What Kind of Supply-Side Policy
for the UK?
What Implications for Scotland?
Nicholas Crafts
Competitive Advantage
• Translate as ‘competitiveness’ in the sense of
‘the degree to which a country can produce
the goods and services which meet the test
of international markets, while
simultaneously maintaining and expanding
the incomes of its people over the long term’
• So focus is on productivity performance
The Five Drivers
The previous government identified the
following as the key to productivity
performance:
Investment
Skills
Innovation
Enterprise
Competition
Still a useful starting point
What is Conducive to Strong
Productivity Performance?
• Strong investment and innovation based on
expected profitability
• Diffusion of new (especially imported)
technology based on good incentive structures
• Strong competition in product markets
• Success stories: pharma (HK, R & D); ICT
diffusion (relatively favourable regulation);
financial services (agglomeration benefits)
Endogenous Growth:
Key Policy Areas
• Public capital
• Innovation
• Regulation
• Competition/Openness
• Taxation
• NB: links to 5 drivers
Policy Implications (1)
• Should intervene to address ‘market failures’,
e.g. where social returns exceed private returns
• May be able to raise growth rate.. a bit
• Much better to incentivize innovation than
physical investment
• UK investment subsidies were a very expensive
failure – high deadweight loss
Policy Implications (2)
• Policy could work through raising expected
returns or making managers try harder
• ‘Productive’ government expenditures
can raise the growth rate; ‘distortionary’
taxes do the opposite
• Need to decide balance between
competition policy and industrial policy
Competition and Productivity
Growth
• Absence of competition allows managers to be
sleepy if ineffective shareholders
• Competition is strongly positive for productivity
outcomes in UK firms without dominant
shareholder (Nickell et al., 1997)
• Competition promotes better management
practices (Bloom and van Reenen, 2007)
• Strengthening competition addressed Britain’s
1970s’ productivity problem quite effectively
(Crafts, 2012)
Creative Destruction
• Central to technological change and long-run
economic growth
• Exit/entry of plants accounted for about ½ of
TFP growth in UK manufacturing between 1980
and 1993 (Disney et al., 2003)
• As with freer trade, economic benefits but lost
votes
• Commitment technology to prevent
intervention may be desirable
Government Failure
• Politics of improving supply-side policies
often unattractive; improving productivity
typically means losers as well as winners (cf.
trade liberalization)
• Lessons of the 1960s and 1970s should not be
forgotten; HS2 and ‘save the high street’ belong
to those decades
• ‘Institutional architecture’ is key area for
reform (cf. LSE’s Infrastructure Commission)
Diffusion
• Matters more for productivity performance than
original invention and deserves more attention
from policymakers
• Vast majority of new technology in UK comes
from R & D in ROW (Eaton & Kortum, 1999)
• Information does matter but need also to think
about absorptive capacity, intangibles and
profitability of adoption
Sources of Growth in Real GDP/HW in the
UK Market Sector, 1990-2008 (dal Borgo et al., 2013)
(% per year)
1990-95
1995-2000 2000-08
Tangible Capital
0.95
0.74
0.67
Labour Quality
0.17
0.25
0.16
R&D
0.05
0.04
0.05
Other Intangibles
0.58
0.63
0.47
TFP
1.19
1.87
0.90
Total
2.94
3.53
2.25
Top 6 Sector Contributions to UK Labour
Productivity Growth, 1995-2007
(Crafts, 2012) (% per year)
Value-added
share weight
Growth
Rate
of Real
GDP/HW
Contribution
Wholesale and Retail Trade
0.123
3.05
0.38
Post & Telecommunications
0.030
9.00
0.28
Business Services
0.220
1.06
0.23
Financial Services
0.046
4.23
0.19
Electrical and Optical Equipment
0.021
6.64
0.14
Transport & Storage
0.048
2.58
0.12
Wholesale and Retail Trade
• Would be considered irrelevant by traditional
industrial policy
• Does not do much R & D (0.5% of UK R & D)
but is the sector that contributed most to recent
UK labour-productivity growth
• Is a big user of new technology
• Has been adversely affected by planning
regulations; TFP in modern supermarkets
reduced by at least 20% (Cheshire et al., 2011)
Agglomeration Economies
• External economies of scale from
localisation and urbanisation economies
• Increase with city size (though not
without limit)
• Much bigger in services: financial
services = 0.25, manufacturing = 0.04
(Graham, 2007)
• Are not fully realised if transport
inadequate or city size restricted
Welfare Loss
NW
New Net Wage
Curve
NW3
B
Welfare Loss
NW2
NW1
A1
A
Old Net Wage
Curve
NA
NB
N
Industrial Policy
• Can define as “public sector intervention aimed
at changing the distribution of resources across
economic sectors and activities” (Caves, 1987)
• Market-failure rationale might be provision of
public goods or addressing divergence between
social and private returns
• Proponents claim positive effects on rate of
economic growth
Types of Industrial Policy
• Horizontal policies target innovation, skills,
infrastructure etc. generally though their impact
is not necessarily sector-neutral
• Sector-specific policies are explicitly selective
and aim to increase the size of particular
industries
• Since the early 1980s the emphasis in UK has
been on horizontal policies including especially
strengthening competition in product markets
Examples of Industrial Policy
Instruments
Horizontal
Product Market Competition
Policy
Labour & Skills General
Schooling
Capital Market Corporate
Tax/Capital
Allowances
Technology
R & D Tax
Credit
Selective
State Aids
Targeted Skills
Policy
State
Investment
Bank
Public
Procurement
UK Success Stories
• Have been promoted by horizontal not selective
industrial policy
• Pharma: human capital, science base
• Financial Services: human capital, deregulation, planning reform, transport
• ICT Diffusion: human capital, industrial
relations reform, less obstructive regulation than
elsewhere in Europe
Horizontal Industrial Policies:
Could Do Better
• Infrastructure
• Education
• R&D
• Taxation
• Regulation
NB: effects on growth through the incentives to
invest, innovate and adopt new technologies
Infrastructure: Government Failure
• Pre-crisis investment in public capital shortfall:
1.3% GDP per year below growth-maximizing
amount (Crafts, 2009)
• E.g, lots of road projects with high BCR not done
• Eddington Report (2006) – big welfare gains and
tax revenues from efficient programme of road
building and road pricing – ignored
• Perhaps roads should be provided by a
regulated utility (Helm, 2012)
Education: Could Do Better
• ‘Cognitive skills’ strongly correlated with long-run
growth; 100 test-score points → 1.4 ppts per year
(Hanushek & Woossman, 2011)
• Institutional design matters a lot for educational
outcomes (principal-agent)
• International comparisons suggest UK could raise scores
considerably by greater private operation (and probably
by having higher-quality exams) (OECD, 2007)
• Key point: better incentive structures could improve
educational quality without spending more money
Cognitive Skills: Top 6 and UK, 2009
(OECD, PISA Maths & Science average)
Shanghai, China
586
Korea
542
Hong Kong, China
552
Japan
534
Singapore
552
Scotland
507
Finland
548
UK
503
R & D: a Mixed Picture
• SME Innovation Support: has
incentivized innovation with high BCR
(Foreman Peck, 2013)
• R & D Tax Credit: also has high BCR but
design issues (Griffith et al., 2001; Bond & Guceri, 2012)
• Patent Box: badly targeted, revenue
reducing, benefits highly questionable
(Griffith et al., 2012)
Tax Doesn’t Have to be So Taxing
• Mirrlees Review (2011) presents powerful case
for reform
• For example, revenue-neutral extension of VAT
base to all consumption and reform of capital
taxation by exempting normal rate of return to
raise GDP by 1.4% and investment by 6.1%
• More generally, OECD research finds significant
increases to GDP from shifting taxes from
income to consumption and property (Arnold et
al., 2011)
Planning Rules Matter
• An important horizontal ‘industrial policy’
• Planning restrictions impose massive distortions
in land use – regulatory tax rate of around
300% makes office space in Manchester more
expensive than Manhattan (Cheshire & Hilber, 2008)
• Successful British cities are too small and
constraints on growth threaten to undermine
competitive advantage
• Spatial adjustment to globalization is inhibited
What is the Most Effective Role
for UK Government?
• Good horizontal industrial policies and strong
pro-competition stance; not back to the 1970s
• Address market failures and remember CBA
• Facilitate diffusion; don’t fixate on R & D
• Recognize that the globalized world of today has
implications for the design of industrial policy
Two Technological Revolutions
• Steam:
Transport costs fell
Industrialization & deindustrialization
Lancashire cotton
• ICT:
Communications costs fell
Vertically-disintegrated trade
Computers and robots
Smile-Curve Economics:
• Fabrication stages become commoditized
• Value shifts to pre- and post-fabrication services
Share of value added
2012 value chain
1970s value chain
Product concept,
Design, R&D
Manufacturing
stages
Sales, marketing
and after sales
services
Stage
% Breakdown of Nokia Phone Price,
2007 (Ali-Yrkko et al., 2011)
Nokia’s Intangibles
47
Physical Components
33
Distribution
14
Licenses and Software
4
Final Assembly
2
Value Chains
• Now more complex and more globalized
• Big ‘manufacturers’, e.g., Rolls-Royce, make a
lot of their money from services
• Need much better metrics to understand how
these input-output connections
• ‘Rebalancing’ should not be conceptualized
simply in terms of ‘manufacturing’
Implications of VerticallySpecialized Trade
• Most value added not in making manufactures
• Need to think in terms of stages not sectors of
production; so horizontal industrial policies
matter more
• Successful rebalancing implies more jobs in
business services which is where ‘real
engineering’ will be found in future
Successful Cities
• Fundamental to competitive advantage (cf.
The Netherlands of 2040); attracting the right
people is key.
• Have hard-to-replicate agglomeration
advantages
• Underpinned by good horizontal policies,
notably, land-use planning and transport
• NB: Edinburgh (4th) and Glasgow (16th) in 2013
competitiveness index for British cities
Implications for Scotland
• An independent Scotland could make
horizontal industrial policies more
growth friendly
• If Ireland is a role model, it is only in the
Celtic Tiger period – not before or since
• As a small country, the optimal rate of
corporate profits tax would be lower
Absorptive Capacity
• Even more than for UK as a whole, diffusion is
key for Scotland so absorptive capacity of
business really matters
• Worrying diagnostic that relatively few Scottish
businesses are ‘innovation active’ (33%
compared with 60% in Ireland and Sweden)
• A high priority is to understand and address this
shortfall (Turnbull & Richmond, 2013)
Policymaking Architecture
• Need to do better than UK in mitigating
‘government failure’ especially given postrecession populism
• Serious independent evaluation and surveillance
of microeconomic policy
• Could consider an equivalent to OBR or NICE
(cf. the Australian Productivity Commission)
Varieties of Capitalism
• UK policy discussion has really been about
improving the functioning of a ‘liberal market
economy’ (Hall & Soskice, 2001)
• Perhaps Scotland would like to become a
‘coordinated market economy’?
• If so, comprehensive institutional reform
would be the focal point to move to an economy
with more patient capital, more training and
wage moderation
Conclusions
• Evidence-based supply-side reforms could
improve UK productivity performance
• The politics of improving productivity is
challenging
• An independent Scotland should consider
institutional as well as policy reforms
• A return to the 1970s is not a good idea