On the eve of the EU referendum vote, according to numerous measures the British economy was performing exceptionally well. Unemployment was low and employment participation rates were at all-time highs, with continued low inflation. GDP growth since the financial crisis was only marginally behind Canada and the US, but well ahead of Germany and France.
For those in tradeable services jobs and already on the housing ladder in London and the south east, the economy was in particularly good health. Direct investment flows into the UK remained robust and house prices continued to rise, along with household purchasing power due to the relatively strong value of sterling. However, these figures hid some major imbalances resulting in an economy that was only working for part of the population. To what extent these imbalances impacted the vote on June 23rd remains difficult to quantify, however, the underlying imbalances themselves can be identified clearly.
Britain’s persistent current account deficit suggests a wider malaise within the economy. The record trade deficit in goods highlights the decimation of manufacturing in the UK which has impacted the midlands, the north of England , Scotland and Wales disproportionately. Moreover, investment and productivity remain low partly due to this decline. Consumption remains the main driver of the economy, however, this appears unsustainable given the negative savings ratio. Despite these indicators, the value of sterling remained high as it has been supported by the sale of UK assets including companies and property to international investors. The sale of these assets has largely been financing the current account deficit.
The picture for those not participating in this growth is rather different, particularly in the midlands and north of England, Scotland and Wales. Rates of productivity remain substantially lower as does employment growth. This bifurcation of the British economy is not a recent phenomenon. In 1984, an elderly Harold Macmillan made his debut speech in the House of Lords citing, “the growing division of comparative prosperity in the south and an ailing north and midlands.”
The recent creation of the Department for Business, Energy and Industrial Strategy suggests that Theresa May’s government is committed to finding a solution to this problem. This follows on from a raft of policies on industrial strategy at the end of the New Labour government and the coalition, covering access to finance, skills, innovation, procurement, sector partnerships and specific technologies. This marked an important shift in the way government interacts with industry. But many of these policies will take time to bed in and have an impact on the economy. For example, each of the 11 new catapult centres have been running at most five years. These are physical centres where businesses, scientists and engineers work side-by-side on late stage R&D, transforming high potential ideas into new products and services, as well as developing supply chains. But they are only beginning to build the networks and infrastructure which other countries have developed over decades.
But how can Theresa May’s government build on what has already been achieved on industrial strategy? British economic history is littered with failed interventions. Indeed, despite the numerous
policies that have been attempted to reverse the trend, this bifurcation has if anything continued to widen.
Samuel Brittan’s insight, despite its gender bias, that a government should intervene in the economy remains at the heart of economic liberalism. But as he pointed out, it is the type of intervention that matters. Government needs to focus on improving the physical and business environment, enabling managers and workers to drive successful businesses. It should also push on with the devolution agenda since this is beginning to create local government institutions with the necessary scale to provide the physical infrastructure to accomplish this.
However, for an industrial strategy to make a difference it will need to address two quite fundamental and pervasive issues that have impacted the economy for generations. First, the persistent overvaluation of sterling has resulted in a general decline in the competitiveness of UK manufacturing firms. Although globalisation has accelerated the outsourcing of manufacturing to lower-cost countries such as China, Britain’s decline has been far greater than other developed economies. Crucially, it has become far less profitable to manufacture goods in the UK than in other advanced countries.
In tandem with this persistent problem, the UK has also failed to develop an appropriate system of technical education. More than 460,000 technical jobs were difficult to fill last year due to technical skills shortages, and this is even after the current ability of firms to attract labour from the EU. Just being able to fill these technical roles alone would lead to a £17,000 jump in salary for hundreds of thousands of workers on the minimum wage across the country, resulting in an overall increase in wages of up to £8bn. Moreover, the productivity data suggests that without a rise in the workforce’s technical skill-base it will be hard to maintain competitiveness in the global market place.
For many British firms, having to rely on a sub-standard technical skills system in addition to the strength of sterling has been a double whammy. In order to address the persistent overvaluation of the pound, an industrial strategy needs to address the market failures that have given rise to an excessive demand for sterling from international investors. This includes ensuring that there is an appropriate monetary policy regime in place in conjunction with reforms that reduce the demand for UK assets such as firms and property that have been financing the current account deficit and which appear to have limited benefit for the UK economy. The following three policies should be central to a 21st century industrial strategy and would help to address the issue of a persistently overvalued currency.
• Recommendation 1: Shift the current monetary policy regime away from an inflation target towards a nominal GDP target. An inflation target can lead to an overly-tight monetary policy. In particular, an increase in commodity prices might generate higher rates of inflation resulting in a tightening of monetary policy. But if an economy is not at capacity, then this is likely to have a damaging effect by increasing the cost of credit and the value of the currency. Moreover, there is increasing evidence that wage inflation is being kept in check by globalisation. As such inflation targeting appears to have largely outlived its usefulness. There are legitimate concerns that if the nominal gross domestic product level is set too high this might lead to rising inflation expectations as well as asset price booms. By targeting nominal income growth to equal the growth in total factor productivity, rising inflation expectations would be avoided.
• Recommendation 2: Remove all confidentiality surrounding beneficial ownership of property and reform land markets to reduce the returns from property speculation. Preventing overseas firms withholding the beneficial owner of UK property assets would reduce inflows into the UK from criminal organisations looking to launder money into high-value assets. It would also make it clearer to the monetary authorities who exactly might be financing the current account deficit. In addition, amending the 1961 Land Compensation Act to improve the efficiency of the land market would reduce capital inflows into existing assets and provide less support for sterling. The dysfunctional land market is one of the main reasons why the rate of housebuilding is so low and why the returns on residential property as an asset class are so high. Extending the capture of windfall profits to existing property assets by aligning council tax and business rates to actual values would also reduce speculation.
Recommendation 3: Strengthen competition policy to prevent consolidation in sectors where the UK has a competitive advantage. Acquisitions of large and successful UK companies as a result of consolidation by international competitors does not appear to support a rebalancing of the UK economy. The 2002 Enterprise Act should be amended to expand the remit of the Competition and Markets Authority (CMA) to review merger situations where it believes that an acquisition of a UK firm may result in a lessening of competition in the UK, regionally or globally. Particular focus ought to be given to acquisitions driven by industry consolidation that might result in negative long-term effects for the UK economy in terms of industrial capacity, less innovation and research, and higher prices. Such an approach would still provide the freedom for M&A transactions that do not increase consolidation, particularly for smaller firms who are more likely to be capital-constrained.
In order to deliver the world-class technical education system that the country so desperately needs, an industrial strategy needs to transform the way that courses are funded to match the technical skills in demand by local employers. This would be underpinned by a more stable system of national qualifications and standards that stands the test of time. The following three policies should be central to a 21st century industrial strategy and would address the issue of an inadequate technical skills framework.
• Recommendation 4: The government should ensure that all local enterprise partnerships (LEPs) are sufficiently resourced to assess the local supply and demand for skills, and further strengthen the evidence base and expertise provided nationally. The 39 LEPs across England play a crucial role in bringing together local employers with councils, colleges and universities to boost economic growth. Given the diverse challenges faced around the country, they should be a key part of the government’s industrial policy. As it stands though, many LEPs lack the capacity to perform what should be one of their core functions: to assess the local supply and demand for skills. They have the links with employers and local knowledge to understand in detail the local labour market, but this needs to be backed up by a stronger evidence base with hard data. The decision to abolish the UK Commission on Employment and Skills, which had strong employer and trade union support, could potentially further weaken the evidence base which both local and national policymakers draw upon.
• Recommendation 5: New metro mayors should prioritise their control of the adult education budget to incentivise local skills providers to focus on either basic or technical education that reflects the needs of the local economy. The decision to gradually devolve control of the £1.5bn adult education budget to those areas that are introducing a metro mayor from May 2017 was a major step forward for the devolution agenda. The budget primarily funds basic education for adults, which can prove crucial in helping those out of work to gain employment. Beyond joining up employment and skills support, this is also an opportunity for metro mayors to incentivise the provision of the right technical education and training. Based on labour market intelligence and local insights into the needs of employers they can agree wide-ranging funding agreements with local skills providers to shift provision to where there are shortages. Over time, this approach can incentivise further education colleges to specialise in what they do best: either providing second chances for those let down by the education system; or delivering high-quality technical education, grounded in the needs of employers.
• Recommendation 6: Set up the new Institute for Apprenticeships and Technical Education with the aim for it to last for at least a generation to give stability to national standards and qualifications. The history of skills policy in the UK is littered with short-lived government agencies that have overseen the standards and quality assurance of technical education and training. Unless we can ensure that the new Institute for Apprenticeships and Technical Education stands the test of time and lasts at least a
generation, the incessant overhauling of qualifications and standards will continue. This has undermined the value of the achievements of students and apprentices by making
it almost impossible for employers to understand the system.
The evidence set out in this report suggests that without tackling these two key issues, the new secretary of state is unlikely to make much progress in rebalancing the economy and delivering the Prime Minister’s objectives of making Britain a country that works for everyone.
Thomas Aubrey is director of the Centre for Progressive Capitalism
Alastair Reed is senior policy research at the Centre for Progressive Capitalism
The image is by Deniz Altindas, published under CC0 1.0