Industrial Strategy

CentrePiece Summer 2017

The regulation of business has been a rollercoaster ride for the UK over the past 20 years. Drawing on their work with the LSE Growth Commission, Anna Valero and Richard Davies outline an opportunity to build a new system based on transparency, independence and a long-term outlook. Towards a new UK industrial strategy

Stable policy frameworks are needed to stimulate business investment

2 CentrePiece Summer 2017

Industrial strategy should be given a new law or long- lasting mandate

then fell out of vogue, and in the 1980s, Stable policy frameworks are needed to Margaret Thatcher ushered in an era of stimulate business investment, and the UK free markets and privatisation – paring is in need of a long-term and overarching back both economy-wide and sector- or modern industrial strategy in order to deal place-based interventions. with a number of challenges facing the When Tony Blair’s Labour government economy – both old and new: instigated wide-ranging economic reforms, most were economy-wide, including a new n First, the UK must address its poor emphasis on research and development productivity performance. Productivity (R&D), public capital investment and a growth is the necessary ingredient for long- long-term commitment to public education run sustainable growth, yet productivity fell and expenditure on science. The financial after the financial crisis and has been flat very government has an crisis in 2008 rekindled interest in industrial ever since, and our longstanding gap with industrial strategy however strategy in the UK and abroad, and countries such as France, Germany and the it is articulated: government business secretary Peter Mandelson began United States has widened. affects the investment climate to develop a case for a return to more n Second, the UK must strive for growth Efor business through tax and regulation; selective industrial policy. that is equitable, regionally balanced and establishes national priorities; invests in But it was his successor Vince Cable environmentally sustainable. skills, infrastructure and research; and in the coalition government who formally n Third, as Brexit becomes a reality, and the procures outputs from the private sector set out an industrial strategy that included UK redefines its international relationships, – all of which influence the evolution of support for key sectors and technologies, the government must consider how to the private economy. and which was coupled with more focus mitigate risks to UK trade, international In the UK, business and politics have on place-based policies like the Northern investment and access to international always been intertwined. The desire Powerhouse. There was a brief hiatus after talent, all of which can be expected to have shown by the political class to nudge and the 2015 election, when the government large impacts on UK business. shape firms goes right to the top, with published its ‘Productivity Plan’ but did not incoming prime ministers often setting out commit to an industrial strategy per se. Here we draw on the recent LSE Growth visions for how companies should work But following last year’s referendum Commission report (2017) to set out soon after arriving in Downing Street. and this year’s general election, it is time proposals for the key areas of focus for The tradition stretches right back for another phase. Since taking office, policy-makers developing the inevitable to Robert Walpole, whose 1721 prime minister Theresa May committed to iteration of the UK’s industrial strategy reforms included subsidies and taxes a new industrial strategy ‘to get the whole following the general election. designed to support the country’s wool economy firing’, and the government set manufacturers. Following the Second out its ideas in a Green Paper in January. Stop rearranging World War, Clement Attlee’s Labour the deckchairs government introduced laws aimed at The need for an The UK’s industrial strategy has long been ‘distributing industry’ more widely across industrial strategy fragmented and mercurial, with teams in the country: South Wales and Tyneside The experience to date shows that what different government departments often were key targets. varies is how far governments have been working separately, and regular re-branding A number of policy mistakes occurred willing to spell out their industrial strategy, or changing of business policies. This in the 1960s and 1970s as governments and the arguments that motivate it. The creates uncertainty for investors. doubled down on losing bets, wasting recent UK experience has also shown that A case in point is the ‘Growth billions of taxpayer funds chasing there has been far too much chopping and Accelerator’ programme, which was declining industries in which they had no changing in this space – it is a worrying introduced by the coalition government comparative advantage – British Leyland sign when your business department has in 2012 to help small and medium-sized is a famous example. Industrial policy had four names in the past ten years. enterprises access coaching and

3 CentrePiece Summer 2017

Table 1: Examples of UK policy frameworks

Monetary policy F Fiscal policy Competition policy

Policy tool Bank Rate Tax and spending Merger clearance and remedies Asset purchases Market investigations Penalties for anti-competitive behaviour

Legal framework Bank of England Act 1998 Budget Responsibility & Competition Act 1998 Bank of England and Financial National Audit Act 2011 Enterprise Act 2002 Services Act 2016 Charter for Budget Responsibility Enterprise and Regulatory Reform Act 2013

Independent decision-maker Bank of England’s Monetary Office for Budget Responsibility Competition and Markets or oversight Policy Committee (MPC): external (OBR) Authority (CMA) Board members Independent panel members

Mandate or guidelines Inflation target Fiscal rules Duty to promote competition for the benefit of consumers

Transparent publication Inflation Report Budgets Merger inquiry findings Economic and Fiscal Outlook Market investigation findings

Source: LSE Growth Commission (2017). match-funding services. It was scrapped government support is channelled to R&D, and there is therefore a strong in 2015 with little justification: initial its most beneficial use.Ex-post reviews, case for increasing such spending in line evaluations had found that the Growth examining how and why taxpayer funds with our peers. Accelerator was viewed positively by were used to support industry should be But the importance of research and businesses and other involved parties, and conducted annually. innovation does not just apply to high-tech more robust economic evaluations of the The ultimate objective is a strategy sectors like aerospace and pharmaceuticals: programme were planned. isolated from political cycles. An independent the UK is primarily a service economy, Lessons can be learned from the body of some form would help to achieve and the service sectors have been the frameworks governing UK monetary, this. There is a menu of options to choose main contributors to productivity growth fiscal and competition policy (summarised from – the Bank of England’s Monetary both before and after the financial crisis. in Table 1), where objectives are defined Policy Committee, and the UK’s independent As Figure 1 shows, productivity growth and enshrined in law, and independent budget, antitrust and infrastructure bodies. in professional, scientific, technical and agents play a role in offering advice and, Any one of these would be better than the administrative services has held up in some cases, taking policy decisions. The current ad hoc set up. relatively well since the crisis – a pattern remit of such bodies is transparent, with To enhance transparency, the that differentiates the UK from France justifications for their advice presented government should publish a long-term and Germany. in statutory publications. This creates a plan setting shared objectives and aligning While the UK excels in terms of the more stable framework and promotes decision-makers across government, industry quality and impact of its research, we open government with external scrutiny by and other stakeholders. The body responsible lag behind other countries in terms of academics, thinktanks and journalists. for industrial strategy should publish a commercialisation. Compared with the Ending the short-term and opaque standardised Industrial Strategy Report on the United States, business and universities system should be the first step. Industrial state of UK business each year. This would collaborate far less (Dowling Review, strategy should be given a new law or provide regular material on the productivity 2015). Government focus to date has long-lasting mandate. And since the existing of UK firms, with updates on industry- or European Union (EU) state aid framework location-specific policies, together with their has blocked arbitrary political intervention costs and measured impacts. in the economy, a new one is needed more than ever when the UK leaves the EU. Breaking new ground The ultimate A set of transparent rules for The UK needs to invest more in R&D. intervention is also required, and Both government and business R&D are objective is an this should be based on identifying – consistently lower than international industrial strategy quantitatively where possible – market comparators as a share of GDP. We know failures. Competitive processes should that public R&D spills over to the private isolated from be used wherever feasible to ensure that sector, and also ‘leverages-in’ private political cycles

4 CentrePiece Summer 2017

been predominantly on the supply side of Figure 1: research (universities). But reviews on this Decomposition of labour productivity growth topic in recent years have noted that the (Gross value added, GVA, per hour) demand side – particularly from businesses carrying out R&D – is crucial. ■ ectin Key to addressing this is improving ■ rt ■ Prein cientiic tecnic n initrtie erice access to finance for innovative firms, ■ innce n inrnce which involves more action to improve ■ nrtin tecn ■ cctin n competition in the banking sector and ■ rnrt measures to stimulate alternative sources ■ eti n ee tre ■ Cntrctin of finance (UK firms tend to rely on ■ ectricit ter debt finance, which is less conducive to ■ nctrin ■ inin n rrin innovation than equity finance). Lessons ■ rictre retr n iin can also be learned from ‘patient capital’ funds, which have already been developed by some universities.

Policies for sectors It is important that processes for granting support to particular sectors are competitive, transparent and based on a real understanding of whether there are market failures that the government can usefully address. This can help to avoid policy being influenced by the lobbying of incumbents with outcomes that are not necessarily beneficial for the UK economy as a whole. Strong and transparent institutions governing the UK’s industrial strategy can help to justify the grounds for sector-based support. Sector support should not be restricted to high-performance/high-growth sectors like aerospace and pharmaceuticals. Low productivity sectors such as retail, hotels and administrative services employ a large share of the population, and suffer significant obstacles to growth (such as the availability of skills or investment in technology) that the government can help to address. Policies that seek to raise Cntritin t r rctiit rt ectr productivity in such sectors could have large aggregate effects and also help to ■ ■ en in ie reduce inequality. ■ ■ rte et t ince rti But it is not always easy to define a ■ sector, and indeed there may be multiple ■ sectors that face common challenges. There ■ is scope therefore for a ‘mission-oriented’ ■ ■ approach, which can help to bring together all relevant companies or technologies ■ ■ across sectors, and be wide-ranging ■ enough to address public policy challenges ■ in areas such as air quality in cities, health ■ and social care. ■ For example, the early sector deal on en ie ne it e re eet the transition to ultra-low emission vehicles rnce ern mentioned in the recent Green Paper could be part of a wider mission to improve air quality in cities, and extended to include Source: EU KLEMS.

5 CentrePiece Summer 2017

other relevant sectors or technologies, and can help to deliver an effective industrial policies for places is universities’ capacity a number of complementary government strategy – including skills, innovation and to improve regional economic performance levers (such as procurement of low infrastructure – are now at the level of via their role as producers of skills and emission bus fleets, and government nations and regions. incubators of innovation. Once again, regulation or incentives to raise consumer But the current structure of local and there is a coordination problem here, with demand for these types of vehicle). regional governance is not well placed no formal requirement that LEPs work to address local challenges. While local together with universities. It is crucial Policies for places enterprise partnerships (LEPs) have the therefore to improve engagement between Regional disparities are now wider in the potential to help deliver successful local LEPs, local government and universities. UK than in other West European countries. economic growth strategies, there is some Figure 2 plots regional productivity relative disjointedness between them and local Conclusion to the country average for both the government and it is unclear how they fit Developing an effective industrial strategy UK and Germany. This reveals that the into the evolving devolution landscape. for the UK is no mean feat, not least UK’s high productivity regions are highly There are also concerns that they lack because it requires the cooperation and concentrated, but that there is more spread sufficient resources and the incentives coordination of a multitude of stakeholders throughout (mainly Western) Germany. to invest in projects for long-term – particularly across government, business Similarly, the UK is more concentrated development. The devolution agenda and and the education sector. Our starting at the low end, with Wales standing out regional initiatives will therefore need to point is that institutional reform will enable as hosting regions with particularly low be underpinned by a national strategy to government to take a longer-term view on productivity relative to the UK average. deliver policies that are tailored to each part these issues, based on political consensus, With the trend towards devolution of the UK’s industrial strengths, and the which would not only increase the and the agreement of a number of right balance between local initiative and chances of success, but also reduce policy City Deals over the last few years, a central direction. uncertainty and help stimulate investment number of important policy levers that Another lever available for improving across the economy.

Figure 2: This article draws on UK Growth: Productivity per hour, regions in the UK and Germany A New Chapter, the LSE Growth compared to national average Commission’s 2017 report (http:// www.lse.ac.uk/researchAndExpertise/ units/growthCommission/documents/ ■ ■ pdf/2017LSEGCReport.pdf). ■ ■ ■ Anna Valero is a research economist in CEP’s ■ growth programme. Richard Davies is chief of ■ ■ ■ ■ ■ ■ ■ ■ ■ ■ ■ ■ staff of the LSE Growth■ Commission.■ ■ ■ ■ ■ ■ ■ ■ ■ ■ ■