8 April 2021

Subsidies are no way to support business – but there is a better alternative

By Terence Kealey

The Department for Business, Energy and Industrial Strategy (BEIS) gives some £2.4bn a year to industry to correct for so-called ‘market failures’. This money goes on a variety of schemes including (i) programmes that provide businesses with advice, (ii) programmes that link businesses with other businesses, and (iii) programmes that fund research and development.

Students of Adam Smith will not be surprised by the next paragraph.

In January 2020 BEIS’s schemes were audited by the National Audit Office (NAO), which found that most of BEIS’s business support schemes:

“Lacked measurable objectives from the outset or evaluations of their impact to know if they are providing the most value or if they should be discontinued. Without such analysis, the Department cannot know if its business support is providing value for money.”

Moreover, the one scheme whose impact was evaluated against measurable objectives, the Smart scheme, failed to show a statistically-determinable benefit. In short, the NAO concluded we had no evidence that the £2.4bn that BEIS had spent on business support schemes in 2016/2017 was of any value – and the NAO hinted very strongly indeed that every single penny had been wasted.

A rational government would have seized upon the NAO’s report to close down BEIS’s schemes and thus save the taxpayer some £2.4 billion a year – a saving that is desperately needed as the nation’s expenditures and debts explode. But we don’t have a rational government, we have one that is led by Boris Johnson.

Johnson came to power under a Brexit star, and the bulk of Brexit’s supporters were not drawn from the ranks of frustrated entrepreneurs yearning to be exposed to the bracing challenges of free markets. Rather, many are probably very comfortable with the state doling out gifts, subsidies and support schemes. If therefore the NAO has discredited the current gifts, subsidies and support schemes, they expect Johnson and co to invent new and better ones.

That’s an expectation our Prime Minister has duly gratified, and in February of this year BEIS published an Open Consultation entitled ‘Subsidy Control: Designing a New Approach for the UK’, in which the department asked people to suggest how it might improve its schemes. In short, BEIS wants advice on NAO-proofing its business support schemes.

For connoisseurs of government, this Open Consultation evokes a certain nostalgia, for it resembles the pleas that Yuri Andropov, Konstantin Chernenko and Mikhail Gorbachev used to make in the dying years of the USSR, asking the cadres and comrades to suggest how Russia might improve its five-year plans to achieve the historically-determined triumph of actually-existing socialism. Oh, happy days of central government planning.

The USSR was constructed on the principle of ‘market failure,’ and – counter-intuitively perhaps – businesses in Britain subscribe to the same principle: only if the government gives them at least £2.4bn a year, they say, can the UK economy possibly struggle on. As Adam Smith noted in his Wealth of Nations of 1776:

“People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public.”

British industrialists have certainly been very clever in scouring modern economic thought to invent a thousand possible causes of market failure to justify gifts of money from government. For such industrialists and their tame economists, the NAO report has proved most inconvenient – as it has for Boris Johnson.

But there is a solution. In February 2020 the NAO published another report. This one was entitled ‘British Business Bank’, and it was very different in tone from its coeval ‘Business Support Schemes’. The British Business Bank was founded by BEIS in 2014, not to give money to business but, rather, to either loan money to companies or to sell money to companies in exchange for equity. And the Bank is a rip-roaring success. It transpires there really is market failure in Britain, which, perhaps not surprisingly, is located within the financial services.

Before Mrs Thatcher lifted capital controls in 1979, banks were socially useful. The years between 1945 and 1979 were the years of 3:6:3, when bankers borrowed at 3%, lent at 6%, and were on the golf course by 3pm because they had nothing much to do but receive deposits, lend money to companies, and thus foster employment and economic growth. Those were the days of Harold Macmillan’s 1957 “most of our people have never had it so good”. when the British economy grew faster than ever before or since.

But they were bad years for bankers, who didn’t earn much more than dentists, so their tame economists invented the idea that Britain would do better if our bankers could speculate abroad. Such speculation, of course, has been very good for bankers, but not so good for British industry. Enter the British Business Bank.

As the NAO has reported, the Bank has been so successful that it has increased the stock of finance going to SMEs (small and medium sized enterprises) by £14bn, it accounts for over 90% of the finance going to SMEs outside that provided by the big five banks (in other words it has identified £14bn of market failure within British commercial banking), and it makes a profit. Its current rate of return is 3.6%.

BEIS has, in fact, conducted a most interesting experiment: it has tested the idea of market failure in the economy at large and found it does not exist (or, if it exists, government cannot rectify it). But on testing the idea of market failure within the financial services, BEIS has found it to be considerable. And we can trust that latter finding because companies will take out loans or exchange equity for capital only if it is in their interest.

So, let Boris Johnson abolish BEIS’s support schemes yet pacify his ‘left-behind’ supporters by transferring the wasted £2.4bn to help expand the British Business Bank. Happily, the Bank’s logo is already the Union Jack, so it’s oven-ready for Brexiteers.

The Financial Times does not know what to think about the success of the British Business Bank. On April 5 it ran a story entitled ‘Taxpayers should know more about UK’s venture capital spree,’ which noted that the Bank seems to have become Britain’s largest venture capitalist – but which complained that it maintains considerable commercial confidentiality. A day later it ran another story: ‘UK Treasury takes stake in hipster record label,’ which sniffed that the Bank was investing in companies such as Gearbox Records (which specialises in unreleased jazz, folk and electronic music) and Propelair, a low-flush toilet manufacturer from Essex.

In the latter piece, the FT‘s business correspondent Daniel Thomas noted that “tech executives have questioned why [government money] was necessary given the vast amounts of money already available from venture capital funds searching for fast-growing businesses to back”. To which the answer is that it’s a market out there, and if the British Business Bank is making a profit, perhaps the private sector’s “venture capital funds searching for fast-growing businesses to back” need to sharpen their act.

The very concept of state gifts of £2.4bn a year to private companies is morally dubious, for such schemes must invite waste and fraud; but the Government’s testing of the idea of market failure within the financial services by creating a bank to compete, on a level playing field, with the private ones, is properly bracing to all players—in the ministry and the markets alike.

Historically, nationalised industries have generally failed, yet they have usually been monopolies. But for as long as the British Business Bank competes successfully with our unsatisfactory financial services, on a level playing field, then all power to its elbow.

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Terence Kealey is a fellow of the Adam Smith Institute and an adjunct scholar at the Cato Institute.

Columns are the author's own opinion and do not necessarily reflect the views of CapX.