Disorder of the phoenix

UK – Investment slump

The UK economy has performed poorly in the last 20 years, both relative to its own history and many comparable economies. There are several factors in this, some self-inflicted, most not.

High on the list of both symptom and cause are the trends in investment (Figure 1). What actually incentivises investment into an economy remains hotly debated. The OECD literature tends to emphasise stable and predictable background conditions (from legal framework to access to workers/markets).

There is intuitive sense here of course. Businesses have plenty to deal with confronting ever-changing consumer preferences, competitors, and more besides. Most will want as much of the rest of the unknowable future fixed to whatever extent feasible.

Figure 1: Private investment as a percentage of GDP has improved over the last decade in the UK

Source: OECD, Barclays

This is something this country has struggled with for the last couple of decades, having more or less invented it in the run-up to the first industrial revolution. The most recent batch of Nobel prize winners are among those who see causation here¹ – strong, stable, and predictable institutions appear to be a necessary (if not quite sufficient) precursor to sustained economic growth.

The fact that the last 18 or so years has seen the launch of almost as many industrial strategies suggests that a lack of focus could be hindering policy efficacy. Some will argue that in an ever-changing world, the industry strategy needs to follow suit to stay relevant. However, the reality is that the bulk of innovation and adaptation is likely better sited closer to the economic action, primarily within the private sector.

This is clearly recognised in the Invest 2035 strategy. However, sticking to it may require lower turnover in cabinet and other government leadership positions. Changes of management always bring new ideas (otherwise everyone wonders why the change²). However, as above, this risks misunderstanding where the state’s edge actually lies in the innovation/investment ecosystem.

The government as growth engine?

This leads on to one of the other key bets by this incoming administration. The period following the Great Financial Crisis (GFC), characterised by government austerity, surprised by many of a libertarian bent. As the state retreated, far from leaping into the space created, the private sector also retreated. Perhaps the private sector GFC bumps and bruises were the main impediments.

However, some, such as Mariana Mazzucato, argue for the state’s ability to crowd in private sector investment.³ She and others point to areas where a particular investment may benefit others more than the investors themselves. From skills development (an individual upskilled by a small firm subsequently moving on to a bigger firm able to pay more) to risky but essential longshot research projects, Mazzucato argues there are plenty of areas for the state to add value.

There are many pitfalls here of course. Clearly specified and understood boundaries between state and market are important hallmarks of successful periods. Part of the difficulty here is that where that line optimally sits varies widely between countries and over time. Many may fancy recreating Sweden’s current social contract, or that in the US at the other extreme, but reality is more idiosyncratic.

In their deliberate post-war break with their Marxist roots, the German SPD’s famous Bad Godesberg resolution suggested state where necessary, markets where possible. Free markets are where optimal resource allocation will mostly happen; they will do a lot of your productivity work for you in many ways. However, as the various chunks of implemented US industrial policy this last couple of years suggest, you can shove them in a particular direction if you go hard enough.

‘It’s not luck…Todd’

There is also an under-acknowledged role for luck in all of this of course. You are now in the foothills of the next industrial revolution, having endured a dry patch in terms of measured global productivity growth this last couple of decades. The UK has an enormous opportunity in amongst this.

The UK already occupies a top five place in the world for innovation.⁴ Our universities and some emerging (linked) regional clusters of excellence in various industries, from life sciences to parts of AI, represent some to build on.

However, the bigger opportunity has long been thought to be outside of the top dog firms. That frontier is globally competitive and continues to flourish. However, it is the next block – beyond the top 5-10%, but above the top 50% – where the majority of the productivity slump this last couple of decades has been felt.

There are a literal mass of explanations for this surprising slump of previously successful firms (from sectoral to measured decline in management quality documented by Nicholas Bloom and others). The former Bank of England’s famous all hub no spokes speech⁵ remains well worth a read for its assessment.

The role of clusters...

There is a huge literature on the role of clusters of similar businesses in productivity growth. One of the most famous case studies internationally is Sheffield during the early 20th century. In the specialty steel area (the silicon of its day), British companies tended to be smaller than their overseas competitors, but Sheffield’s clusters seemed able to keep up with their larger overseas competitors both from the perspective of production efficiency and product and process development. Being in the same city, the businesses could draw upon the same pool of skilled labour and use the same specialist suppliers and service companies.

In this context, different companies specialising in different stages of production could each achieve scale economies in their own activities and, between them, match the performance of a vertically integrated producer. Alfred Marshall (1925) memorably observed that knowledge was “in the air.”

Investment conclusion

There is much for the UK to build on in the years ahead. The economy has surprised a determinedly gloomy consensus for much of this year. The consumer has proved more resilient and the business community more adaptable. As with the last couple of decades of slumber, there will be much outside of the control of policymakers. Events and such.

However, the global technological context is as helpful as it’s been for some time. Meanwhile, the fact that workers are increasingly scarce and expensive may even be helpful. Many past periods of accelerated technological change have mixed the carrot of attractive technology with the stick of relatively scarce expensive workers. For the government, there is probably quite a lot to be said for a bit of grey and boring where possible.