Wednesday 21 December 2016 4:59 am

The UK economy doesn’t need an industrial strategy – it needs liberation

There seems to be widespread agreement within the political class that the British economy is in need of “rebalancing.”

It is argued that too big a fraction of UK output is generated by the services sector, and too little by manufacturing. Changing the sectoral composition of British GDP is an explicit objective of Theresa May’s industrial strategy, while shadow chancellor John McDonnell recently promised a “manufacturing renaissance” if Labour get elected.

We ought to be wary whenever government and opposition find themselves in agreement on policy, and industrial strategy is no exception.

First, accounts of an urgent need for a change of economic model do not do justice to Britain’s actual economic position. Real incomes per head have doubled in the UK since the heyday of industrial activism in the mid-1970s, when manufacturing was a greater share of both output and employment. Recent labour market outcomes have been unambiguously positive, with unemployment back to pre-crisis levels below 5 per cent, labour force participation at an all-time high, and wages growing faster than consumer prices.

Furthermore, the story of industrial decline since the 1980s is only partially true. Although manufacturing has indeed fallen as a share of both GDP – from 32 per cent in 1973 to around 10 per cent today – and employment – from 30 to 8 per cent – manufacturing output in absolute terms is about 20 per cent higher than in the supposed “golden age” of the 1960s and 1970s. The reason why manufacturing has become less weighty in national income is not that we are making less. It is that other sectors have grown even faster over the last 40 years.

Economic progress tends to lead to a declining share of manufacturing in countries’ GDP, for two reasons. First, there has, at least until recently, been greater scope for productivity increases in manufacturing than in services, many of which are labour-intensive. As a result, prices for manufactured goods have dropped in relative terms, meaning that they count for less in national accounts.

Second, the so-called income-elasticity of demand for manufactured goods is low. This simply means that, as our income doubles, we do not necessarily buy double the number of cars, washing machines and televisions. We spend the excess on other things instead, and these are often services such as restaurant meals and foreign holidays.

Could government intervention improve matters? The state, for better or worse, currently accounts for about half of national income, and through its profuse legislative activity regulates most of the other half. There is thus a role for the state in helping to improve the UK’s economic performance.

But that role should not, as proposed by some, involve the state choosing the industries “of the future”. The experience of industrial activism in the post-war period was dismal, with money-guzzling basket cases such as British Leyland and Concorde, topped by labour unrest and macroeconomic instability. Nor is the state a good entrepreneur: for each successful venture backed by government, there are many more examples of failed projects which the state – under the influence of interest groups – then struggled to get out of.

There is an alternative, as Len Shackleton and I propose in a new paper for the Institute of Economic Affairs. The government has a chance to liberate the economy in order to boost its productive potential – a task to which Brexit has only added momentum. Such a “horizontal” industrial strategy would involve the liberalisation of planning rules, which will lower the cost of running a business, freeing up funds for productivity-enhancing investment and bringing down consumer prices.

Energy policy is also ripe for change: Britain currently has the third-highest industrial electricity prices in the EU-15, and the highest for large firms. Prices are made higher by a raft of measures nominally aimed at tackling climate change, but which come at a very high cost. Crude interventions such as the Climate Change Levy, which adds 5 to 6 per cent to industrial electricity bills, should be phased out and replaced by a single, market-driven mechanism to reduce emissions, such as a cap-and-trade scheme.

The list goes on: financial services, employment regulation, and the tax code can all benefit from deregulation and a removal of barriers to productive activity. A liberalising agenda was at the heart of the UK’s economic renaissance in the 1980s, and it will deliver for post-Brexit Britain, too.