Economic Theory

The government’s new ‘industrial strategy’ will fail


The Government’s industrial strategy, released yesterday, is a paean to received wisdom about what the future economy will look like. By focusing on artificial intelligence, green energy and agriculture, and self-driving cars, business minister Greg Clarke is seeking to distance himself from the dismal experience of past industrial policy. Formerly, it would throw money at the old, failing industries in a bid to forestall the inevitable job losses and capital reallocation.

Doubtless, the grandiose rhetoric of a “strategic partnership” between the public and private sectors in today’s white paper will be welcomed by business. At a time when politicians are more likely to slam the corporate sector for anything from its pricing and environmental practices to its investment and compensation policies, the Government’s friendly tone signals a willingness to engage. Though business should beware that Mr Clarke makes no attempt to hide who will be setting the terms of the partnership.

The reaction by Labour is also predictable: howls that the Government’s budgeted spending “isn’t enough” and that too little emphasis has been placed on the public sector and, specifically, the National Health Service.

From an economic viewpoint, however, there is reason for scepticism. Success, of course, must be meaningfully defined: It cannot be measured by how much money is spent or how many new committees and quangos are set up as the industrial strategy is implemented. Rather, the focus must be on whether the promised public spending raises the rate of return on investment and the productivity of capital, which in turn will lift the trend rate of output and wage growth. But will it?

Economists typically raise two objections to industrial policy which can be summarised as follows: If it would have happened anyway, then public spending was unproductive; if it wouldn’t have happened anyway, then public expenditure was equally unwarranted. To use more “economicky” language of the sort the Chancellor ostensibly favours, public subsidies to private capital investment tend to lower the cost of capital for firms, but they rarely change the gross return on projects. So, industrial policies either hand additional profits to firms beyond what they would have made in a free setting, or they lead to projects being pursued which would be uneconomical without the subsidies.

Some economists of a Keynesian bent give a more qualified argument: The state can improve outcomes when aggregate private demand is in shortfall, or when projects (such as infrastructure) which would raise productivity rates cannot be undertaken by the private sector. The latter is presumably because the gains to be had from such undertakings wouldn’t be wholly captured by the firm pursuing them but would accrue, instead, to the individuals and businesses making use of the new more productive roads, bridges and broadband.

Raising theoretical objections to established orthodoxy is a favourite pastime of economists. But the point is whether those have any teeth in the real world. If we look around us, can we say with any confidence that the fundamental reason why the UK economy isn’t performing better has to do with sluggish demand or a lack of available capital for productive projects?

The answer is that we can’t. With unemployment at record lows, consumer spending and producer confidence high, the British economy has left behind the 2008 slump. Nor is there a dearth of private capital, with bond yields exceptionally low and price-earnings ratios unusually high.

The problems lie, almost invariably, on the supply side: land-use planning restrictions make housebuilding and infrastructure development expensive and protracted; energy price interventions raise the cost of a vital input into productive activity; airport expansion, for which there has been private appetite for decades, has failed to proceed because of political obstacles; and post-crisis financial regulation has made capital costlier to raise by both banks and the capital market.

To this must be added the state’s singular incompetence at picking productive investment projects, with which Britons are all too familiar. “Ah,” you may say, “but that was the time when industrial policy picked obsolete industries. This time, it’s about the technologies of the future!” Yet, to the planners of the 1960s and 1970s, British Telecom and British Aerospace – not to mention the joint Concorde venture with France – were as much of an attempt to shape Britain’s economic destiny as present efforts to stimulate AI in the minds of our elected officials.

Industrial policies can lift or sink the fortunes of politicians, but they rarely turn around the economic fortunes of the communities affected, or the economic prospects of the country that pursues them. There is no argument in today’s white paper which would lead one to believe this time will be different.

 

This article was first published on CapX.

Policy Analyst at the Cato Institute's Center for Monetary and Financial Alternatives

Diego was educated at McGill University and Keble College, Oxford, from which he holds degrees in economics and finance. His policy interests are mainly in consumer finance and banking, capital markets regulation, and multi-sided markets. However, he has written on a range of economic issues including the taxation of capital income, the regulation of online platforms and the reform of electricity markets after Brexit. Diego’s articles have featured in UK and foreign outlets such as Newsweek, City AM, CapX and L’Opinion. He is also a frequent speaker on broadcast media and at public events, as well as a lecturer at the University of Buckingham.


2 thoughts on “The government’s new ‘industrial strategy’ will fail”

  1. Posted 28/11/2017 at 13:43 | Permalink

    The Industrial Strategy white paper acknowledges that the skills and capabilities of people who are not in the pay of the State needs upgrading if the UK is to pay its way in the world, post-Brexit. However, there is no mention of shortcomings in people who are in the pay of the State – the other party to this Industrial Strategy, on whom its success is dependent.

    It is perfectly laudable to seek to use subsidies funded by the Public Sector to invest in public works, as part of a modern Industrial Strategy.

    Indeed, some people have argued that money can be borrowed by the Government, at a time when interest rates are a record low, and spent on infrastructure projects and regions to create jobs, invigorate the economy and boost productivity. Of course, such a move would be a great idea – if, this borrowed money was paid back over the next several years.

    However, the fact of the matter is that it will simply be added to the burgeoning national debt (currently at £1,790 billion and rising) and only paid-off during the lifetime of today’s millennials, their children and grandchildren – thereby transferring this burden onto future generations. It is morally wrong to foist debt onto citizens who are not yet born, and force them to pay the price for the irresponsible behaviour and excesses of those in charge of public policy today.

    It is not so much hesitancy on the part of elite politicians in Westminster that is stalling decisions on key infrastructure projects, but a lack of confidence in the ability of civil servants in Whitehall to agree taut commercial contracts with Private Sector players, which will secure best value for money for taxpayers’ money over the long term – no one in Government wants to even mention this in public, least they blurt out the truth.

    Notwithstanding the spin from the Government regarding the superlative capabilities of its technical and commercial staff, the reality on the ground is that they are woefully ill-equipped to deal with the Private Sector – it remains the single most important constraint which is holding back politicians from committing public funds!

    Additionally, there is concern in some quarters that Government/Industry forums, which are the formal mechanism for discussing these sorts of issues, will be hijacked by those with superior negotiating skills like big business, to swing spending decisions in their favour – at the expense of the interests of others like, small and medium-sized enterprises who are seen as the lifeblood of the UK economy, and should rightly be given equal access to publicly-funded contracts.
    @JagPatel3

  2. Posted 29/11/2017 at 13:52 | Permalink

    Bureaucrats and politicians, none of whom knows anything about business (and many of whom are actively hostile to it) sit down and draw up a plan to be imposed on entrepreneurs.

    All this to be payed for by taxes on – wait for it – businesses.

    What could possibly go wrong?

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