Earlier today I had the privilege of my first in-person appearance before a Select Committee – Business and Trade interviewing me, George Dibb, Geoff Owen and Paul Swinney on Industrial Policy.
I inevitably found myself confronting a question I was not prepared for: “has the UK lost its competitive edge?”. Thankfully, George’s tweet broadcasting the event gave me some 20 minutes’ headstart before the Chair, Liam Byrne, asked each of us “Has the world become more competitive?”, or something to that effect.
To nearly everyone, it is the most natural question when thinking about why the UK has done so badly this past 15 years. Our living standards are stagnating, other countries are growing faster. This turns quite quickly into a story of how they are doing better than us, and somehow eating our lunch. Drilling deeper, the characterisation suggests a finite quantity of good, high quality economic activities, and because other people work harder or smarter (or some combination) they are taking these activities from us. This often means high value manufacturing jobs, which we end up importing instead of making, leaving us doing less valuable and virtuous things, dependent on untrustworthy foreigners, and poorer. This, to many people, is the essential motivation for industrial strategy. It is why people like David Cameron used to declaim in some doomerish way that “we are in a global race” and
“that means an hour of reckoning for countries like ours. Sink or swim. Do or decline.”
Yikes.
But I have read my Paul Krugman, who in the 1990s wrote an absolutely brilliant piece titled “Competitiveness: A Dangerous Obsession”, confronting very similar rhetoric back then under Clinton; President Bill Clinton, that great globalist, who nevertheless said each nation is “like a big corporation competing in the global marketplace”. The mental image of every nation competing with one another for a finite prize was embedded in people’s heads: in Krugman’s words
People who believe themselves to be sophisticated about the subject take it for granted that the economic problem facing any modern nation is essentially one of competing on world markets — that the United States and Japan are competitors in the same sense that Coca-Cola competes with Pepsi — and are unaware that anyone might seriously question that proposition. Every few months a new best-seller warns the American public of the dire consequences of losing the “race” for the 21st century
But as PK goes on to explain, it was a largely erroneous way of explaining why a country’s living standards are rising or falling. Productivity (the basic ability to do more with less) is what matters, not our ability to beat anyone else. The empirical data said it: “the growth rate of living standards essentially equals the growth rate of domestic productivity — not productivity relative to competitors, but simply domestic productivity“.
My emphasis. Please read his whole piece, it is one of his classics. It is fair to say that Krugman came to acknowledge caveats, that trade can restructure relations within countries, that demand a political response (read this excellent Frontier Economics blog). But his core point stands.
In the committee, I found a slightly more provocative way of putting it, doubtless less well-grounded than Krugman’s brilliant piece. As I set out in an earlier blog, the price behaviour of the stuff that we actually buy has really changed its trajectory over the past 30 years. From 1992 to 2008 we saw spectacular drops in the prices of things we really wanted to buy and spent a lot on: cars, white goods, key IT infrastructure. These price falls slowed or even stopped and went into reverse for the next 15 years. Here is the table:
The earlier price falls had been a major tailwind to our quality of life: people overseas making more and more stuff for less and less, and we getting to buy it. Economics is about consumers as well as producers! And one way of looking at this is that we benefited from the increasing productivity of other countries like China, and the subsequent slowing of that process (or our exposure to it) is a reason for our own prosperity no longer improving as fast. So: no, the world has not been getting more competitive, and that has hurt us.
Smart-Alec contrarian, me. But for an economist, it is quite hard to conceive of how your neighbours doing things better is going to hurt you. Their productive potential increases the total size of the pie- it takes quite a few contortions to produce a scenario in which Country X producing 1000 beans instead of 100 beans is somehow bad for Country Y.
Krugman also takes on the idea that the point of industrial strategy is to “choose the right high value sectors”, the (again commonsense-sounding) idea that “Our standard of living can only rise if (i) capital and labor increasingly flow to industries with high value-added per worker and (ii) we maintain a position in those industries that is superior to that of our competitors.” But this would straightforwardly argue for us to funnel cash into the most capital-intensive areas. And as I and others have explained at length (in 2021), the failure to allocate to the ‘right sectors’ does very little to explain the productivity shortfall since the Great Financial Crisis. Over 25 years before me, Krugman was knocking over the same straw men. He writes that even if exposure to overseas trade had taken 1 million people out of manufacturing, and they were 30% more productive than the rest, their small size as a share of the workforce means this would explain just 0.3% of any fall in the US wage rate.*
So does this mean I am not in favour of industrial strategy? Far from it! I think you need it for many interlocking reasons, including:
- There are major and predictable changes coming to the economy, global and national: a total revamp of our energy system, the electrification of transport, society ageing, the onset of certain key technologies, and these all involve long term government policymaking, financial support in places, essential public goods and so on;
- The government affects the economy in all sorts of ways and an industrial strategy is a way of being conscious and responsive about that. Most of the good ideas for intervention bubble up from beneath, and the government should build systems to identify and respond to them. But it also needs to be much better at noticing when it is clumsily damaging the business environment.
- The government/society has essential interests, most obviously security but also environmental, which can require that it becomes involved in economic matters, like ownership, technological diffusion and the attainment of certain key capabilities.
This leaves plenty for the government to be getting its teeth into. Questioning the concept of “competitiveness” in no way argues against the great importance of productivity, but most of the work there is going to be “horizontal” rather than selecting particular high-value sectors and trying to win at them. This means: creating a better skilled workforce; improving infrastructure; exploiting agglomeration effects; improving the functioning of markets (including dynamism, the entry and exit of companies and job market churn); and above all increasing the extent of the market in which our businesses operate. And this matters in every sector, high- or low-value-add – all of them increase the national pot of wealth.
The point about extending the market is key, the real secret sauce of economic growth over the centuries. Bigger, more complete and functioning markets are a driver of growth that exceed all others, including technological virtuosity. Technological leaps drive the world forward, sure, but 98% of the benefits of innovation go to its users. Small countries cannot invent everything, and it is trade that exposes them to transformative innovations. Most of us didn’t invent the Internet, all of us use it.
Ultimately we would benefit in lots of ways from a more enlightened industrial strategy. But too much anxiety about “competitiveness” can be a risk, if it leads to protectionism and the closing off of markets.
*I unknowingly echoed him, writing “manufacturing workers were 50% more productive than all others, a shift from 20% of the population working in manufacturing to 10% would lower economy-wide productivity by only about 4.5%.” –
Freethinking Economist 