A question of ownership

What this week's green paper on industrial strategy does and doesn't do

Invest 2035: The UK’s Modern Industrial Strategy starts the UK off on a new road. The government’s green paper on industrial strategy published this week is more ambitious, comprehensive, strategic and evidenced than anything we have seen in this country for at least 40 years. Even so, what’s missing seems to me as important as what’s there.

The central goal of the green paper is to support Labour’s growth mission and to this end it establishes a conceptual framework with both vertical and horizontal dimensions. The verticals are a list of industrial sectors that are expected to generate the bulk of growth in the country over the coming years and which are to be targeted for intervention. These have been identified primarily by identifying sub-sectors where economic analysis shows the UK enjoys a revealed comparative advantage over other nations (more on this later) and then aggregating them into a manageable and plausible sounding list. The eight are Advanced Manufacturing, Clean Energy Industries, Creative Industries, Defence, Digital and Technologies, Financial Services, Life Sciences, and Professional and Business Services. Agriculture aside, it’s quite hard to think of things that could not conceivably find a place in this list; even hairdressing is a kind of creative industry.

The underlying idea is that improvements in growth and productivity in the economy, and – hence ultimately better jobs, tax revenues and security – will come from high productivity firms displacing low productivity ones. Hence the goal is to accelerate the growth of good firms rather than improve bad ones. This will be achieved by focussing on the most promising sub-sectors.

The horizontals are a broad range of generic concerns that impinge on any sector: people and skills, innovation, energy and infrastructure, regulatory environment, crowding in investment, international partnerships and trade. Again, it is hard to think of any problem that cannot find a home in this list.

Cutting through

Cutting through this matrix are three more concerns, for place, Net Zero and economic security. The green paper articulates a desire to de-skew the country’s economy away from London and the south-east, but also promises to focus support on “places with the greatest potential for the growth sectors”, amongst which London and the south-east will feature strongly. Net Zero is to be pursued not only via the Clean Energy Industries sector but also by seeking alignment from the other sectors. Economic security will bring geostrategic risks (e.g. Covid, China invading Taiwan) and national security into the equation.

Policy development will be informed by a new Industrial Strategy Council, and sub-committees for each industry. The ISC will be independent and advisory, with its own secretariat. So in terms of government machinery, the approach is a middle way between the ordinary ministerial diktat we’ve had for the past 40 years and the approach embodied by the National Economic Development Council under governments of both stripes during the 60s and 70s (the NEDC was not independent and not purely advisory; it met monthly, was chaired by the Prime Minister and featured representatives of both industry and unions).

The overall approach is comprehensive, inclusive and almost entirely neutral. There is a conceptual framework, a language, an institution and these provide a structure for ongoing development of policy. It is the exact opposite of the Boris Johnson style of government in which policy arises through manoeuvres within the Prime Minister’s court of intimates. This makes the promises of enduring stability in approach believable and I want to sigh with relief. At the same time, it is all achieved without making much in the way of substantive choices. As the LSE economist Neil Lee put it on BlueSky: “Nice to see an industrial strategy - but my concern remains that we are in a cycle of high-level theorising rather than focusing on the actual policy interventions. Still at the powerpoint phase, not the excel phase”

Now to the absences. First, money is hardly mentioned. The outcome of the consultation the green paper initiates will be revealed alongside the conclusion to the three year Spending Review next spring, so we have to expect some kind of budget then. Second there are no targets; it’s all “strengthening” and “improving”. These absences perhaps would not have stood out so starkly if the title of the green paper did not echo the highly effective and vastly more committed Made in China 2025.

Third, there is no mention of tariffs. Historically, tariffs were used by industrialising countries such as South Korea and Japan to protect nascent industries. Britain wants now to re-industrialise, so these precedents are directly relevant. And we are seeing trade barriers of this type going up in both the US and EU – tariffs on Chinese electric vehicles are now 100 per cent in the US. Yet, instead of tariffs, the green paper makes a renewed commitment to free trade, emphasising it as an advantage that makes investment easier.

China

This sketches out a distinct position for the UK. David Lammy, the Foreign Secretary, is to visit China next week, so perhaps the idea is to try and recruit Chinese capital and technology. The green paper makes room for this idea by promising to “seek economic partnership opportunities internationally” and to help the financial sector “to pivot to export to new and growing markets”. If this is the idea, it is both a return to one of George Osborne’s gambits and difficult to pull off as the world increasingly settles into trade blocks.

Osborne hoped Chinese capital would both flow through the City of London and pay for the reindustrialisation of the North. It never happened, in part because of the Huawei débâcle in which the US obliged us to push the Chinese firm out of plans for the 5G mobile phone infrastructure. Since then a hawkish UK has sent an aircraft carrier to patrol the South China Sea and arranged to provide Australia with submarines that have the capacity to sink Chinese ships. So Lammy is going to have to both broker some kind of rapprochement with China and find a way to keep the US on board so that we don’t get yet another mini-Suez down the line. It won’t be easy, but if he can pull it off, it could start to make sense of the UK’s post-Brexit position in the world.

The fourth absence is that it appears the government’s goals are to be pursued with the absolute minimum of legislation. The ISC will be put on a statutory footing but otherwise nothing is planned. One victim of this is the National Wealth Fund that Labour promised in its manifesto. This is simply going to be the new name for the existing UK Infrastructure Bank. The significance of this lies in the difference between a wealth fund and a bank. A wealth fund invests, a bank lends. Thus, just as the Conservatives chose after Brexit not to replace the European Investment Bank (which did investments) with a UK institution that invests, so Labour is choosing again to stick just to lending.

To invest, you need much deeper expertise in the sectors and companies that you are investing in. Thus we are not going to get a financial institution with that kind of expertise and the government will lack the institutional capacity to make smart investment decisions. This does not mean, I think, that investments in individual companies will be entirely absent. Even the last government put money into, for example, Pragmatic Semiconductors, to support the expansion of its foundries in County Durham, thus showing that Conservatives were finally ok again with picking winners. Rather, it implies that winners will, as with Pragmatic, be picked by ministers in a subterranean fashion.

This institutional absence may also make it more difficult for the government to access arguably the UK’s most promising mechanism for intervening: investing via venture capital funds (a line of argument developed by NESTA here and me here). This gets government capital into the market in a much more targeted and direct way than far-from-market support for sub-sectors but, thanks to a diverse portfolio and the expertise of the VC firms, avoids the pitfalls of picking winners.

Politics

The fifth absence concerns Net Zero. It is not that Net Zero is missing from the document. Rather, it is that Labour is showing no signs of engaging with the political reality it faces, and this is storing up trouble for the future. The leitmotif of this failure is the image chosen for the cover of the green paper, a techy shot of the aerodynamics of a wind turbine.

This image seems to encapsulate the promise that has been made repeatedly to Labour’s electoral coalition, that the green transition will be win-win, that the cost of the transition can be transmuted into a successful investment in new technologies, new industries and new jobs. But look deeper and what do we find? The green paper cites a report from the Institute for Public Policy Research that examines the UK’s Net Zero strengths and weaknesses across a wide range of product categories. This analysis is summarised in the grid of pie charts below. The colours indicate the revealed comparative advantage of the UK in 143 product categories, grouped into nine pies. Only green indicates an advantage. Yellow, orange and grey indicate increasingly severe degrees of disadvantage.

The UK has no comparative advantage in any wind farm product category. Thus, by the green paper’s own reasoning, there will be no support for turbine manufacture under the industrial strategy. That atmospheric turbine on the cover of the green paper does not symbolise a future that the government is intent on grasping, it symbolises an alternative future that might have been seized if we had made different choices earlier but which has today already slipped out of our grasp. And this detail reflects the general picture. As I have written previously, there is no clear path to making Net Zero win-win for the UK. Labour is still telling its supporters what they want to hear rather than engaging in the hard work of constructing a reality-based narrative.

It can’t last. Whether it is Kemi Badenoch or Robert Jenrick, it is a nailed on certainty that the next Conservative leader will hammer the government whenever the costs of the Net Zero transition bite because the attitudinal reality is that voters in the UK like the idea of Net Zero but remain reluctant to pay for it from their own pocket. And this kind of gulf between popular sentiment and Labour policy is not something Morgan McSweeney is known for tolerating. So there is a kind of fragility in the industrial strategy on Net Zero that I expect to break in due course.

Innovation

Sixth, the document is remarkably light on innovation. There is for example no mention of the Start-up, Scale-up report that Rachel Reeves commissioned from Jim O’Neill a year ago. Although the basic dynamic the green paper has in mind is high productivity firms displacing low productivity ones, it shows remarkably little interest in how we create and grow such firms. It looks very like Johnny Reynolds is leaving this question to Peter Kyle at the Department for Science, Innovation and Technology, and that Kyle has his hands full transforming public services and is leaving it to Patrick Vallance.

Seventh, there is no explanation of the word “modern” in the title of the document. Is it modern in the sense that it leaves behind failed ideas of industrial strategy from the past 14 years? Or modern in the sense that it rejects, or perhaps embraces, the approach that Peter Mandelson started to sketch out in the last years of New Labour? Or modern in the sense that it rejects the repudiation of government support for near-market research established by Margaret Thatcher?

It feels most of all like a rhetorical echo of the modernising language of New Labour, a way of escaping the old dichotomy between left and right via the Third Way. Most obviously, this is needed to avoid hard scrutiny on the rightness of government interventions in the marketplace, whether through investment or other mechanisms. But you can’t work the same magic twice. Precisely because the country has lived through the New Labour years, the word modern has a different ring to it than it did back then. In this case, we remember that the Blair-Brown years were a period of substantial de-industrialisation in the UK.

The significance of this is more than just linguistic. It exemplifies the fact that the green paper has no explanation of how the UK has ended up in its current weak position (see that IPPR report above) and hence no clarity about what needs to be repudiated. As a result, there is a touch of motherhood and apple pie about many of the arguments put forward. Nowhere is this more marked than in what seems to me the central and eighth absence of the paper, the lack of any interest in the ownership of companies operating in the UK.

The very idea of comparative advantage on which the green paper stakes so much dates from the world of the early 1800s when it was taken for granted that capital could not move easily between countries. Today, the world’s economy is dominated by global companies that move capital, intellectual property, staff and operations around freely. Does this matter? Here are three reasons why it plausibly does.

Silicon Valley

First, let’s compare Silicon Valley with the Golden Triangle. As I have argued in Research Fortnight, the US tech economy’s success rests on three pillars. First, in a globalised economy, one or two companies often come to dominate each market niche; Silicon Valley mobilises large amounts of capital to include its companies in the winners. Second, most job creation happens in mature companies after they have turned the original idea into products, and the US holds on to its successful startups as they scale up. Third, when a new company somewhere else in the world starts to master a niche, the US often either buys it or invests enough to acquire a controlling stake.

The effect of this success is not limited to Silicon Valley. In the US, the venture capital-driven economy not only generates extraordinary, hi-tech, export-oriented growth, it spreads it around. For 30 years, companies backed by venture capital have always created at least 60 per cent of their jobs outside the tech hubs of California, New York and Massachusetts.

The Golden Triangle has none of these features. It mobilises too little capital, too slowly, so that even cutting-edge technology companies are routinely outmuscled by US competitors. In the rare cases where this doesn’t happen, our companies run into a shortage of domestic capital to scale up and are either acquired by US companies or turn to US investors. Either way, they often end up migrating across the Atlantic.

The result is that the Golden Triangle delivers jobs and growth in the early part of the company lifecycle but rarely moves on to spreading this around the country. So when we look at the economic impact of the Golden Triangle in the UK, we see the jobs created by young companies, which are concentrated in the triangle. We don’t see the jobs created by the same companies as they mature, because these are often scattered around the United States.

Thus it is clear that if the UK is serious about spreading the fruits of the many successes of the Golden Triangle around to other parts of the country, as the green paper seems to be, this is going to be extraordinarily difficult to achieve until we start to hold onto more of our scale-ups.

DeepMind

Second, for a global company it is surely easier and, everything else being equal, more attractive to invest in your home country. If you’re going to invest elsewhere, the most obvious reasons are low costs or market access and the UK doesn’t score high on either. Among the good reasons that the green paper cites for investing in the UK is our supply of highly skilled staff coming out of excellent universities. So, for our third example, let’s see how that is working out in the case of DeepMind, a UK company now owned by an American one, Google, and which is generating a situation quite unlike a foreign firm buying a factory that makes widgets in the 1950s.

Look at tables of which countries are publishing good papers on AI and the UK does well. But most of them are coming from DeepMind. What does the UK get out of this arrangement? Does it get tax revenues as Google deploys AI into the marketplace? No. The UK firm, Deepmind Technologies Limited, made a profit of £175 million last year, a drop in the ocean of an AI boom measured in trillions. Does it get a cluster of British AI start-ups? No, with salaries measured in the hundreds of thousands a year, engineers stay put. This is the post-industrial equivalent of a stubbornly agricultural economy. We are selling our limited natural resource, the engineers, and failing to move up the value chain.

Now, perhaps there are countervailing arguments to these three examples that mean we should indeed be intensely relaxed about who owns the companies here. Certainly Google paid to buy DeepMind and some of that money gets recycled. But is it not strange that the government evinces no interest in a matter that is so central to the goals it cherishes?

The Budget is coming and Research Professional is reporting that Vallance’s budget for UK Research and Innovation is going to face a significant squeeze. This situation has in large part been created by the pre-election commitment to pharma to maintain R&D tax breaks. The UK is spending about £10 billion a year on each and there was bound to be a squeeze somewhere.

The Conservatives have always been generous with the science base, using it as a cheap symbolic shield that keeps at bay demands for an industrial strategy. Labour is committed to a bigger game but this approach is intrinsically more expensive and will only pay off if it does manage to make the industrial strategy hum. Dodging the difficult questions won’t get us there.