Business Secretary speech on industrial strategy at Policy Exchange

This speech was published under the 2010 to 2015 Conservative and Liberal Democrat coalition government

The role of industrial policy in shaping the economy.

Good afternoon. Today I would like to talk about something that I once made my name criticising: the role of industrial policy in shaping the economy.

Before becoming a politician, I spent some years as a trade economist, at the Overseas Development Institute and Chatham House, and working for the World Bank on trade issues. During the debates amid the great upward surge of globalisation, post war, I contributed on the free trade side. My first book was called ‘Protectionism and industrial decline’, and its title alone ought to be enough to explain where I stood.

During a period in government, including as a special adviser in the DTI of the late 1970s, I saw the mistakes of heavily interventionist government; picking winners which often turned out to be expensive lame ducks.

Now, as Business Secretary, I find myself calling for, and indeed designing, a New Industrial Policy. So does this mean I have changed my mind?

The answer is no. I am still strongly against mercantilism - the idea that exports are good and imports are bad. I believe in competition. I still believe that the best route to economic success is through openness: the free movement of goods, services, capital and labour - properly regulated.

There is a more sophisticated alternative to the old industrial policy which recognises that governments play a role in the economy, which works with the grain of markets but is not passive.

Otherwise sectoral choices are made by default. Twice in the last three decades, Britain has enjoyed periods with a strong real exchange rate; partly a consequence of macroeconomic policy, but partly a consequence of a ‘Dutch disease’ problem of a dominant tradeable sector - oil in the early 1980s; financial services in the last decade. Weak supervision of banking and loose fiscal policy contributed to a strong real exchange rate and in turn to a badly unbalanced and unstable economy.

Looking ahead rather than back, our policy of financial discipline isn’t just an end to itself but consistent with a story of economic rebalancing. Our clear choice of tight fiscal and loose monetary policy has resulted in two things necessary for a balanced recovery. Short and long-term interest rates are low, which provides a strong incentive to invest, while a more competitive exchange rate is supporting exports. Investment and trade are the key drivers upon which we want to base recovery.

Moreover, while financial credibility is an essential precondition for success, it is not sufficient. Other choices still have to be made. One of the first decisions I took was to put manufacturing at the centre of our long term economic vision. I did so because it is the most important tradeable sector and, if we are to rebalance the economy, there has to be a shift of resources to tradeable goods and services, from debt financed private consumption and public expenditure. There are other important traded activities too - creative industries; professional services; teaching overseas students; tourism - and they are also important.

But manufacturing contributes disproportionately to overall levels of productivity as well as generating half the UK’s exports of goods; and is responsible for much of the business R&D in this country and thus the innovation which drives growth. So providing the right framework of incentives and support will have a material effect on future rates of growth.

Clearly turning the tide on manufacturing will be no easy task. In common with other industrialised countries - including the US, Japan, France, and Germany - the share of manufacturing in the economy has fallen. In the UK, however, the share of manufacturing in GDP fell to just over 10% in 2008. This was a far more precipitate fall than in competitor countries and Germany, in particular.

It would be unwise to promise that we could somehow reverse all the structural factors that have led to industry’s declining share of output and employment in Western economies - technological change; a shift in demand to services; or tough competition from low-wage producers in Asia.

But we have allowed the pendulum to swing too far. If these trends were so inevitable, why was Germany only overtaken (by China) as the world’s largest exporter in 2010? Why - thanks to manufacturing - is the market share of Germany in the emerging BRIC countries four to five times larger than ours? Why have we even been overtaken in these markets by France and Italy? These are not irreversible trends. And the growing prosperity of booming Asia will itself cause some rebalancing. In real terms, the yuan is 50% higher than in 2005. Chinese wages are rising 20% annually: Boston Consulting Group has predicted that this might return millions of jobs to those Western producers which are competitive.

We cannot control these forces, but we do have a role in ensuring that the UK is in great shape to compete for manufacturing business.

In many areas, years of overvalued exchange rates have left us with a very competitive manufacturing sector in these areas where price is not a critical factor and quality and brand count for more. Despite the misconceptions that have been allowed to flourish in recent years, Britain is still a country that excels at making things.

Where once we led the way as innovators in textiles, shipbuilding and iron and steel production, we now have companies blazing a trail in frontier technologies such as new materials, robotics, software design and some renewable energies. I have recently visited highly successful manufacturing companies in sectors which we seemed to have written off, like bicycles and motorbikes; casting and forgings; machines tools, steel making and large scale car production (which you will remember was a sad joke a generation ago). So it is important we explode the myth that UK manufacturing is moribund.

We have outstanding manufacturing companies, both large and small. I have enormous confidence in British industry’s ability to lift the British economy so I am backing our ‘makers’. British companies are building global reputations in sectors such as pharmaceuticals; the automotive industries - and not just Formula 1; chemicals; aerospace; off-shore oil and gas supply industries, among others.

There are big new industrial investments taking place, even in these difficult times. Airbus has opened its new £400m factory in Broughton, North Wales in the past fortnight. Jaguar Land Rover is investing £355m in a new engine plant in Wolverhampton. BMW is ploughing £500m into its UK production operation. Nissan has chosen to design, develop and make the next-generation Qashqai here because of its success in Sunderland. The Thai company SSI is reopening the blast furnace at Teesside.

But in other areas, we have allowed our latent capacity to wither. When I visit some often superb, manufacturing plants the machine tools are usually Italian, Japanese, German or Swiss - rarely British. When visiting Dubai Ports at the London Gateway, I was saddened to see no British-made cranes at that important development. The skills and capacity have just gone.

A perspective of revival and recovery enables us to look at industry in a new way. Traditional distinctions between manufacturing and services are breaking down. Manufacturers increasingly rely on sleek design, sophisticated IT or ingenious marketing as an integral component of success. At the same time, companies selling leisure services such as computer games, film making or music recording need hi-tech equipment to reach consumers. Today, over half of all industrial value added comes from intangibles, in particular from the intellectual property protected by patents and copyright.

When we think of a brilliantly successful company like ARM designing semiconductors, or Autonomy, now part of Hewlett Packard, where does manufacturing stop and services start? Last week I met the owners of Henry the vacuum cleaner, Numatic International Ltd; made - manufactured - in Britain. But the company sell mainly on its brand, not on its manufacturing costs. My constituency, Twickenham, is these days an important part of British shipbuilding because of the computer based design work we do.

Another new dimension to manufacturing is the growth of global supply chains, contributing a component or an associated service rather than making the finished product. In order to choose to base operations in the UK, multinationals need to know that they will have local firms of the quality needed to supply parts in a totally reliable way. This is what the Mittelstand offers to Siemens, Bosch and BMW in Germany. In the UK, years of underinvestment - and arguably neglect from government- has seen a decreasing proportion of the supply chain locally sourced, and a persistent trade deficit.

So where does government have a legitimate, and necessary role in helping the UK revive manufacturing in its modern forms? I would start with innovation and technological leadership. Markets supported by intellectual property rights can take us a long way. But innovation does not occur in a vacuum. A knowledge economy needs people with the right training and education to develop technologies and apply them. We have some of the best universities in the world, a strong record in scientific discovery and some outstanding entrepreneurs. We need to keep it that way, which is why we agreed a good settlement for the science budget - and why, also, I am determined to keep the borders open for bright people looking to come here to study, research, and innovate. The recently announced funding for graphene development and to enhance our e- infrastructure is part of that commitment.

But in the UK there has been a bigger gap between scientific theory and business innovation than in, for example, Germany. Supporting the industries of the future requires addressing some of the market failures involved. That needs a subtle approach, in order to avoid interventions that fall victim to political favouritism or commercial vested interests and to insist on a proper appraisal of costs and benefits.

That is why I have given such support to arms-length bodies such as the Technology Strategy Board, and the Technology Innovation Centres that it will oversee. These Centres will identify and support core technologies, smoothing the path from original academic research to commercially viable application. There is often a market failure in the innovation phase of new technologies. Revolutionary technologies are often too risky, or simply too complex or resource intensive, for an individual company to make the necessary investment.

The TICs will provide university researchers and businesses with facilities to collaborate to build prototypes, use large-scale clean rooms or develop virtual environments to support product design. This approach builds on the German Fraunhofer model and has been recommended by James Dyson and Hermann Hauser.

A fortnight ago, I announced £140m funding over the next six years for the first of these centres- for high value manufacturing. Comprising a network of seven facilities, the manufacturing TIC will help advance concepts in the fields of photovoltaics, biochemicals and composites, to give a few examples. Separate TICS are planned focusing on cell therapy and offshore renewable energy. Others will follow. This is a down payment on a new approach to the support of innovation.

The second pillar of our new industrial policy comprises the carefully managed use of limited public sector seed capital to leverage in private investment. The £1.4bn Regional Growth Fund is providing direct government support as a necessary catalyst for projects with the potential to ramp up investment enterprise, in areas of the country where there has been a historic reliance on the public sector for jobs. The gearing is high, as it should be. The aim is to facilitate new private investment not displace it.

There is also a market failure where it is not possible to fund high risk but potentially profitable projects. This is the reason we are capitalising the Green Investment Bank with £3bn from next year.

The novelty of low carbon technologies and the uncertainty over the long-term future of these nascent markets means many projects would not get off the ground without some, pump priming government support.

I recognise that these interventions need to be depoliticised and rigorously appraised - to produce value for money and to minimise dead weight (investment which would have occurred in any event).

A third pillar of our strategy is a focus on skills, centred on apprenticeships. Despite the incredibly tough fiscal backdrop, we have managed to finance a sustained investment in training, where it delivers clear social benefits in terms of delivering a more skilled workforce. There is a systematic problem that the private sector will often under-invest in training since the benefits may accrue to competitors. That is why we offer 50:50 funding. Provisional figures show that over 326,000 Apprenticeships were started in the first nine months of the 2010/11 academic year, a record in modern times, including many in manufacturing or SMEs. We are looking at how to build on the success of the Apprenticeship brand by ensuring that they are employer demand driven, focussing on advanced skills and sectors, and age groups with the highest social returns.

The fourth pillar is our work with major manufacturers to rebuild their supply chains, which have suffered from the hollowing out of industry. Sectors such as automotive and aerospace have an appetite for increasing UK-based suppliers - a trend reinforced by the competitive exchange rate and the disruption to supplies following the Japanese earthquake and Tsunami. So we are collaborating with industry to identify demand that firms here could meet. Decisions of this kind are necessarily commercial in character, but we increasingly recognise that there are externalities involved: leading manufacturers will be more likely to invest in UK suppliers if there is a wider commitment to supply chain reinvestment.

Planned new UK manufacturing investments and increased appetite for UK supply create new business opportunities, so my Department is looking at how government can support UK supply chains across a number of sectors critical for future growth. We are taking a flexible approach, looking at what might be done in terms of skills and management development; and targeted support for capital investment and R&D.I will be able to say more over the coming months.

We also recognise that in some sectors we should not rely on established networks of business relationships. New internet based technologies are necessarily disruptive and break up existing systems. There can be no more one size fits all approach. But finally, there is scope for the government to recalibrate its approach towards public procurement to boost support for UK industry and its supply chains. Currently, the regime is underscored by considerations of cost and EU competition rules. These are sound principles - but applying them too narrowly risks neglecting wider economic considerations and the benefits of maintaining a competitive supplier base.

To be clear: I am not advocating a lurch towards protectionist procurement or breaking international rules. But recent controversies over procurement have raised real questions over the best way to balance short term cost considerations with longer term value for money and industrial competitiveness. To be frank, we have been too tactical and short-term.

Let’s not forget, either, that a resurgence of UK manufacturing depends not just on industrial policy but on broader policies that support business. For this reason, we are devoting a lot of energy to implementing a range of supply-side reforms needed to build and maintain business confidence.

A broad policy requirement is a tax regime for manufacturing which is ‘competitive’ since new investment in manufacturing is potentially footloose. The government’s action to improve the competitiveness and stability of the UK tax system and cut corporation tax year on year is part of the response. A particular sensitivity is the potential impact of environmental taxation which inadvertently risks ‘carbon leakage’ if energy intensive industries like steel, chemicals and ceramics were to migrate, losing the UK products but emitting carbon elsewhere. That is why the government is committed to reducing the cumulative impact of energy and climate change policies for these industries, as our competitors, such as Germany and France, have done.

It is crucial for British industry that we promote the UK as an open economy, welcoming inward investment and promoting exports through active trade diplomacy, especially in the big emerging markets. Where Britain has fallen behind is in the export performance of SMEs, and that failing is being addressed by providing more varied export finance facilities and support, with an expanded role for UKTI.

We are, in addition, dismantling unnecessary barriers that stymie growth and hold back investment. The planning regime is being liberalised and regulation and bureaucracy, the bane of businesses large and small, is being cut back.

And we must continue efforts to generate more bank lending and equity. Access to finance remains a key issue. For innovative and growing manufacturing companies there is a gap in equity finance which the new Business Growth Fund is designed to address.

The work happening on all these fronts is critical if we are to achieve our aim of rebalancing the economy from domestic consumption to trade and investment; towards tradeable goods and services, particularly manufacturing.

Our new industrial policy is still a work in progress, and there is substantial room to develop it in scope and scale in future. I am confident that world-class manufacturing will once again be at the heart of our economy.