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Why industrial policy isn’t working

Long-read

Why industrial policy isn’t working

Excessive corporate welfare is sucking the dynamism out of the UK economy.

Phil Mullan

Topics Long-reads Politics UK

There can be good reasons for governments to pursue a so-called industrial policy – that is, a policy that sustains or develops certain industries in order to achieve national goals. In less developed countries, an industrial policy can help develop foundational industries, such as energy or food production. In developed countries, a government might pursue an industrial policy during wartime, providing financial assistance to armaments producers.

But in Britain today, there are several compelling reasons for not pursuing an industrial policy. As things stand, government efforts to shape and direct industry are slowing growth, encouraging corporations to depend on state handouts and distracting from the core role of the state in providing decent public services and infrastructure.

Yet despite the many drawbacks of industrial policy, there is no shortage of support for it among the political and media classes. Indeed, all of the UK’s major political parties seem committed to industrial policy. The Labour Party, odds-on to win the next General Election, has even made a debt-funded green-industrial plan central to its programme for government (despite back-peddling on the volume of funds it will provide). In its ‘green prosperity plan’, Labour is trying to emulate US president Joe Biden’s industrial-policy centrepiece, the $369 billion Inflation Reduction Act (IRA) of 2022. The IRA is designed not only to curb inflation, but also to create jobs, fight climate change and strengthen national security.

Labour’s industrial policy is similarly all-purpose. Shadow chancellor Rachel Reeves has said Labour’s green industrial policy is not just about reducing carbon emissions. She also hopes it will promote ‘securonomics’ – that is, help to develop resilient homegrown industries, thus securing the UK economy against external shocks.

While Labour talks the talk, the Conservative government has actually been busy walking the walk on industrial policy. The Rishi Sunak administration doesn’t use the term ‘industrial policy’ for internal political reasons, but it’s certainly pursuing one in practice. Last year, there were several multimillion-pound industrial-policy announcements. This included £500million in subsidies to upgrade Tata Steel’s furnaces in Port Talbot; another £500million to Tata, the owner of Jaguar Land Rover, to help persuade it to build an electric-battery plant in Somerset; a rumoured subsidy of £300million to Chinese-owned British Steel to incentivise its adoption of green steel-making technology in Scunthorpe and Teesside; and a (so far) unspecified grant to Nissan to encourage its Sunderland plant to build electric versions of two car models. Despite the Tories’ rhetoric about the free market, these government subsidies amount to substantial state handouts to favoured industries.

This shows that, in practice, industrial policy is the established reality in 21st-century Britain and is embraced across the political spectrum. Indeed, it has been the habitual practice of most Western governments since the financial crisis in 2007-8, which exposed the fragility of Western economies and the poor state of their productive activities. The interventionist response to the Covid pandemic and later the energy crisis have only further normalised state activism.

Prime minister Rishi Sunak and chancellor of the exchequer Jeremy Hunt attach a Nissan badge to a car as they visit the car manufacturer Nissan on 24 November 2023 in Sunderland, England.
Prime minister Rishi Sunak and chancellor of the exchequer Jeremy Hunt attach a Nissan badge to a car as they visit the car manufacturer Nissan on 24 November 2023 in Sunderland, England.

The rationale for state activism in the economy has changed over the past 75 years or so. According to the postwar Keynesian consensus, state activism was a means of stimulating economic activity to make up for insufficient demand during a recession. Indeed, this notion of the need for ‘stimulus’ survived longer than Keynesianism itself. It formed the official justification for the ultra-loose monetary policy and quantitative easing of the 2010s and 2020s.

Today, however, state activism is expected to tackle a whole range of problems, including climate change, an ageing population and rising geopolitical tensions. For Sunak and opposition leader Keir Starmer, the prime economic goal now seems to be economic stability, not stimulating growth, as it was during the postwar era.

This tells us that the dominant impulse driving industrial policy today is profoundly conservative. The aim is to sustain things the way they are. This is not just a sign of the limited imagination of the political class – it is also an indication of Western elites’ loss of purpose. Unable to provide a positive vision of the future, they are attempting instead to conserve the status quo. They would rather prolong the present malaise, than initiate any change that might create uncertainty.

This deep-seated conservatism, this fear of change, helps to explain the continued political and media attacks on last year’s brief Liz Truss administration. What really angered Britain’s political and media elites wasn’t Truss’s tax cuts in and of themselves, but the threat her short-lived government posed to economic stability. For all the faults with her programme (and there were many), she at least recognised the necessity of disruption for economic growth. It was her willingness to tolerate disruption that turned her into such a bogey figure for the British establishment.

The new mode of industrial policy expresses the now-dominant conservative instincts of Western political elites. Hence, the objectives of today’s industrial policy go beyond productivity growth, innovation and jobs. The aim now is to protect the status quo from anything considered disruptive, including more nebulous threats like climate change to geopolitical conflict.

The state can certainly play a role in the economy. It should be helping to bring about a more prosperous society – especially during a protracted period of sluggish growth, such as is being experienced in Britain today. Living standards have been pretty much stagnant since just before the banking crisis over 15 years ago, while real national output per person remains below 2019 levels. In these conditions, the state needs to remove the constraints holding back business investment and productivity growth.

But industrial policy won’t help us here. Industrial policy is not just inappropriate for dealing with today’s economic malaise. It is actually counterproductive. It tends to preserve what needs to be replaced, impeding investment, holding back innovation and hindering the forces of creative destruction. It is, in short, fuelling a make-do culture.

Business leaders often blame an assortment of familiar obstacles for the lack of investment in innovation that we’ve seen in recent decades. They talk of overregulation, a shortage of skilled workers, failing transport and energy infrastructures and so on. These complaints are valid, but they can also camouflage the biggest barrier to investment – the make-do culture that has taken root over the past 40 years.

From the 1970s onwards, corporate leaders have seized every opportunity to avoid confronting the falling profitability of their businesses. Many firms have been able to keep going not from their own internally generated resources, but through outside relief, especially easier credit facilities. Indeed, it is thanks to the rise of easy money that corporate insolvency has actually fallen, even as corporate debt has risen to near unsustainable levels.

Without the imminent threat of going belly up – since another corporate loan is always available – business leaders can keep putting off disruptive and risky investment programmes. As a result, capitalism’s traditional renewal mechanism of creative destruction has atrophied.

From the end of the Cold War to the financial crash of 2008, the sight of businesses muddling through was misinterpreted as an indication of economic strength. What was being ignored was that this era of relative economic stability came at a huge cost: the continuing decay of productive capacity.

Of course, there was still some degree of innovation going on. Even ailing Britain still hosts several world-leading producers and innovators, including Nissan, Rolls-Royce, GlaxoSmithKline, AstraZeneca, Sage, Arm and DeepMind. But such frontier companies are being held back by the fact that too much capital is tied up in older, more laggard firms. When capital can’t reach the most dynamic companies, the whole economy stagnates.

This is posing a serious problem. Capital restructuring – the need for investment to replace older technologies with newer technologies – is essential for productivity growth. But committing to such investment has become ever more daunting for business leaders. To potentially generate innovation now requires bigger outlays, bigger write-offs, bigger disruption and bigger risks. As these obstacles to investment have expanded, making-do has emerged as the business norm.

Government policies have fuelled this make-do culture. Fiscal policy, public-procurement policies, monetary policy and business regulations have increasingly acted to prop up the existing economic and business structures. The state’s attempts to patch things up, from crisis to crisis, has only perpetuated economic stagnation and dysfunction. It has entrenched the structural barriers to new investment and amplified deep-seated economic imbalances and instabilities.

That’s why it’s ironic to hear politicians today justify state activism as a means to ensure economic stability. Because as recent history shows, this pursuit of economic stability hasn’t prevented some rather destabilising flare-ups, from financial bubbles to chronic corporate indebtedness.

The industrial landscape across the Dee Estuary at sunrise as steam rises from Deeside power station, Shotton Steelworks and other heavy industrial plants on 13 April 2016 in Flint, Wales.
The industrial landscape across the Dee Estuary at sunrise as steam rises from Deeside power station, Shotton Steelworks and other heavy industrial plants on 13 April 2016 in Flint, Wales.

The truth is that it’s disruption, not stability, that has historically been the midwife of social and economic progress. Since the dawn of the Industrial Revolution 250 years ago, the creative destruction of capitalism has produced greater wealth and improved living conditions. The past two decades of stability, in contrast, have resulted in flatlining productivity and the stagnation of real incomes.

Today’s industrial policy essentially works to preserve what isn’t working. Now, admittedly, there are well-publicised instances of state subsidies to businesses creating additional wealth and extra jobs. But these are more than offset by the bigger and less apparent damage to wealth and job creation that comes from propping up the antiquated economic order. As The Economist put it recently, the ‘concentrated benefits [of industrial policy] that are evident… need to be set against greater, though diffuse and undetermined costs’. Today, each cherry-picked example – like the successful state-funded development of a Covid vaccine or of Tesla’s electric-vehicle technology in the US – is eclipsed by the economy-wide drawbacks of industrial policy.

Above all, industrial policy supports ‘what is’ at the expense of ‘what could be’. Indeed, for all politicians’ talk about a ‘new deal’ – green or otherwise – industrial policies mostly support older incumbent businesses. Unsurprisingly, these recipients of state largesse are usually very keen on industrial policy. A few of these firms may well be dynamic and successful innovators. But they are the minority.

Industrial-policy initiatives tend to draw resources away from the best to the mediocre. Some producers, such as Tata Steel and British Steel, are only able to continue operating because of government subsidies. These subsidies only offer a temporary fix, and they come at a bigger cost to the rest of the economy.

Even the OECD, which is usually keen to champion industrial policy, pointed in 2020 to the potential pitfalls of today’s approach. ‘State aid might end up favouring some firms over others, supporting inefficient or failing firms and lead to the survival of zombie firms, thereby slowing down productivity-enhancing reallocation’, it said. This can apply both to the direct beneficiaries of state support and also to their second and third-level suppliers that public money can flow down to.

One study into the British manufacturing industry of the late 20th century noted that state subsidies had ‘various unintended dysfunctional consequences’. They advantaged the recipients at the expense of competitors, and tended to go to larger, established firms and industries, including ‘old uneconomic enterprises’. New small enterprises, it noted, typically got nothing. Yet it was precisely these smaller firms that ‘were usually in the forefront of radical technical-product developments from which long-run economic growth would actually come’.

The same pattern is evident with the initial beneficiaries of the IRA, with state subsidies again going to established businesses rather than start-ups. Indeed, analysis from the Wall Street Journal in 2023 found that the IRA’s complex tax-credit scheme is often tied to production volume, which means it rewards the largest corporations the most.

Contemporary industrial policies are also protectionist, prioritising domestic firms even when they are far less efficient than foreign firms. As a recent IMF analysis explains, reshoring and increasing domestic sourcing can actually be detrimental to national economic resilience. Favouring domestic industry over overseas production protects sub-par home firms from external competition. It removes any incentive for firms to become more productive.

Today’s industrial policy thus reinforces the structural barriers to much-needed business investment in better technologies and processes. Bankrolling the existing make-do businesses further clogs up an economy with low-productivity operations. Through industrial policy, governments are effectively reinforcing the huge disincentives to invest that are embedded in stagnant economies.

Furthermore, industrial policies are corroding what’s left of the entrepreneurial spirit. You can see this in declining business dynamism, as well as in falling investment and innovation. Since the 1980s, sustained government support for particular businesses has bred a culture of corporate welfare dependency. Industrial policies are encouraging business leaders to rely on the state for favours rather than on their own commercial acumen.

This public-private relationship lies at the heart of the huge expansion of corporate political lobbying of recent decades. This isn’t just a recipe for cronyism, with the state favouring particular businesses over others for potentially dubious reasons. State support also relieves the pressure on firms to raise their productivity and to concentrate on the sort of innovating activities that might generate higher returns.

Indeed, many business leaders have now become more focussed on their relations with the state than on developing and innovating their products or services. Executives are drawn to the easier prize of public largesse than to the trials and tribulations of making money from risky innovation. This is especially so when the corporate begging bowl is being filled by a willing government.

It is worth remembering that the steam-powered Industrial Revolution, and the electrification revolution after it, did not happen through state industrial policies. They flourished as expressions of the Enlightenment spirit of reasoned experimentation and courageous risk-taking. They were products of a can-do culture that is very different to today’s make-do one.

To oppose modern industrial policy does not mean supporting a hands-off, laissez-faire mode of governance. Far from it. The modern state definitely has a significant economic role to play. But there needs to be a far sharper separation between the economic activities of the public and private sectors.

Above all, the government needs to stop interfering in businesses and should instead encourage them to pursue their commercial objectives. At the same time, the government should take back responsibility for the public services that it has outsourced since the 1980s.

The state needs to be able to perform its traditional role of providing the public goods that are vital to a modern, civilised society. These are areas of need that the private sector is ill-suited to provide, either because of the limited potential for profit, or because returns might be received only over an extremely drawn-out period.

So alongside law and order, defence capabilities and border controls, these core state responsibilities include: a modern transport infrastructure; a cheap and reliable energy sector; functional water services; sufficient living accommodation for all; well-funded scientific research; quality academic and vocational education; universal healthcare; a welfare safety net; and light-touch regulations for start-ups and young, scaling-up businesses. That’s more than enough for any ambitious government to get on with.

Any future government that genuinely wants to generate a high-productivity economy and a prosperous society should abandon the industrial-policy consensus of recent decades. It should accept that the system of taxpayer support for corporations has been sustaining an increasingly worn-out and dysfunctional production base. And it should rally society against the business sector’s constant demands for bailouts.

Campaigning for an end to corporate welfare would give substance to the ‘time for change’ rhetoric we’re likely to hear a lot of in this General Election year. There is so much the state should be doing to improve life for all in Britain. But when it comes to industrial policy, it needs to start doing a lot less.

Phil Mullan’s Beyond Confrontation: Globalists, Nationalists and Their Discontents is published by Emerald Publishing. Order it from Emerald or Amazon (UK).

Picture by: Getty.

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Topics Long-reads Politics UK

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