future trading relationships (ironically, Brexit has made the idea of national champions politically salient once more, and not just on the left). But these political imperatives are ignored by the white paper in favour of generic environmental factors, described as "Grand Challenges": AI & data economy, clean growth, future of mobility and ageing society (like MBA bumf the world over, the paper has a lot of abstract nouns and pious verbs but a shortage of definite articles). The key policies are grouped into five "foundations of productivity": ideas, people, infrastructure, business environment and places. Like the challenges, their generic nature indicates that there is little that is distinctive about the analysis or the proposed solutions, while some of the specifics point to longstanding institutional flaws that aren't about to be addressed.

An example of the latter is the continued segregation of technical and elite education. The paper commits to "Establish a technical education system that rivals the best in the world to stand alongside our world-class higher education system". UK universities routinely appear in the top 10 of global ranking tables. By contrast, Germany, France and Japan rarely make it into the top 50, but those countries are clearly superior to the UK in terms of productivity. This isn't simply because their efforts tend to be directed more towards technical education and away from elite establishments, but because there is actually little connection between pure research (let alone elite status) and the application of technology by industry. That, after all, is why we've traditionally had a "brain drain" and a reputation for being good at coming up with ideas and poor at making money out of them. Rather than privileging research, a better industrial strategy would focus on disseminating and applying existing technologies to SMEs. As the Japanese experience in the 60s and 70s showed, absorbing innovations made in other countries will actually create the institutional infrastructure necessary to then incubate native inventions. Rather than case studies about thriving UK businesses, the white paper would have done better to include case studies of successful state intervention by other countries.

History suggests that jumping on the bandwagon of emerging technologies, such as robotics or batteries, can lead you up a blind-alley (consider the trajectory of the UK's semiconductor industry, particularly in light of last year's sale of ARM Holdings to Japan's SoftBank). Many other countries will do likewise, which reduces the prospect of any comparative advantage, while the presence of a home market is usually crucial to success. A country with a sizable manufacturing base, an ageing population and a well-developed electronics sector is more likely to succeed in the area of robotics, which is why much of the early running has been made in Japan. More generally, a focus on a general purpose technology (GPT), like steam-power or IT, will only deliver advantage during the early-adoption phase. Once the technology becomes ubiquitous, that advantage largely disappears or is overwhelmed by more fundamental factors such as geography. The strength of the German car industry has less to do with the pioneering work of Carl Benz and Gottlieb Daimler and more to do with the proximity of large markets in all directions. One obvious trend over time is the quickening pace at which GPTs become ubiquitous. Today, a productivity-enhancing change in software can be disseminated globally in a few days. Seeking first-mover advantage is increasingly a fool's errand, which partly explains the growing reluctance of business to invest in R&D.

Like its weak productivity growth, the UK's low R&D rate (1.7% of GDP compared to the OECD average of 2.4%) is partly a reflection of the dominance of the services sector (and financial services in particular), but it also reflects the financialised turn of the last 30 years. The problem with capital allowances and R&D credits is that they are of limited effectiveness if the tax regime makes the distribution of free cash via dividends more attractive. To increase the proportion of profits reinvested in industry, you need to make taking the money out of businesses (or its use in share buybacks) less attractive. You also need to address the persistence of zombie firms: the long tail of low-productivity and lifestyle businesses that survive by dint of low wages and a tax regime that indulges private owners. An industrial strategy should concern itself not just with facilitating market entry but also with encouraging market exit. Given that the paper considers the high level of firm formation (one every 75 seconds) to be something to crow about, ignoring that the vast majority of these are micro-businesses that won't survive beyond 5 years, I doubt the promised "review" of this area will seriously grasp the nettle.

Overall, the white paper looks like a holding operation. There are old initiatives rehashed, more promised reviews and commissions, and the usual lip-service to devolution and innovation. More fundamentally, it does not represent a departure from the horizontal policy adopted since the 1980s, despite talk of "sector deals". As with Theresa May's commitment to addressing inequality, there is little here beyond a change in tone. A serious analysis would start by considering the strengths and weaknesses of the economy. This doesn't just mean identifying comparative manufacturing advantage, but looking at institutions and regulatory arbitrage. The UK's current status depends on three things: a hybrid relationship with the EU (inside the Single Market and Customs Union but outside the Eurozone); London's role as a global financial entrepot (and tax haven gateway); and our ability to leverage the English language (through business services as much as media). Given that we are in the process of degrading the first of these, and habitually omit the second from strategic consideration, the white paper was never going to offer more than liberal references to our "creative industries". The doctor's report still reads "poorly".


  1. Do you mean comparative advantage or absolute advantage in the three you mentioned: EU/Global Wealth concierge/English?

    Given the ubiquity of certain technologies, do you think there are any candidates for reshoring within a comparative advantage type of argument?

    1. Viewed separately, the UK has a comparative advantage in each of the three. Others, such as Norway and Switzerland, have a hybrid relationship with the EU, but nowhere near as good as the UK's. Others can provide the financial markets and wealth services, but none has as developed an institutional structure as the UK by virtue of the City's history and the convenience of its overseas territories. The UK's comparative advantage in English is weakening at the global level, but it remains dominant in Europe.

      If you take all three together, then the UK has an absolute advantage as no other European country offers more than two, and this often involves trade-offs. For example, Switzerland has had to offer financial transparency in return for EU access. Ireland can offer the advantage of English-speakers, but its corporate tax advoidance offer depends on being 100% integrated into the EU and the Eurozone. Sweden is outside the Eurozone and has a fair few English-speakers, but it is never going to attract financial markets let alone tolerate systematic tax avoidance.

      As regards reshoring, the trend is towards the replacement of Far Eastern labour (whose price is rising) with robots in home markets, where proximity provides comparative advantage. The UK's relatively low-level of robot use, combined with the worsening of the terms of trade with the EU post-Brexit, mean that we're unlikely to see this advantage developed.

  2. Thank you for answering. I suppose what strikes one about the the UKs advantages, such as they are, is that they are rooted in a overlapping set of regional jurisdictional arbitrages. We are an outlier and I cannot help but feel (as much as think) that the withering of the London hinterland (UK minus London) is the price we have already paid. Brexit confronts us with the fact of what we have already done to ourselves. Was it really destined to be like this by force of geo-political geography, or is there a meaningful counterfactual?

    1. In terms of industrial strategy, I think any meaningful counterfactual would have to pivot on the 1950s. This was the era when British industry rested on its laurels and failed to adequately invest while its competitors caught up. It was also the era of the Sterling Area, which led to a vain policy of a strong pound that left exporters vulnerable as output expanded globally.

      The burdens of Sterling and the high level of defence expenditure were retrospectively fingered by many historians as the reasons why the UK wasted both its US loans and its opportunity as one of the few industrial economies left largely intact after the war, while some on the right go so far as the blame the welfare state for diverting investment away from industry.

      However, this ignores that abandoning the pretensions to global influence inherent in the Sterling Area and high defence spending would have been deeply unpopular at the time (the tide of opinion only started to turn after Suez), and thus electoral suicide, while the welfare state was a conscious investment in labour to the benefit of industry. It also ignores the degree to which US policy actively undermined UK interests (the "special relationship" is the rationalisation of the abused spouse).

      I'm not sure there is a credible counterfactual beyond amelioration. We could have done more to rationalise overseas commitments and defence spending in the 70s, and could certainly have handled deindustrialisation better in the 80s and financial regulation in the 90s, but we'd still have ended up in pretty much the same place.

    2. Could the British people have been convinced to sacrifice more in defence of Empire if they had been convincingly informed that decolonization would inevitably lead to deindustrialization? (I'm thinking of Thomas Dewey's quip that the Morgenthau Plan was worth 10 fresh German divisions.)

      Incidentally, would more of British industry have survived if Britain had embraced the Morgenthau Plan and thus permanently eliminated Germany as an industrial rival?

    3. On the contrary, I think the argument that UK industry depended on the colonies was strongly put from the 1870s onwards and convinced all too many. The problem was a surfeit of imperialism, not its lack, whose momentum led to the continuing delusions of the 1945-56 period.

      Unlikely as it was to happen, Britain would have done better to have started decolonisation after 1918, not least because its large military commitment in the Middle East and Far East could have been partially diverted to home defence, which might have given WW2 a different complexion.

      The rebuilding of Germany as an industrial power actually benefited British industry in the late-40s and through the 50s, essentially by creating demand for plant & machinery, though this benefit was undermined by the UK's attempt to focus its exports on the far-flung Commonwealth. The Morgenthau Plan would have been bad for all the economies of Western Europe.

  3. 'The rationalisation of the abused spouse' - I may have to borrow that. 'Ending up in pretty the same place', is strong stuff. Are we just a slow motion tragedy, hung on the petard of our own amour propre. There's still a fight on about the meaning of this Brexit thing. Do you not think we need a more hopeful post WW2 alternative story to stand a chance in that fight?

    1. I wouldn't describe it as a tragedy - we're just adjusting to reality - but we are still in the midst of a slow motion decline. The popular view is that the 70s marked the trough and the Thatcher years a revival, but I think most people now realise that was an illusion.

      The period between 2003 and 2016 can be thought of as one of disillusionment and a loss of confidence in the state. Paradoxically, Brexit may turn out to be the purgative that marks the end of this period.

      I think what we need is not a postwar counterfactual, which is no more helpful than the nostalgia of empire, but an alternative vision of the UK post-Brexit (recognising that a simple cancellation of Article 50 is unlikely to happen).

      Unfortunately, that can't realistically happen until the current process runs aground, which means a bit more self-harm.

  4. ..."an alternative vision of the UK post-Brexit"

    So you're not in agreement with the remainiac viewpoint that the only possible future for a UK outside the single market is that of a third-world sweatshop-cum-tax-haven?

    1. No, I think there are more options than that, and the idea of the UK becoming a sweatshop on the EU's doorstep strikes me as unlikely for a host of reasons.

      What an alternative vision looks like will now be heavily determined by circumstance, specifically the degree to which we maintain access to the single market and/or the customs union. That we are not in control of the outcome explains the vagueness of the vision emanating from both the Tories & Labour, and makes an ironic point about our delusion of "taking back control".