Last year, a couple of economists from the International Monetary Fund published a book called The Return of the Policy That Shall Not Be Named. What was this daring breach of economic taste?
Industrial policy. For economists of a certain age, the very words are an uncomfortable reminder of wasted taxpayers’ millions. Some studies have indeed reviewed policies in countries like South Korea, Taiwan, and above all China, and suggested that some kinds of government intervention could boost growth, and these have caught the eye of later cohorts of think-tankers and politicians. But other analysis has continued to find that government subsidies to industry—state aid—do more harm than good.
Successive British governments have tried (and usually failed) to bribe and coerce companies to do better. In the 1950s and 60s, politicians attempted to use a combination of planning controls and public funds to drive particular industries to parts of the country that needed jobs—and might offer votes. The system of Industrial Development Certificates, devised soon after the Second World War, forced companies to get government permission before building or expanding a plant. The scheme aimed to divert jobs from the industrial southeast and the midlands to “development areas.”
This regime sent Rootes, manufacturer of the Hillman Imp, to build a factory at Linwood in Scotland, where the militant workforce had no experience of building cars and the main suppliers were many miles away. In spite of repeated government bailouts, the plant shut after less than 20 years.
Sceptics recall other disasters. British Aluminium was persuaded by the promise of cheap nuclear power to locate a smelter at Invergordon: the power plant never materialised and the smelter shut after only 10 years in operation. Indeed, Scotland was home to a disproportionate number of failures of state aid. In 1971, Upper Clyde Shipbuilders, sustained initially by a generous dollop of government money, collapsed when the government refused further subsidies. And British Leyland, the country’s biggest car company, had to be rescued by the government in 1975, at the cost of more than £3bn. With the arrival of the Thatcher years, industrial policy of this crude sort was dead.
But now industrial policy is creeping back into academic fashion and state aid, often a key component, has become a Brexit battleground. Where the Conservative right used to stand firm against rescuing “lame ducks,” these days latter-day Thatcherites demand freedom from Brussels to bail out firms as they please.
So does state aid actually give economies a competitive advantage? And do European rules actually blunt it? You might assume so, given the furious noise at the moment. Certainly, and unusually around the world, the EU has firm rules on state aid: selective industrial subsidies are generally banned if they damage competition and trade between member states. The EU rules are aimed at preventing the sort of thing that happens in the US, where rival states fling subsidies at big companies like Amazon to persuade them to create local jobs.
Yet most EU countries make more use of state aid than the UK has recently done, which rather undercuts claims about Brussels tying our hands. In economic reality, state aid is unlikely to do much good without some clear thinking about where the money goes—and why.
States giving aid to industry are sometimes trying to buy jobs—and often placing a bet that the private sector thinks is unprofitable or too risky. There are particular dangers in trying to foster high-tech businesses, as this government clearly wants to do. A good example: in July, the UK government put £400m into OneWeb, a bankrupt satellite operator, in spite of being warned by a senior civil servant that taxpayers might lose the lot with “no wider benefits accrued.”
Governments will sometimes have broader objectives that justify this sort of investment, but they are also subject to pressures or ambitions that can entice them to do silly things. Certainly, they find it just as difficult as any investor to know whether they are backing a winner or simply bailing out a loser. After all, the people taking the decisions—politicians and officials alike—aren’t used tobacking a winner with their own cash. Very few people with experience of making large investments from positions of senior management in the corporate sector end up in top ministerial jobs. One who did—David Sainsbury, minister of science under Tony Blair—recounts in his recent book Windows of Opportunity that the civil servants in his department, whose remit included industry, “had very little systematic knowledge about the performance of British industry, and apparently did not see any need to have it.”
Sometimes, state support for one purpose can end up paying huge (metaphorical) dividends elsewhere: think of DARPA—the Defense Advanced Research Projects Agency—whose R&D, financed by the US Defense Department, has bred a string of innovations with profitable civilian applications such as computer networking and the basis for the modern internet. But putting money into defence projects does not guarantee such spillovers into the wider economy, nor indeed successful spin-offs or marketable products for the companies concerned. Rather like when governments subsidise fundamental scientific research, there may eventually be benefits to companies that create products from the findings—but the uncertainty about the outcome explains why the private sector won’t invest in much basic scientific research in the first place.
State aid tends to go disproportionately to manufacturing, which is these days capital- rather than labour-intensive—even in Germany, manufacturing employs only one worker in four, and the proportion steadily dwindles as productivity grows. So it rarely generates many jobs directly. Amid a second wave of the pandemic, some of the appeal of Rishi Sunak’s “Eat Out to Help Out” subsidy may be lost, but it remains an impressive rarity in one sense: state aid targeted at an industry with a large number of low-paid jobs, rather than a few high-paid ones.
Long before coronavirus made state aid more urgent, decisions about rescuing companies were increasingly complicated by patterns of international ownership, which raised questions both about exactly who was being bailed out and whether or not they needed that help. Thus the government dithered over rescuing Flybe, which serves so many small regional airports. It is owned, as former British Airways chief executive Willie Walsh pointed out, partly by Virgin Atlantic, which in turn is part owned by Delta, one of the world’s largest and most profitable airlines. (BA itself, meanwhile, is owned by a company registered in Spain.) In an open economy like the UK, where many big companies are foreign-owned, it will often be hard to see whether taxpayers’ cash ends up in British jobs or foreign pockets.
Right now, lots of companies are being bailed out in a scramble to salvage jobs and businesses amid the pandemic. That may make sense in the short run. And there are areas—such as environmental policy—where state help, alongside state rules, may accelerate desirable but uneconomic change. Generally speaking, though, there are better ways to help companies than by simply writing cheques. Companies are profoundly influenced by the burden of regulation—and that is particularly true of those that compete internationally. Rules about health and safety, about workers’ rights, about product specifications—mostly set by and policed by the government, or government-sponsored regulators—have an immense but often surreptitious impact on corporate decisions, especially for small and middle-sized companies.
[su_pullquote]“The government put £400m into a bankrupt satellite operator, despite warnings taxpayers might lose the lot for no benefit”[/su_pullquote]I sit on the board of a small spin-out from Oxford University that has developed a product that exactly mimics ketones, which the human body produces and which allow athletes to run or swim for longer. But the process of providing the information about it required by the Advisory Committee on Novel Foods and Processes was so laborious that the company decided to move manufacture and distribution to the US. America’s Food and Drug Administration was more flexible and accommodating.
Most legislation that applies to companies and employers has implications for economic activity. Labour laws that offer more generous leave or tougher safety checks are not cost-free. The consequences for jobs, profits and company growth may be hard to measure and take time to become apparent. The benefits to society may outweigh the costs to an individual entrepreneur. But this is, in a sense, the flip side of state aid: what one might call “state drag.”
Significantly, the most prominent academic rehabilitator of industrial policy is Dani Rodrik of Harvard, who argues less in favour of direct public investment than of subtle collaborations between governments and the private sector. That is a far cry from conventional state aid. But focusing on ways that government can nudge and stimulate may not only be cheaper than old-fashioned state aid: it may lead to less wasted public cash and fewer international squabbles. And improving the quality and impact of regulation may help more companies—and create more jobs—than state aid could ever do.
When governments step in where commercial investors fear to tread, they inevitably take a bigger risk than the market is prepared to. The market is not perfect—but there were good reasons why Rootes and British Leyland floundered. Through the months ahead, many firms may justifiably need a state-financed lifebelt. But that is different from using taxpayers’ cash to bet against the market. A reputation for unreliability killed the Hillman Imp.
