September 04, 2014
Ha-Joon Chang and Antonio Andreoni
Policy Network, September 4, 2014
See article on original website
Since the 2008 global financial crisis, there has been a widespread acceptance – even among many of the traditional proponents of the finance-led service economy – that the UK needs to rebalance its economy and engineer a new manufacturing renaissance. However, few people realise the scale of this challenge, given the longstanding structural problems affecting the UK national industrial system. Also, the widespread scepticism about the possibility of the government partnering with productive companies to transform national productive capabilities has made policy responses slow, poorly coordinated and ineffective.
Until the end of the nineteenth century, the UK dominated the global industrial landscape. In 1860, it produced 20% of world manufacturing output. In 1870, it accounted for 46% of world trade in manufactured goods. The scale of the UK’s then industrial dominance can be put into perspective by recalling that currently the share of China, the new ‘workshop of the world’, in world manufacturing exports is only around 17% (as of 2012).
Over the last half-century, especially after 1970, the UK industrial base has been diminished, not just in its scale relative to the economy, but also in its degree of diversification. The advanced manufacturing activities that remain in the UK today are concentrated in three sectors, namely automotive, aerospace and life sciences. Between 1997 and 2007, only aerospace and pharmaceuticals registered a sustained GVA (gross value added) growth, although the pharmaceutical industry has entered a profound contraction cycle since 2007.1 These three and other ‘advanced manufacturing’ industries (such as nuclear energy and offshore wind) may account for only 4% of the UK’s GDP, but they provide two thirds of all manufacturing business R&D and almost one third of total export.
Outside of these advanced manufacturing sectors, critical manufacturing competences have been lost and domestic supply chains have become highly fragmented. Moreover, even the few sectors in which the UK still excels internationally rely on relatively few companies, whose activities are concentrated in few regions. More importantly, their supply chains are rather globalised including in the important area of knowledge-intensive producer inputs, such as production technologies and complex sub-system components.
The best evidence of the structural weakness of the UK national industrial system is given by the missed manufacturing export boom after 2008, despite a 30-35% devaluation of sterling. The UK industrial sector did not witness a significant production expansion even with a reduction of one third of the prices of its export goods. This shows that, without rebuilding the industrial base, even macroeconomic policies become ineffective.
Global landscape and emerging challenges
Many of the challenges that the UK is facing today can also be found in other mature industrial economies. However, unlike the UK, countries such as Germany, Japan or the US have more proactively used the opportunity offered by the financial crisis to address some of their structural problems and boost their industrial sectors. This has been done with a combination of demand-side stimulus packages and supply-side industrial policies.
Many of the industrial policies adopted by these countries are not new at all.2 Indeed, they have never stopped adopting these policies – often they have simply re-labelled them as innovation or competition policies. In those countries, governments have continued to play an entrepreneurial role, in partnership with private sector companies, in: reducing critical cost factors such as energy and finance; creating and regulating markets; investing in long-term and highly uncertain technological endeavours; building technological and physical infrastructures, and investing in industrial skills development.
Over the last decade, emerging industrial economies like China, Brazil, India, and Singapore, have even strengthened their industrial policy packages to maintain the pace of manufacturing output growth and their penetration of the international manufacturing trade.3 As a result, China has been able to increase its shares in world manufactured trade from 4% to 17% over the period 2000-2010 (while the UK lost 2% of its shares), while building its technological and production capabilities. The increasing richness of these competences and the policy offering of these emerging countries have attracted not simply manufacturing plants but also R&D centres of major multinationals like IBM in China, DuPont in India, Rolls Royce in Singapore.4
These international manufacturing and policy trends are of critical importance for the UK for at least two reasons.
The first and the obvious reason is that the experiences of other countries show how rebuilding the UK industrial base is not simply a way for rebalancing the economy. More critically, it is a pre-condition for preserving the existing advanced manufacturing sectors and their R&D facilities, for attracting multinationals willing to invest in competences-rich industrial ecosystems, and for making the UK national industrial system more resilient and ready to capture future global market opportunities.
Is industrial policy non-British?
Another, less often recognised, implication of the international diversity of industrial policy experiences is that there are many industrial policy measures, programmes and institutional solutions to draw on in rebuilding the UK industrial base. Learning from other countries in relation to any policy generates scepticism in all countries, but that reaction is particularly strong when it comes to industrial policy in the UK. Industrial policy, it is often argued, however successful it may have been in other countries, is against the country’s history of laissez-faire capitalism and its tradition of individualism.
One problem with this view is that it is based on a mistaken view of British history. Between the industrial policy reform of Robert Walpole in 1721 until the transition to free trade in the 1860s, Britain was in fact the pioneer of industrial policy. It is because he knew this history that Friedrich List, the 19th-century German economist who is mistakenly known as the father of the infant industry argument (when the real father is Alexander Hamilton, the first US Treasury Secretary), wrote in the 1840s that Britain’s preaching of free trade to then economically backward nations, like Germany and the US, was like ‘kicking away the ladder.’5 In turn, Alexander Hamilton is known to have drawn inspirations from Walpole’s policies in inventing his infant industry argument, so much so that he was accused of being a ‘Walpolean’ by his opponents who did not share his belief in government intervention. So, it is a convenient myth for the opponents of industrial policy that industrial policy is against the British tradition, when one could argue that Britain actually first invented it.
All the success cases of industrial policy are countries that have actively learnt from the more successful countries in terms of policy traditions, institutional set-ups, and culture. Just to cite some prominent examples: in the 18th and the early 19th centuries, the US and Germany learnt from Britain’s industrial policy; in the late 19th century, Japan imported a lot of policies and institutions from Germany; in the 20th century, Korea and China have aggressively learnt from Japan.
The first important step in the revival of industrial policy in the UK is thus changing the negative perception around it. Without this change, the UK government would not be open to learning from the successes as well as failures of other countries in the area of industrial policy and whichever industrial policy measures that it adopts will not become integral parts of the government agenda, resulting in policy misalignment that reduces the effectiveness of those measures.
Misunderstanding modern manufacturing industries
The negative perception of industrial policy in the UK has been reinforced by the misunderstanding of modern manufacturing industries. Manufacturing industries have witnessed a dramatic transformation over the last few decades which, despite the dominant vision, have indeed increased their strategic relevance for even service-led economies like the UK.
Modern manufacturing companies orchestrate production processes through complex producer networks spanning across the globe, as well as across different industrial sectors. Not only have they become vertically more disintegrated, they have also reached higher levels of flexibility in production processes and higher degrees of customisation in product design. As a result, manufacturing products have become ‘systems’ whose production requires the integration of different manufacturing sub-systems as well as the deployment of an array of sophisticated producer services. This, in turn, means that manufactured products are in fact critical vehicles for exporting knowledge-intensive business services in which the UK has developed a distinctive competitive advantage.
The technological capabilities that underpin these complex manufacturing processes are owned by companies of different sizes and operate at different links in different global value chains. Many of these companies often work across different sectors, supplying different value chains with similar technical solutions and components. This cross-cutting nature of manufacturing capabilities also means that mature manufacturing companies can start a new life in new sectors by applying some of their existing capabilities to different sectors and products. Given this, sectoral policies focusing on particular sectors should be complemented by cross-sectoral measures and better aligned to technology policies. These cross-sectoral measures include investments in technologies whose applicability span across industries, such as advanced materials and robotics.
Appreciating the systemic nature of the economy also means that companies cannot be seen in isolation. For example, when some big companies with deep roots in the UK (here we are not merely talking about the legal ownership status, as in the case of Astra Zeneca) are taken over by foreign companies, it can lead to the disruption of the entire supply chain of SMEs and even the impoverishment of the industrial ecosystem around it, including their relationships with universities and local research centres.
The systemic perspective also means that government policies towards small and medium-sized enterprises (SMEs) should not be conceived simply in terms of their size status. An un-differentiated support for SMEs would ignore the critical role that knowledge-intensive small companies and specialist contractors play in value creation and in attracting foreign investments. The regional industrial ecosystem around Cambridge is a good example.
New industrial policy options for the UK
Given the above considerations, what are the industrial policy options for the UK? Not denying the value of the ‘traditional’ sectoral industrial policy measures intended to encourage upgrading at the sectoral level, we would like to highlight the importance of industrial policy measures intended to upgrade the ‘industrial infrastructure’ of the UK economy. The focus on industrial infrastructure means that industrial policy will require more than before the coordination between different specialised agencies, in particular the Business, Innovation and Skills (BIS) Department and the Technology Strategy Board (TSB), but also other central government departments and local government institutions, like the Local Enterprise Partnerships (LEPs).
That the UK requires a serious upgrading of the physical infrastructure is widely accepted. Far less recognised is the need to upgrade the technological infrastructure – that is, the tissue of institutions and organisations that encourage technological progress. This infrastructure is made up of institutions and organisations that facilitate the sharing of knowledge (e.g., public agencies funding pre-commercial research), the spreading of knowledge (e.g., ‘extension services’ for SMEs), and the cross-fertilisation of knowledge across industrial sectors and different actors (e.g., public and semi-public agencies facilitating collaboration in innovation between firms, universities, and government agencies).
And indeed, many competitor countries to the UK are building a better technological infrastructure. In the US, the National Network for Manufacturing Innovation (NNMI) together with the Manufacturing Extension Partnerships (MEP) are getting technologies to SMEs, support the adoption of new organisational models, and help companies in scaling up their production. Fraunhofer Institutes in Germany are even more effective and comprehensive in their roles, not least thanks to an annual budget almost four times bigger than its UK counterpart TSB. Even some emerging economies have built impressive public-private R&D institutions, like the agro-tech institutional network EMBRAPA in Brazil. EMBRAPA’s success has been such that its model has been recently imported into the UK.
To enable the upgrading of technological infrastructure, the UK’s financial infrastructure needs to be redesigned. The UK financial institutions are too much driven by short-termist incentives, hampering investments in technologies that will bear fruits only in the long run.
The establishment of a development bank with a longer time horizon (five years instead of one, to put it crudely) is one solution that has been used to encourage long-term investments in many countries, including Germany (KfW), Japan (JDB), Korea (KDB), and Brazil (BNDES). Indeed, this option has been frequently discussed in the UK, most notably by Lord Robert Skidelsky, for the development bank set up by the current government (the British Business Bank).6 Unfortunately, the BBB is insufficiently focused on manufacturing industries, which need longer-term finance for technological development than any other sector does.7
Another idea is to induce banks to lend more to productive enterprises by tightening the regulations on consumer loans and housing loans. This measure will have an added benefit of dampening the inherent tendency of the UK financial system to create financial bubbles, especially property bubbles. Of course, the difficulty here is that in the recent period the UK banks have lost the ability to assess, discriminate and evaluate the risk (and potential future returns) of industrial projects. This means that there is a need for a significant re-tooling of loan officers in the banking industry. This will take time, but at least it can be kick-started in the two major banks in public ownership – RBS and HBOS.
Furthermore, we can introduce measures to encourage long-term shareholding. Some people accept the need for this but are sceptical of its feasibility in the UK, given the inherently shareholder-oriented nature of its financial system. However, we believe that some of this can be achieved even without fundamental institutional re-designs, like the introduction of a co-determination system like in Germany. For example, longer-term shareholding can be encouraged even within the current UK system by measures like graduated reduction in capital gains tax according to the period of shareholding or conferring of more votes to shares held over a longer period.
Last but not least, the UK needs an upgrading of its infrastructure producing skills. It is widely agreed that the UK suffers from serious gaps and mismatches in skills, which are hindering the country’s firms’ capacities for transforming and translating research outputs (which are exceptionally high by international standards) into industrial activities at the shop floor level.8 The challenge is huge if we consider that UK companies are projected to need 1.86 million people with engineering skills between 2010 -2020. However, a lot of useful lessons can be learned from other countries that have been more successful in this respect – Germany’s integrated vocational training system or the Scandinavian system of re-skilling and continuous education.
New industrial partnerships
The structural weaknesses of the UK’s industrial base call for effective industrial policy by its government. However, this does not mean going back to the 1960s or the 1970s – the last time the UK tried industrial policy. The policy measures need to take into account recent changes, such as the changed structure of the UK manufacturing sector and the rise of global value chains. Moreover, in order to be effective, the UK’s new industrial policy measures have to be better coordinated than they are now. For the UK, the most important step is the re-building of the country’s industrial infrastructure in partnership with the private sector – not only with those manufacturing companies that are currently playing a pivotal role in the industrial sector but also with all the companies that are willing to share the risks and the gains of a systemic industrial restructuring of the UK economy.
1. BIS Growth Dashboard, 2014.
2. O’Sullivan, E., Andreoni, A., Lopez, C. and Gregory, M. (2013) ‘What is New in the New Industrial Policy? A Manufacturing System Perspective’, Oxford Review of Economic Policy, 29(2), 432-462.
3. Chang, H-J., Andreoni, A. and Kuan, M.L. (2013) ‘International Industrial Policy Experiences and the Lessons for the UK’, in The Future of Manufacturing, UK Government Office of Science, London: BIS.
4. Berger, S. (2013) Making in America. From Innovation to Market, Cambridge MA: MIT.
5. Chang, H-J. (2002) Kicking Away the Ladder. Development Strategy in Historical Perspective, London: Anthem Press.
6. British Business Bank (2014) Strategic Plan, London: BIS.
7. The same goes for other government lending and investment. Most notably, as of December 2013, only one-fifth of the 2.6bn allocated investments from the Regional Growth Fund established in 2010 reached productive businesses.
8. According to the International Comparative Performance of the UK Research Base Report commissioned by the BIS Department, the UK has a strong and highly productive research base, both in terms of articles and citation outputs per researcher. While the UK accounts for just 2.4% of global patents applications, the UK’s share of citations from patents to journal articles is 10.9%.
Ha-Joon Chang teaches economics at Cambridge University, and writes a column for the Guardian. He is also a Senior Research Associate at the Center for Economic and Policy Research. His last book, Economics: The User’s Guide, was published by Penguin in August 2014.
Antonio Andreoni is a researcher in industrial economics and policy at the Institute for Manufacturing, Cambridge University and coordinator of the Babbage Industrial Policy Network