9 August 2016

Theresa May’s industrial policy must accelerate innovation, not subsidise failure


Last month, Theresa May announced the return of a formal industrial strategy to British economic policy. Under Cameron’s ministry, Sajid Javid was loath to consider any policy that smacked of state intervention as Business, Innovation and Skills minister.

Indeed, one of the first programmes on Javid’s chopping block at BIS was the Manufacturing Advisory Service (MAS). This provided modest government support for industrial firms with long term business plans, as well as helping to arrange funding to prevent capital shortages holding back these firms’ growth. Programmes such as the “tooling up fund” run by the MAS allowed SMEs to better compete for bulk orders, particularly in the automotive industry, by offering capital to prepare factory floors properly for such orders.

However, such programmes were considerably reduced in scope under his watch.

Now that Javid has been redeployed elsewhere, there has already been an about turn in policy under Greg Clark . While newspaper hacks across Westminster struggle with the pronunciation of a new departmental acronym, civil servants are also getting used to a new driving logic within their department.

It is unlikely that the well-publicised sale of ARM Holdings, Britain’s Cambridgeshire tech giant, to Japanese firm SoftBank is unconnected to the announcement of the return of a British industrial policy.

The sale strengthened attitudes in Westminster that while investment in the UK is welcome, consistent sales of such crown jewels of the economy are unlikely to be an unmitigated success for the economy overall. Profits will be sent abroad rather than being reinvested, and as happened with Cadbury’s sale to Kraft, manufacturing processes in the UK are put at risk, with the potential for jobs to disappear to foreign shores.

At its heart, this change of view recognises the economic truth that there is no such thing as a completely free market.

Geopolitical power games, strategic necessities, and domestic political realities play on the minds of economic power brokers around the world, who use their leverage to try to tip the odds in their favour.

To see this application of state power and resources to the market, one needs to look no further than Redcar in North Yorkshire. There, British steel mills are not closing because they are inherently inefficient; indeed, Britain is a world leader in producing high tech metals. They are closing because the Chinese taxpayer is subsiding its own steel output to the tune of billions. Ever conscious of domestic strife, the Chinese government continues to plough money into steel orders to maintain demand, and sells the surplus on the global market to avoid a downturn that it thinks could harm its grip on power.

The comeuppance of this is that the price of steel has fallen through the floor and is pulling the legs out from under the unsupported British steel industry. Firms simply cannot compete with the coffers of the Chinese state, and without support to restructure matched with regulatory action against such dumping, more mills will close due to political, not market, pressures.

It is for cases like this – where market failure is undermining commercial success – that a coherent industrial strategy is needed.

That said, an industrial policy should not take us back to the bad old days of the nationalised economy of the 1970s, with British Leyland selling Minis for less than they were worth, and the taxpayer footing the difference. That would be to make the Chinese mistake, which will cost them in the long run.

The first priority of any industrial policy must, instead, be for the state to recognise its strengths and its weaknesses. States have an ability to absorb risk in a way no small firm can. It is no coincidence that states can borrow on the market at vastly cheaper rates than any business, however large. It is this risk absorbing capacity that is the state’s best asset in supporting business.

That said, without the profit motive, states are poor innovators. Such a weakness can be ameliorated, however, by partnering with banks. Using the banking system’s expertise at assessing risk, but using the state’s risk-absorbing capacity to increase the scope of loans that can be made, more firms can get the boost they need to grow, at a relatively small cost to the government.

For Professor of Industrial Strategy at Aston University, David Bailey, something akin to the US Small Business Administration is the best way to achieve that in the UK.

“In the US, the government supports small businesses by arranging investment loans through banks, credit unions and other lenders, who partner with it.

“It provides an American government-backed guarantee on part of the loan. Under the Recovery Act and the Small Business Jobs Act, SBA loans were enhanced to provide up to a 90 per cent guarantee in order to strengthen access to capital for small businesses after the global financial crisis of 2008-9.”

With banks remaining risk averse, the state can use its ability to absorb such risk to support banks in making this capital available, without picking blindly itself, and damaging the chances of potential innovators by subsidising bad firms.

Beyond capital availability, it is cost pressures rather than regulatory burden that are holding back industrial firms in the UK. This is perhaps clearest in the energy sector, for reasons not just do to with the price of energy on the global market.

As Professor Bailey put it,

“The OECD sees the UK economy as one of the most deregulated in the world. But UK energy prices are far higher than continental Europe partly because of lack of investment in generation capacity and partly because of extra taxes piled on to energy costs.

“We lack a proper energy compensation scheme for manufacturing. This has been talked about by government but we’ve so no real action.”

Debacles such as decisions over Hinkley Point do not just hit individual consumers, they hold back industrial SMEs. Instead of focusing on white elephants, British industrial policies must plough money into proven infrastructural projects, such as energy generation capacity and super-fast broadband, which directly benefit businesses. Indeed, political interference in a final decision on Heathrow’s third runway is yet another example of political interference holding back growth.

Farming such choices out to independent decision makers, rather than allowing ‘nimby’s to rule the roost, could also be an effective part of a new industrial policy.

Overall, the most important thing for a successful industrial policy is collaboration. A government acting alone, without commercial nous, risks picking winners from the top down. That allows uncompetitive firms to encroach on the market share of the competitive ones, all on the taxpayer’s pound. That prevents strong firms from growing properly, and can leave weak firms high and dry when such subsidies inevitably become politically impossible to maintain.

Professor Bailey highlights this:

“Industrial policy as a collaborative process helps avoid old style ‘top down’ risks of ‘picking winners’. Rather the market and the state can, together, back winners.”

Supporting loans, sharing of risks, and investing in infrastructure are all things the government could and should be doing more. We should welcome the return of industrial policy to the British economy, as something that can support future growth. We should not mis-remember the lessons of the statist past.

Used correctly, an effective industrial policy can accelerate the re-balancing of the economy away from financial services, which leaves the British economy vulnerable to sector specific economic shocks. It can also begin to heal the regional divides that certainly played a role in producing a Brexit vote.

However, Theresa May must take a long term view, and not just look for quick PR wins by making well-choreographed announcements about British successes. The focus must be on giving British firms the environment they need to succeed, rather than lazily funding them by the back door with cheap loans. There is always a risk that state industrial policy picks winners. But policies that back fundamentally inefficient companies are bound to be found out eventually. Such dirigisme just does not work in the 21st century, and could do far more harm than good.

George Greenwood is a freelance political journalist, published in the New Statesman, The Independent and The International Business Times.