9 November 2017

Rebalancing the economy would make Britain less dynamic


Since the Brexit vote, it has become the conventional wisdom that there is a backlash against globalisation by the left-behind. That this revolution isn’t limited to Britain has allegedly been confirmed by the election of Donald Trump in America, and various national and regional electoral gains by the far right across Europe. If globalised capitalism is to survive in anything resembling its present form, we are told, those who have lost from recent economic disruption must be helped.

In the UK, demand for reform has so far been met in the form of proposals for industrial policy, regional policy, currency devaluation, infrastructure spending, retraining programmes and myriad other forms of state intervention. The Northern Powerhouse, HS2, devolution to cities and regions, industrial subsidies, and even energy market reform have been framed as part of this agenda. Those sceptical of the City and the financial sector are enthusiastically endorsing proposals which, in their view, will help to “rebalance” the economy.

Given that the people advocating these policies were doing so before the EU referendum, there is reason for suspicion. Proponents of intervention have clearly sensed that the timing is right to put their ideas into practice. But that doesn’t mean their arguments are any truer in 2017 than they were in 2014.

In fact, the historical experience of industrial policy in Britain has been poor, with interventions rarely improving employment outcomes, and often dampening productivity growth and efficient resource allocation. The British example is mirrored across most jurisdictions: if you assess industrial interventions across rich and developing countries, you will tend to find more British Leylands than DARPAs (a US government programme which contributed to the development of the internet).

There is one particular and glaring inconsistency in the Government’s current programme for reform. On one hand, we are told that regeneration of the country’s deprived regions is essential for inclusive growth and to rekindle public support for the market economy. On the other hand, there is a growing sense of urgency about stagnating productivity. Boosting Britain’s failing regions at the same time as the output efficiency of the workforce is, however, likely to prove impossible.

Consider someone from Hull with a degree in engineering. Upon graduating she has two options: stay in Hull and work in a small manufacturing firm there, or move to Malmesbury, where Dyson is based, or Sunderland, home to Nissan’s UK plant. Regional policy dictates that taxpayers’ money ought to be dedicated to making Hull more attractive so that our engineer will remain there. Boosting productivity, on the other hand, calls for public policy to make it easier for this person to leave Hull and take a job in more productive industries further afield.

What is true of one engineering graduate is true more generally. Productivity is a function of many things. The more capital someone has to work with – better, more sophisticated machines and software – the more productive she will be. The larger the firm, if there are economies of scale, the better for output efficiency. There may well also be agglomeration economies whereby people’s productivity is enhanced by working alongside – and competing with and learning from – others who are geographically close. This is the reason tech firms concentrate in Silicon Valley, and why the same actuary is likely to be paid more if he works in Bishopsgate, London than if he is based in Belfast.

Regional policy calls for stability – some would say, stagnation. We yearn for the past or the vanishing present. Productivity policy, on the other hand, calls for mobility and change. It understands that the economy is dynamic and resources constantly need to be reallocated as opportunities emerge and consumer tastes change. Many of us might like to have a bit of both, but in practical application they are mutually incompatible.

The Government may say that it can in fact achieve the two simultaneously, by being “strategic” with its regional spending so that it creates the agglomeration economies and other factors that drive rising productivity. But consider the record of industrial strategising by governments: it points to ghost airports, white elephants and a nuclear plant whose electricity will cost Britons twice the prevailing market price far into the future. This is not in the least reassuring as to the effectiveness of new initiatives.

Furthermore, consider what would happen even if the government succeeded. Our engineer would stay in newly burgeoning Hull and make herself most productive there. But this would probably mean that Sunderland and Malmesbury were no longer optimal production locations, so resources would have to move to places like Hull. This might even trigger a local contraction, calling – according to regional policy – for public spending to restore the status quo ante. You can see that this leads to a cycle of expenditure only part of which, if at all, will be recouped by increased output and employment.

Regional policy may, in some instances, be a worthwhile undertaking on which taxpayers are prepared to spend their money. But let us not pretend that it will not come at the cost of a more flexible and dynamic economy.

Diego Zuluaga is Head of Financial Services and Tech Policy at the Institute of Economic Affairs