Industrial Strategy

Lord Eatwell Excerpts

Monday 8th January 2018 Lords Chamber

[Lord Eatwell (Non-Afl)]

My Lords, it is a great pleasure to follow the noble Lord, Lord Prior, particularly as I had set out to be critical of the White Paper. Having listened to him, I realise I must temper some of my criticisms.

Although the policy set out in the White Paper is a step in the right direction, the measures proposed are a pale imitation of the sort of programme of institutional reform that could produce a real industrial renaissance. One of the fundamental problems is the failure to recognise the sheer scale of the economic difficulties facing Britain. The White Paper begins with the statement:

“The UK is a fundamentally strong economy”.


That extraordinary statement confirms a myopia. It refers to an economy in which investment as a proportion of GDP is lower than in both the US and the European Union and is below the average of OECD countries. Corporate investment in fixed assets fell from 11% of GDP in 1997 to just 8% in 2014, which is below the rate of capital depreciation. In other words, the corporate capital stock is being eroded. As has been pointed out by many earlier speakers, research and development spending in the UK as a proportion of GDP is about half the level of that in the US or Germany. Productivity—a concept that has been referred to many times—is lower than in the US and all the major European economies; since the financial crisis a decade ago, productivity has barely grown at all.

Of even greater relevance is the long-run deterioration of the core competitiveness of the UK economy. Our share of world trade has halved in the past 40 years, while Germany’s has been stable. The result has been a continuous deterioration in the balance of payments, now a persistent deficit of 5% of GDP a year. In other words, about one-twentieth of our standard of living—our food, clothing, travel and shelter—is paid for by borrowing from foreigners. At the moment, Britain cannot pay its way and the idea that the country is on the verge of conquering new global markets is an ignorant fantasy. These long-term, baked-in trends have all worsened since the financial crisis and, in particular, since the 2010 imposition of austerity policies by the coalition of Conservatives and Liberal Democrats.

Indeed, a serious lacuna in the White Paper is the lack of a policy on demand to match its supply-side policies. The Government seem to have learned nothing from the enormous damage done to the British economy by austerity. If demand is not growing, it does not matter how big the tax incentives, how creative the government initiatives: no one is going to invest. If there is no demand for your product, why would you? Similarly, it does not matter how cheap money might be: there is no incentive to invest without the prospect of a growing market and a positive return. No wonder that these days, British businesses are accumulating and distributing cash, not spending on investment.

In essence, as the White Paper rightly suggests, there are three main tasks, and any policy proposals need to be judged against the template of how far they promise success in these tasks. First, Britain needs a competitive industrial base; this can be defined precisely as an industrial structure that delivers a positive balance of payments at high levels of income and employment. It is easy to have a positive balance of payments by impoverishing your own society sufficiently, but a positive balance of payments with high levels of income should be our goal. Secondly, it is absolutely right that to achieve this, Britain needs a significant increase in efficient investment in new technologies, capacity and people. Thirdly, Britain needs an economic policy framework that can be sustained over many years to turn around those 40 years of decline. This means that the programme must have strong political roots, involving, as it must, significant and sometimes disruptive change. There must be a broad social consensus behind the need for a programme of national economic renewal.

Instead of relying on the latest fashion in economic theory, we can turn to economic history for some insight into how this is done. In the mid-19th century, Germany, France and the United States faced the overwhelming industrial challenge of a dominant Britain. All three countries recognised explicitly their backwardness, and to compete, all three undertook fundamental institutional reforms focused on exactly the same goals I have referred to for Britain. Similarly, Japan and South Korea faced competitiveness problems after the war; once again, the reaction to backwardness was a major reform of institutions targeted on the three goals.

What are the institutional lessons for Britain? First, we must own up to the fact that the economy as a whole is in seriously poor shape. This recognition is undoubtedly hampered by the important point, emphasised in the White Paper, that Britain does have some world-beating companies, but we do not have enough of them and focusing on these exceptions obscures the underlying problems. Secondly, we must recognise that little or no good will be done by new tax incentives and various investment initiatives if the country’s fundamental institutional structure is not up to the job of overcoming our competitive backwardness.

What institutional reforms would at least start to tackle the job? First, research by the Bank of England has shown that the UK’s capital markets are more short-termist than they used to be and more so than those of other countries. There has been an observable increase in the priority that investors give to short-term returns over long-term returns. The result is that over the past quarter of a century, the proportion of profit that UK companies have been distributing to shareholders, rather than reinvesting in their businesses, has been increasing. The interaction between British finance and British corporate governance is resulting in exactly the wrong sort of incentives.

In many ways, of course, the UK finance sector is a great success story. In terms of its size, exports, employment and profits, it is one of the most successful in the world. However, that international success has been bought at a price. The financial sector injects international instability and risk into the domestic economy, as was so evident in 2008. No wonder there is an emphasis on short-term liquidity, a ubiquitous desire for exit and an unwillingness to commit to the long term when that long term is regularly punctured by financial disorder. There were attempts to address these failings in the ring-fencing provisions of the Financial Services (Banking Reform) Act 2013—a pale imitation of the 1930s Glass-Steagall Act in the US. That was relevant to America, but the reforms in the UK failed to take into account the reality of the British economy. Once the real structure of British finance is taken into account, it becomes clear that the ring-fence is in the wrong place. It should be between domestic finance and international finance. The stability of comprehensive financial services for UK firms should be rigorously enforced, while our booming, if unstable, international financial sector should be encouraged to do what it does best: selling outstanding services to the rest of the world.

Secondly, a stable domestic financial system would provide the motivation for and the possibility of a reform of corporate law, including the regulation of mergers, to incentivise the long-term investment culture that Britain so desperately needs. The current corporate structure, with its emphasis on the primacy of the shareholder—an individual whose commitment to any one company is totally transient—has to go.

Thirdly, we need new ways of tackling the long tails of very poor companies that exist in just about every industrial sector. The White Paper refers to the creation of sector deals, but again these are a rather weak version of what should be done. What is needed is an industrial reorganisation corporation with real powers to tackle the long, unproductive tails of inefficient companies that blight our economy.

Fourthly, in addition to financial reform, corporate law reform and industrial reorganisation, the rescue of the British economy from its uncompetitive quagmire will require an entirely new approach to research and development. As the White Paper acknowledges, in Britain we are fortunate to have some of the finest research universities in the world, but the Government seem intent on ruining the sector with their ideological pursuit of the marketisation of higher education. In both Germany and the United States, publicly funded R&D underpins their superior innovative performance. As my former pupil, Mariana Mazzucato, has pointed out, every significant innovation that went into the iPhone was developed in the public sector. In Germany, where 58% of companies invest in academic research, publicly funded R&D—much of its content stimulated by the private sector—underpins the country’s remarkable competitiveness in manufacturing. Long-term public support is a crucial component of long-term R&D success.

Fifthly, we need a complete rethink of the ridiculous “Britain is up for sale” strategy that the Government falsely identify with being an open economy. How many times in recent years have we seen successful companies, many of them built on the foundations of public investment in education, research and skills, sold off to foreign interests as soon as they reach a decent scale? No other country pursues such a foolish and short-sighted policy—when will it stop? When will we have a policy on mergers and acquisitions based on the national interest?

Sixthly, these changes will not work unless the prospect of stable and growing demand provides a sustained incentive to invest: growing demand at home and growing demand from abroad. At home, government commitments to their own increased infrastructure spending must lead the way. Internationally, the fall in the pound provides an opportunity to recover lost markets, just as long as the competitive boost is not squandered on increased consumption. Monetary policy must ensure that the gains from the low value of sterling are sustained over the medium to long term.

Finally, as argued by the noble Lord, Lord Prior, any campaign of national economic renewal must be a truly national campaign that benefits all the people in all the regions of this country. Again, the White Paper puts a brave face on the issue of regional inequality, but it fails to address adequately the more important issue of personal inequality of income and opportunity. As noted already, successful national renewal, particularly in an era of remarkable technological innovation, will involve disruptive change. People whose lives are disrupted in this way should not be paying the price for the nation’s renewal, and they should not be living on handouts either. As part of the reconstruction programme, there must be a comprehensive and supportive programme of training and retraining for decent, well-paid jobs.

In summary, the state of the UK economy requires that all government policies should be directed towards the long-term recovery of British competitiveness. There should not be a revival of the tired old argument about the role of the market and of the state. Of course the state can be inefficient, but as we in this country know only too well, markets and the private sector can be massively inefficient too. A programme of national renewal is not about creating a socialist utopia or a libertarian capitalist utopia, but reconstructing our market economy to achieve national goals. This White Paper could be a small and significant step in the right direction, but it could also do significant damage if we end up thinking that it represents all that needs to be done.

Queen’s Speech

Lord Eatwell Excerpts

Monday 26th June 2017 Lords Chamber

[Lord Eatwell (Non-Afl)]

My Lords, there has been a lot of debate about the likely impact that leaving the European Union will have on the UK economy. To date, there have been two indisputable negative impacts. First, the fall in the pound as a consequence of the referendum vote has the direct effect of reducing real incomes. The second negative impact, indisputably, is the content of the gracious Speech. For the next two years at least, government energy and parliamentary time will be totally absorbed by the legislation needed to leave the EU. No time at all will be devoted to tackling the long-term trends in the UK economy, trends that herald very difficult times ahead for Britain, whatever may be the eventual deal reached in Brussels.

Consider the following. Investment in the UK as a proportion of GDP is lower than in both the United States and the EU. Corporate investment in fixed assets has fallen well below the rate of capital depreciation—in other words, the corporate capital stock is eroding. Research and development spending in the UK as a proportion of GDP is just a little over half the level that it is in the US or Germany. As a consequence of these, productivity in the UK, output per worker hour, is lower than in the US and all the major European economies, excepting Italy where it is about the same, and for the past decade productivity has not grown at all. It is hardly surprising that these trends have resulted in a seriously uncompetitive UK economy with a falling share of world trade and a persistent deterioration in the balance of payments. Britain is uncompetitive. The idea that we are in a fit state to conquer new global markets is an ignorant fantasy.

The competitiveness failure cannot be solved by the cheap-money policies of the Bank of England. It does not matter how cheap money might be; there is no incentive to invest unless there is prospect of a growing market and a positive return. No wonder companies today are accumulating and distributing cash, not spending on investment.

So what is there in this Brexit-dominated gracious Speech that might do something to reverse these miserable trends? Precious little. We are told that the Government will,

“work to attract investment in infrastructure to support economic growth”.

Note the careful wording—not a Government spending but a Government whistling in the wind in the hope of “attracting” investment. We are also told that the Government,

“will spread prosperity and opportunity across the country through a new, modern industrial strategy”.

But can we have any confidence in this strategy when over the next four years the Department for Transport’s infrastructure plans will see nearly £2,000 per person spent in London but just £280 per person in the north of England? There is not much spreading of prosperity there.

To become competitive again, Britain must become an investing economy. In policy terms we need nothing terribly original, just to learn from what has worked elsewhere. It is clear that low investment is related to the interaction of the UK’s financial markets and corporate behaviour. The Bank of England has shown that the UK’s capital markets are more short-termist than they used to be, and are more so than those of other countries. Investors give priority to short-term returns over long-term ones. In many ways the UK financial sector is a great success story; in terms of size, exports, employment and profits it is among the most successful in the world. But that international success has been bought at a price. The financial sector injects international instability and risk into the domestic economy. No wonder there is an emphasis on short-term liquidity, an unwillingness to commit to markets that are regularly punctuated by financial disorder.

Attempts to address these failings were made in the Financial Services (Banking Reform) Act 2013, which sought to erect a ring fence between, on the one hand, commercial banking for households and small and medium-sized firms and, on the other, banking for large companies, investment banking and more risky market activities. However, once the real structure of UK finance is taken into account, it is clear that the ring fence is in the wrong place; it should be between domestic finance and international finance. The stability of comprehensive financial services for UK firms should be rigorously enforced while our booming, if unstable, international financial centre should be encouraged to do what it does best: sell outstanding services to the rest of the world. A stable domestic financial system would provide the motivation for, and the possibility of, a reform of corporate governance, including the regulation of mergers and a revamped, publicly funded R&D strategy, and would incentivise the longer-term investment culture that Britain so desperately needs. Those changes, and the many others that are necessary to create a long-term competitiveness culture, will not work unless the prospect of stable and growing demand, at home and from abroad, provides a sustained incentive to invest. Internationally, the fall in the pound provides an opportunity to recover lost markets, just so long as the competitive boost is not squandered on increased consumption.

In sum, the state of the UK economy requires that all government policy should be directed towards the long-term recovery of British competitiveness. Instead, as is clear from the gracious Speech, all government policy is directed towards a complex divorce from the EU, a huge misdirection of time and effort that in itself will do lasting damage to the UK economy.