The Labour government has recently published a Green Paper called Invest 2035: The UK’s Modern Industrial Strategy which sets out its plan for an industrial strategy. This is the first attempt at formulating an industrial strategy for the country since then Business Secretary Kwasi Kwarteng decided in 2021 that industrial strategy was incompatible with his ‘Britannia unchained’ libertarianism. We now all know how Kwarteng’s and PM Truss’s attempt to turn the fantasy of Institute for Economic Affairs (IEA) sponsored economic libertarianism into reality turned out (see my account of that fateful week). As such, a return to industrial policy making is welcomed. Sadly, if the Green Paper is the blueprint for how the government is trying to do that, then it is clear already now that its strategy will fail. There are at least four reasons for that.
Growth fetishism
The first reason why the government is setting itself up for failure is its growth fetishism. “Growth is the number one mission of this government” reads the first sentence of Chancellor Rachael Reeves’ foreword to the green paper on the ‘Modern Industrial Strategy.’ That short little sentence is worrying in several respects: Firstly, it indicates that the new Labour government’s economic approach remains deeply rooted in 20th century thinking – considering any kind of economic growth to be good and implicitly relying on ‘trickledown economics.’ Secondly, the narrow focus on growth as the one metric that determines the new industrial strategy betrays and reinforces a shocking lack of vision and sense of urgency regarding the need to make the UK economy contribute to climate change and biodiversity loss mitigation. Indeed, it is telling that the government’s ‘Modern Industrial Strategy’ does not contain much reference to the Green New Deal that Keir Starmer promised in his 10 pledges before the election. Instead of a transition to an ecologically sustainable economy, what we are promised now is ‘growth, growth, growth.’
Fetishising growth as a goal in itself leads the government to proposing an industrial strategy that selects the sectors to be targeted with its industrial strategy on the dependent variable (namely growth potential), while completely ignore – despite claims to the contrary – that economic sectors interact with each other. Indeed, the most basic and fundamental flaw in the government’s proposed industrial strategy is the way in which it seeks to identify which sectors should be targeted by government intervention. The green paper explains that eight sectors have been chosen based on a combination of factors that are meant to capture ‘current strengths’ and ‘emerging strengths’ including forecast growth, future importance of the sector, and ‘the UK’s global position now and in the future.’ Based primarily on these sectors’ past performance (output growth, productivity, comparative advantage) they are labelled growth-driving sectors. The plan is to provide a stable policy environment that “businesses need to invest in the high growth sectors that will drive our growth mission” and to “channel support to 8 growth-driving sectors – those in which the UK excels today and will propel us tomorrow.”
The proposed ‘strategy’ is hence to help various sectors grow by looking at them in isolation and without any particular sense of urgency to move the UK economy to an ecologically sustainable model. As such, the proposed strategy is ‘upside down’ in the sense that it puts growth on top of the priority list, rather than seeing it as a byproduct of an urgently needed fundamental transformation of our economic system.
Implicitly, the fetishism of growth is linked to an underlying flawed understanding of how economic growth links to our country’s prosperity. Here, the government’s strategy suggests that any type of growth in any type of economic activity will do, because economic growth will then trickle down to the rest of the population – i.e. a rising tide will lift all boats. This is, of course, the industrial policy paradigm of the 1980s-2010s often referred to as ‘Washington Consensus,’ which has failed so miserably and caused – or aggravated – many of the environmental, political, and economic problems we are now facing. The International Monetary Fund itself now acknowledges that. Yet, the UK government still seems to base its industrial strategy on this thinking. Therefore, while “growth, growth, growth” may have been a good slogan for the General Election campaign, it is a very poor guide for industrial strategy.
Ignoring sector interactions
A second reason why the industrial strategy driven by the sole metric of ‘growth’ will fail is the fact that interlinkages among economic sectors are not being considered. The Green Paper does refer to positive and negative ‘spillover effects’ among economic sectors, but it is not clear where that insight was taken into account when drafting the industrial strategy. Since the industrial strategy starts from growth as the only relevant desired outcome – rather than from a vision of a sustainable economic model the UK should move towards – it ignores how sectors may interact to contribute to the desired outcome. Seeking to simply boost growth in individual sectors will lead to a situation where policy measures taken to boost growth in one sector may very well prevent growth in others.
The most important example where this is like to happen is regarding financial services, which is one of the eight sectors the government will target with its industrial policy to promote growth. It is increasingly becoming clear that the way the government will try and achieve that is through de-regulation. Chancellor Rachel Reeves made that clear – most recently when stating that regulations introduced after the Global Financial Crisis were excessive.
It is relatively easy to generate growth in financial services through deregulation. Contrary to the economists’ trope of ‘scarcity’, there is an excess of financial capital in the world economy looking for a ‘yield uplift.’ If a financial centre like London makes speculative activities easier by reducing regulation and oversight, more capital will flow to our shores, boosting growth in the cities of London and Edinburgh.
But of course, the (very recent and very ancient) history teaches us that this strategy literally invariably leads to financial crisis. Of course, the Labour government will argue that ‘this time is different,’ but 800 years of experience suggest that it never is (see Carmen Reinhart and Kenneth Rogoff’s work on this). The only time where financial liberalisation does not lead to a financial crisis is where prudential regulation follows suit (see my own work on this). Here, the government’s promise to be ‘unreservedly pro-business’ is bad news, because such an attitude tends to lead to light-touch oversight over private market actors.
The right kind of finance
Besides the risks a narrow-minded growth strategy holds in terms of laying the ground for the next financial crisis, growing the financial sector as a goal in itself is almost certainly bad news for some of the other sectors the government wants to see grow. Most importantly perhaps advanced manufacturing.
Political economists have for a long time rejected the argument that boosting the financial sector means more capital is available for productive enterprises to tap into. There is a clear difference between financial capital that flows into speculative activities – which is what the City of London mostly does – and financial capital that supports productive enterprise. The sort of growth of financial services the government seems to have in mind, most likely will bloat the former without increasing the latter.
LSE Professor Susan Strange’s work (e.g. in her books Mad Money and Casino Capitalism) has hinted at the negative effects on the UK economy of an overreliance on financial services for a long time – and indeed predicted the financial crisis. Her warnings were not heeded by politicians, arguably due to politicians’ short-term thinking (i.e. in terms of the next general election, not the next financial crisis) and the lobbying power of finance in the UK.
For manufacturing firms, the type of financial activities that dominate the City of London will not provide the type of investment that is needed to grow a manufacturing business. The City of London has always been more focused on speculation and international trade finance rather than industrial investment. This has been made worse by the ‘Big Bang’ deregulation push in the 1980s and financial innovation of the 1990s, which has meant most of financial activity is now speculative rather than financing any productive activities – which Ian Toporowski calls ‘the end of finance.’
In other words, just like growth is not equal growth (some types of economic growth are not actually socially desirable or beneficial – e.g. a car crash increases GDP), so not any type of finance is “good” finance. What manufacturers and other productive sectors need is “patient capital” i.e. investors who are in it for the long howl, who allow firms to innovate, develop good and desirable products, and pay decent salaries while doing that. Speculative investment – through private equity for instance – makes investment in long-term projects – e.g. innovation and R&D -impossible, because the impatient shareholders want a quick and high return on their investment.
Ten years ago, then Lib Dem Business Secretary Vince Cable understood that when he launched the British Business Bank – a state-owned bank meant to provide loans to UK SMEs to fill the gap in financing UK companies were facing despite having one of the largest financial centres at their doorstep. The new Labour government on the other hand seems oblivious of these subtleties and thinks deregulating the city of London (and that of Edinburgh) will boost availability of finance and hence benefit everyone. Instead, what a new round of deregulation will lead to is further ‘financialisation’ of the UK economy, which means quick financial returns – not decent jobs, clean production, or innovation – will be the top priority of UK firms.
Wither Voluntarism: Being anti-business to be pro-business
A third reason why the government’s industrial strategy will fail is that it naïvely relies on business voluntarism to contribute to achieving the government’s stated goals. Indeed, the government does not tire to state that it is ‘unreservedly pro-business.’ Yet, decades of research on industrial policies around the world shows that very often to be pro-business in the long run, government’s need to be somewhat ‘anti-business’ in the short run.
Indeed, where governments impose ‘beneficial constraints’ on firms, they manage to make companies invest in workers’ skills, productivity enhancing technology, and R&D, and innovation. Without state-imposed constraints, companies may choose the ‘low road’ to competitiveness, i.e. competing on low prices, low quality, using low wage and low skilled workers. Where states impose limits to the extent to which such low road strategies are permissible, companies invest in quality and productivity making them and their workers more productive and more competitive. Businesses may not like it (due to greed and/or short termism of top management teams) – but the overall economic outcome for themselves, there employers, and the country as a whole.
The goal of a sustainable high-skill, high-wage economy can only be achieved with strong state imposing a regulatory framework that rewards firms that invest in quality, safety, and skills and punishes firms that seek to pursue a ‘low-road’ business model based on bad working conditions, low wages, low quality and safety standards. While this may prevent certain firms/investors from investing in the UK, firms that are willing to adopt a ‘high road’ approach will greatly benefit from these constraints that keep low-road competitors out of the market.
Trade – the elephant in the room
A fourth reason why the government’s strategy will fail is that it is still not honest about the impact of Brexit and the exit from the European Single Market (SM) on the UK economy. Indeed, while attracting investment to the UK is the government’s key objective, it seeks to do so through deregulation rather than by considering the impact of losing access to the EU SM on the attractiveness of the UK as a place to produce.
Indeed, there is very little mention of the elephant in the room in the Green Paper – namely the fact that the UK has lost access to the EU’s Single Market. Instead, there is the habitual talk about ‘market-opening trade deals’ and ‘international partnerships’ that is reminiscent of the previous Brexiter Tory governments’ rhetoric. But the single most important barrier to investment in the UK, namely Brexit is not explicitly being considered.
The government asks in its consultation questions ‘Which international markets do you see as the greatest opportunity for the growth-driving sectors […]?’ Basic logic and decades of research (in particular the gravity model of trade) provide a clear answer here: it is the EU.
Reducing the barrier to investment that Brexit imposed would lead to increased attractiveness of any sector of the UK economy. The OBR has estimated the impact of Brexit on business investment in the UK has been estimated as high as 16% below what it would have been without Brexit. Therefore, much more cost-effective way of stimulating investment than deregulation and government subsidies would be to seriously address the trading relationship with the EU and make sure the UK gets as close to Single Market membership as it can. This seems impossible not only due to Starmer’s ‘red lines,’ but also due to the deregulatory approach to the economy. For regulatory reform in the UK to be generating investment, it necessarily needs to align with EU regulation in some form or shape. Here a pro-active alignment with EU rules should be given serious consideration, e.g. in the area of sanitary and phytosanitary rules. This would reduce costs for businesses dramatically and avoid further decline in UK exports to EU countries especially from UK SMEs.
There is also a geopolitical reason why the Brexit trade barriers should be the government’s main target to stimulate trade and growth. Indeed, improving trade links with EU countries, seems particularly important if the government also wants to deliver on its “commitment to upholding the international rules-based system,” because most other major markets – China, India and possibly the USA under Trump – are increasingly undermining the rules-based system. The focus should therefore be on strengthening our trading relationships with those countries that share our values of liberal democracy and rules-based world order. That will then also facilitate foreign policy stances that do not compromise liberal democracy and the rules-based world order due to our dependence on autocracies. To be sure, within the EU too, illiberal authoritarian tendencies are growing increasingly stronger. Still, compared to countries like China and India, liberal democracy is still stronger in Europe.
The positives: Industrial council
All that said, there are also positives in the Green Paper. Thus, there is a proposal to establish an Industrial Strategy Council (ISC), which will be ‘a statutory, independent, and evidence-led industrial’ body ‘reporting to the Business and Trade Secretary and the Chancellor of the Exchequer.’ It ‘will be responsible for informing and monitoring both the development and delivery of the industrial strategy over the long term, ensuring that policy interventions are informed by a broad and high-quality evidence base.’
To some this will sound like a technocratisation of economic policy making – akin to the establishment of central bank independence (CBI) during the 1990s, which is often considered as a key problem of government’s who have lost key policy leavers in the area of monetary policy.
Yet, from my perspective, technocratic policy making in specialised areas is not a problem per se. in the case of central banks, the problem is not so much de facto policymaking by unelected experts – rather than elected politicians – but the fact that their policy-making is based on outdated and deeply flawed monetary theories. That does not have to be the case, as the BoE’s monetary committee could also be composed of a broader range of experts with more up-to-date ideas. Regardless, in the case of industrial strategy, the establishment of the ISC seems like a very good initiative to reduce the erratic industrial strategy making of the past decades.
Indeed, such an Industrial Strategy Council could resemble a semi-autonomous representative body that have proven successful in several East-Asian cases in implementing successful industrial strategies. A large empirical literature on the “Developmental State” shows that the most successful attempts of delivering industrial strategies in the interest of the nation (as opposed to the interest of the politicians and businesspeople involved) were based on what is called ‘embedded autonomy’ of state authorities responsible for industrial policies (e.g. Evans, 1995). Embedded autonomy implies that civil servants have regular exchanges and close ties with businesses to understand their needs. At the same time, they need to be sufficiently autonomous from both politicians and businesses to not be captured by either group’s particular interests and focus on delivering the strategy in the public interest instead. The proposed ISC does seem to contain elements of autonomy from politicians, which is commendable.
At the same time, developmental states work when the state is the senior partner and manages to discipline businesses by making it adhere to policy goals through regulation and/or direct or indirect control over credit flows, not those where the state was ‘pro-business’ and hoping businesses would play ball. Therefore, it will be key that the ISC also remains sufficiently autonomous from – while being embedded in – the business community. Lessons from Japan, South Korea, and Taiwan’s experience with consultative fora, meritocratic public authorities, and successful government strategies to discipline businesses may be useful here.
Putting the financial genie back in the bottle
In short then, the Green Paper is a worrying piece in the sense that it betrays the complete absence of any vision for the future of the UK’s economic model and instead focuses on the same old short-term goals and flawed means that have caused the problems we have to deal with in the first place. Indeed, if Sir Keir Starmer and Rachael Reeves had three wishes it would be ‘growth, growth, growth’. The most worrying bit of the outlined strategy is that it will undo some of the safeguards against excessive financial speculation that have been put in place after the Global Financial Crisis of 2007 and following. This spells disaster in the medium turn, as another financial crisis seem inevitable.
What the government should focus on instead is putting the genie of financialisation back into the bottle and provide other economic sectors with more oxygen to grow. Instead, despite all the talk about ‘making hard choices,’ the government seems to choose the seemingly simple way of trying to ignite the UK economy by lighting a straw fire in the financial sector. That may well work for a while. Deregulating the financial sector will generate an inflow of excess capital from around the world which will spur localised growth in the UK’s financial centres. That will increase employment in these areas, but also increase house prices and rents, without producing any positive spillover effects for other sectors, but rather competing with them for talent while driving up the exchange rate at the expense of exporters who are already suffering because of Brexit.
Putting the financial genie back in the bottle may not be a realistic political goal to hope for. Once the financial sector has been unleashed, a self-reinforcing political cycle sets in because tremendously wealthy financial services firms acquire more political clout that allows them to push back on state attempts to re-regulate. The financial crisis of 2007/8 may have been an opportunity to break that vicious cycle, but it was a missed one. Clearly Labour has no intention of correcting that mistake. We may be too far down the path of financialisation to reign in the power of finance through political action and thus reset the UK’s economic model. Only a major crisis – bigger than the one of 2007 and following – may allow to reestablish an equilibrium between financial speculation and finance as a service to productive activities.
Ultimately, it may very well be that the two biggest risks facing humanity in the 2020s – the impending environmental catastrophe and the increasing geopolitical tensions – may turn out to be a blessing in disguise. Indeed, the above-mentioned developmental state literature considers the state’s capacity to ‘discipline business’ and make it adhere to a public good-driven industrial strategy tends to work best when there are strong external threats facing the country. Richard Doner and colleagues call this a situation of ‘systemic vulnerability’. Such vulnerability creates a sense of urgency, enhances public-spiritedness, and makes it easier to align the interests of all stakeholders needed for successful delivery of an industrial strategy. This was the case in South Korea and Taiwan for instance with the threat of invasion from North Korea and China respectively. In such contexts of perceived vulnerability, the state may have strong popular support to regulate businesses and businesses may have the incentives and normative disposition to rein in their short-term self-interest. The geopolitical threats stemming from increasingly aggressive authoritarian regimes around the world but especially climate change are sources of systemic vulnerability like we have never seen before in human history. As such, they may provide the government with what it needs to be a lot bolder on the fundamental changes the UK economic model requires than what the Green Paper suggests it is currently willing to do. Systemic vulnerability is, however, only a precondition for successful industrial strategy, not a guarantee that the government will pursue the right kind of policies. Here, the Starmer government’s complete lack of vision is the country’s worst enemy.