An industrial strategy that works for the UK: Framework and principles

The UK economy has several deep structural issues. We are less productive than our peers in Europe, and progress at closing the gap has stalled since the 2007/8 financial crisis. The long-term erosion of our manufacturing base has contributed to a persistent trade deficit, and reduces the extent to which UK manufacturing firms benefit from a falling pound, or investment in major domestic infrastructure projects. Economic activity is increasingly concentrated in London and the South East, and many regions of the UK are yet to recover their pre-crisis levels of GDP per capita. And we are falling well short of our ambition to cut carbon emissions by 80 per cent relative to 1990 levels by 2050.

Against this backdrop, ‘industrial strategy’ has taken on the qualities of a panacea. With the inclusion of industrial strategy in the newly named business department, the government looks primed to launch a more interventionist, ambitious approach to economic policy.

Given the significance of the service sector for UK GVA, productivity and employment, industrial strategy should support innovation as it applies in a service sector context, in addition to technological breakthroughs, with an approach that encourages adoption as well as origination of innovations. The strategy should have a strong spatial dimension, and be determined at both the regional and national levels. Manufacturing should be supported in two ways: firms and research institutions developing new technologies should be supported, but so should less innovative firms with the potential to transition to more sophisticated products. Finally, the decarbonisation objective should underpin the entire strategy.

Key findings

There are several ways in which private markets, left unchecked, deliver sub-par outcomes. They include:

• Underinvestment in innovation: economies don’t innovate to the extent that they should, because some of the benefits to that learning are not captured by the individual or firm that does the innovating.
• Lack of coordination: an uncompetitive endeavour for a single firm can be made economically viable by coordinating the activities of several firms in a ‘cluster’, but no one firm has the ability or incentive to create that cluster.
• Short-term and risk-averse finance: banks and venture capital funds alike do not offer sufficient finance to the riskier, innovative activities that it is in society’s interest to pursue.
• Failure to capitalise on public (or publicly driven) demand: the potential benefits to society of the demand generated by public policy decisions – such as the approval of a major infrastructure project – are not fully realised, as UK firms are not necessarily configured to supply to them.
• Lack of motivation to solve societal problems: the private sector is not sufficiently motivated by market prices to solve the UK’s biggest problems – such as climate change, an ageing population or regional decline.

These private sector failings do not necessarily imply that public intervention is the solution. Critics of industrial strategy tend to argue that public intervention carries two key risks:

• the ‘waste’ argument – that the public sector cannot know better than private markets which investments are worth making, resulting in a high risk of bad investments
• the ‘rent-seeking’ argument – that involvement of this kind risks capture by private interests.

However, good policy design can help to overcome these risks.

The risk of capture can be reduced, for example, through a clear statement from the government of its objectives and success measures. Built-in sunset clauses on any support extended to an individual firm can similarly alleviate that risk, and an emphasis on evaluation – making use of new data-generation and data-gathering techniques – allows for a much richer, real-time understanding of a given intervention’s effectiveness than has been possible in the past, reducing the risk of both waste and rent-seeking.

Recommendations

Given the UK’s unique challenges, the best approach to industrial strategy would be a hybrid of the US-style ‘liberal capitalism plus’ and the Franco-German-style ‘coordinated capitalism’ industrial approaches, but with a broader definition of innovation and a sectoral coverage that goes beyond manufacturing to encompass services.

The core aims of industrial strategy should therefore be:

1. To spur innovation to boost productivity, pay, and the quality of work: industrial strategy should facilitate the adoption of existing innovations, particularly by the service sector, as well as the development of new ones. The definition of innovation should be broadened, to cover innovation as it applies in a service sector context, in addition to technological breakthroughs.
2. To ‘level up’ growth and productivity in the regions and nations of the UK: industrial strategy should have a strong spatial dimension, and be determined at both the regional and national levels.
3. To grow the UK’s manufacturing capabilities: government should do two things – it should support firms and research institutions developing new technologies; and it should support firms further from the technological frontier, who have the potential to transition into product lines where quality commands more of a premium, or to supply to innovative firms.
4. To put the UK on track to meet its decarbonisation targets: the decarbonisation objective should underpin the entire strategy.