The next UK government needs an effective industrial strategy. The Labour Party are promising one, as a means to raise the country’s growth rate and accelerate the transition towards a greener, cleaner and more productive economy and society.
A definition
An industrial strategy, or industrial policy, as it used to be more commonly known, is a set of policies which aim to develop particular sectors which are deemed to be beneficial for the economy as a whole. Although manufacturing has traditionally been the focus, these days targets tend to be broader, given its relatively small share of overall GDP and the dominance of the services sector. This is not to neglect it, nor to belittle its role in innovation and raising productivity, and its linkages with other sectors.
Some progressives draw attention to what they call the foundational, everyday and overlooked parts of the economy, which together represent around 60 percent of employment in the UK, and consist of universal basic services in the public and private sectors as well as both essentials such as food, and occasional purchases such as furniture, all of which are deemed vital for sustaining a good quality of life for the mass of the population.
Taking such a broad outlook risks overloading the definition of industrial strategy, but it at least emphasises that progressive or widely-shared economic and social development which generates greater welfare and well-being requires more than just an innovative and productive manufacturing sector.
Need
I have posted here on the need for industrial policy in both rich and poor countries. Depending on the level of development, technology, politics, institutions etc., an industrial strategy can take different forms. However, when considering the potential for intervention in the economy, it is important to get past the misleading ‘state versus market’ dichotomy, with the political left supposedly favouring a greater role for the state, and the right favouring the market. This leads on to arguments over the likelihood and potential harm caused by market failure on the one hand, and government failure on the other.
In truth, all capitalist economies are mixed economies to greater or lesser degrees, with an inevitable symbiosis between the state and the market, and the public and private sectors. Economic policy can never be completely technocratic and apolitical. All economic change creates winners and losers, vested interests often loom large in pushing for change or preventing it, and there is thus a need for a political economy approach in analysing socioeconomic development and the scope for policies which support it.
An industrial strategy is not simply about the state correcting market failures. Historically it has also played a much more varied role in its pursuit of development, not least in responding to non-economic factors, such as national security threats alongside geopolitical trends, as well as securing political legitimacy and political stability. These often require policies favouring one social group over another, for example in reducing inequality and the potential for social conflict. While they can consume resources which might otherwise be directed towards economic development, they can be the least bad option since political instability and a lack of social cohesion can undermine the conditions required for growth. Thus a ‘pure’ focus on growth and development may in fact be impossible.
State-driven ‘missions’ are another way in which governments can coordinate resources and institutions in the service of a national vision for the future, as prominent economist Mariana Mazzucato has long argued. A brief quote from her book Mission Economy, which sums up this way of thinking, can be found here.
Goals
There are many goals which an industrial strategy can encompass, not least for the UK. Again, there is a danger that this may undermine its coherence. At the same time, the country has multiple problems to solve, and an approach which integrates government policies in the service of a common vision seems sensible.
The UK economy needs to raise its growth and productivity performance in order to realise higher living standards for the mass of the population, to reduce inequality and poverty and to improve the provision of public goods and services. It needs to do this in a way which promotes a green transition of the economy. It also needs to improve its international competitiveness so that growth becomes less dependant on rising private and public debt. Regional inequality needs to be tackled so that the benefits of growth are shared more widely across the nation, and particularly outside the historically more dynamic London and the South East. Having said that, there are pockets of deprivation in all regions, and tackling these will not be straightforward.
Many economists agree that the UK needs to invest more, in both the public and private sectors, in infrastructure, skills, innovation and in productive capacity more generally.
Raising the productivity of firms which have lagged behind the average must be part of the solution to improving it for the overall economy, as well as reducing the inequality deriving from wage income. Without faster growth in productivity, there is less scope for wages to rise without either squeezing firms’ profits or leading to higher prices. Having said that, higher wages across the economy can boost consumption spending, while forcing the least profitable firms to restructure or go out of business, releasing resources to be employed by more profitable firms. So a ‘high wage’ economy can to some extent support aggregate demand, while encouraging structural change and greater efficiency.
Another aim of an industrial strategy which supports the emergence and growth of more innovative and productive firms should be an improved foreign trade performance. Alongside international competitiveness, this depends in part on growth in demand in the rest of the world, particularly among our trading partners. The EU remains the UK’s largest market for trade. Following Brexit, we are now outside this market, and the regulatory costs of trade with it have increased, stifling growth to some extent. Geography is not everything in international trade, but it has an impact. A closer relationship with the EU might help to ease the costs of trading with it.
Policies
The UK remains an advanced economy, but policymakers can draw some useful lessons from industrial policy successes and failures in Asia, as detailed here. They can also draw inspiration from the UK’s own success in turning around its national Olympic team performance from a low of being ranked 36th in the medals table in 1996 to 2nd in 2016. I discuss some aspects of this transformation here. Briefly, for industry more generally, it shows that a combination of vision at the national level, financial resources, cooperative relations between government, industry bodies, universities and colleges, and labour market institutions, and a willingness to learn from other countries and adapt the lessons to the UK’s specific circumstances, can go a long way.
An increase in government support to encourage greater investment in research and development might be welcome, but for it to broadly benefit the economy, it needs to be commercialised and lead to the production and sale of new goods and services.
A successful industrial strategy also rests on improvements in the nation’s physical and social infrastructure, including transport, clean energy and communications networks, and a healthy and skilled workforce.
Demand-side policies such as public procurement can be as important in catalysing private sector investment as the supply-side policies just outlined. But once again, these need to be driven by a coherent vision and integrated with the rest of the strategy.
Governments of all stripes have placed an emphasis on creating an attractive environment for foreign direct investment. Tax breaks, improved local infrastructure and skilled labour are examples of this. But the real benefits of FDI beyond a successful but isolated industrial enclave may only be realised if it stimulates job and firm creation more widely, and enables the transfer of improved technological and organisational capabilities beyond the investing firm to local actors.
Few would disagree that increasing the investment share, both private and public, in overall GDP must be part of the solution to economic stagnation. A classic argument, made by many leftist economists over the years, is that the dominance of the UK’s financial services sector, particularly in the City of London, has proved to be a drag on industrial development. There are different strands to this point of view, so I will mention a couple, which are not particularly left-wing! Firstly, the UK’s sophisticated financial institutions and markets attract foreign capital and keep the exchange rate persistently higher than is good for the health of the overall economy. A stronger currency reduces the international competitiveness of many otherwise viable and productive exporters, creating larger trade and current account deficits, and making economic growth more dependant on debt accumulation while weakening productive investment. Stronger regulation of the sector and of inward capital flows could be one response to this problem. Secondly, the emergence of the bonus culture for the CEOs of large publicly listed firms has reduced the incentives for them to invest, and instead encourages higher payouts and share buybacks, rather than long term investment. Andrew Smithers’ book Productivity and the Bonus Culture makes a good case for this perspective. Policies which change management incentives and promote long term investment could help here.
The UK financial system also tends to neglect lending for long term investment in risky innovations, for small and medium-sized enterprises and in physical and social infrastructure. One solution to this is a national public investment bank, potentially modelled on institutions in countries such as Germany and South Korea. It should aim to increase the supply of risk capital to promising firms and projects which would otherwise find it relatively hard to get long term funding. Of course, it should not simply replace existing private funding, rather it should target projects with high projected social returns.
Politics
A progressive government aiming to improve socioeconomic performance may try to bring together business, trade unions and other institutions so as to coordinate policy. But in order to drive change it will be creating winners and losers and will thus come up against vested interests with the potential power to block reform. If faster growth becomes a reality, then hopefully there will be more winners than losers, but to get there may be as hard politically as it is economically.
The ability of the state to manage the ‘rents’ it can generate in providing support for business and other economic actors will remain crucial to the long term success of any industrial strategy. Government financing which aims to stimulate investment in new productive capacity, in skills, in workplace reorganisation etc., needs to be time-limited and conditional on future success, such as in improving productivity or export performance. The success of this kind of ‘rent management’ depends to some extent on the balance of power between the different organisations involved in the process. An inefficient outcome would lead to a failure to withdraw subsidies or tax breaks even if performance does not improve sufficiently and thus to wasted resources and inefficiency. A successful strategy will require learning and experimentation by policymakers and the ability to change course in the event of policy failure.
Devolution of political power away from London may be one way of improving the efficacy of regional policy, elements of which inevitably overlap with an industrial strategy. Institutional reform of this kind could be key to poorer areas of the country catching up with the richer ones, at least to some extent, and thus to a more equitable growth strategy. One worry with this is that the poorest regions lack the resources needed to step up investment to begin with, so it will still require a mix of central and local government funding. But a more devolved government with local stakeholders having a greater say in development strategies, including funding levels and allocation, could be a great help.
Labour’s shadow chancellor Rachel Reeves has promised to lead a resolutely pro-growth Treasury if her party is elected as the next government. Politicians over many decades from both left and right have tried to enact more developmentalist policies, only to end up blaming the department for scuppering their ambition. It remains to be seen if this will change under potentially new political leadership.
From industrial strategy to the labour market
There is a lot which can come under the rubric of an industrial strategy, because there is a lot which it can impact: productivity, innovation, jobs, pay, inequality, trade, energy, etc. The risk of overloading the term, and the policy ambition, could result in disillusionment. Perhaps a clear, compelling and realistic vision which comes from the top can help to bind a range of policies together in a coherent fashion.
As well as an industrial strategy, Labour has promised to improve worker’s rights and to bring business and trade unions together as part of its strategy for improving economic performance in a more equitable fashion. In this spirit, next week’s post will focus on the labour market.
The Political Economy of Development 