Do industrial strategies work?

Do industrial strategies work?

by Eben Wilson
article from Monday 31, July, 2017

THE ESSENTIALLY COMMUNIST NOTION of centrally planned innovation appears to have taken firm root in our body politic.  Britain appears once again to have “an industrial strategy”.  We should all be cautious.

Scotland, as an overtly planned satrapy of the wider British state has, like Wales and Northern Ireland, had more than its fair share of induced progress through state direction. Our technology transfer institutes were catalysed through EU and university funded initiatives. They are rarely lamented. Scottish Enterprise and a maze of other entities dot the national and local landscape offering bungs of various types to make industrial change happen. 

Do industrial strategies work? Political economy tells us that this is unlikely, although to an extent this depends on how the plan is executed.

Markets adjust to subsidy

Economically, state sponsored innovation reduces the price of entry to certain pre-chosen technological opportunities. As such, they divert resources.  An incisive critique called “The Industrial Morass”, written in the late 1970’s towards the end of a long period of intense industrial planning, found that industry chosen for subsidy spent an inordinate time of management time chasing funding, moved operations for no good commercial reason, and did very little innovating; essentially it consumed investment funding and human capital for not much productive advance, to the benefit of company shareholders rather than workers or consumers.

In economic terms, in any subsidised sector those who do not benefit from the chosen advances face increased competition and therefore increased risk. Companies not in those sectors face higher taxes and less available investment funding. These negative effects on the innovation strategy are largely hidden but run counter to the subsidised investment.  Writ large, industry moves towards competing for funds rather than enhanced output.

Innovation accelerator programmes have another effect; unexpected consequences for prices, especially if the grand plan is wide-ranging.  For example, should battery technology prove fruitful, the price of Lithium from Chile and various rare metals from China is likely to rise greatly; or even more likely the price of certain unknown compounds or tooling methods supplied from Germany. Think about the imports here. The momentum of a specific commitment to a specific mix of technologies can often make the outcomes of planned industrial growth through innovation the opposite of those intended. In Scotland, you only have to think about our imports of the expensive parts of wind turbines to realise that any claims about building an indigenous industry need close examination.  Comparative advantages cannot often be engineered by the state.

The conceit of knowledge

A Hayekian economist would argue that there is a great conceit in the idea that industrial strategies can construct creative change that is sustainable. Think Linwood, think Ravenscraig, think Invergordon. The difficulty is that the policy choices tend to be second hand – with civil servants and their advisers attempting to divine the future more productively than industrialists steeped in detail.  Professional marketers call this product focus, where the imaginative idea trumps the hard realities of product, price, consumer preference and channel to market; a much more complex mix needed to produce profitably.

Few in government have experience in the hard daily grind of making a business grow; in particular the chore of balancing the costs of increasing overheads with a yet more rapid growth in cash flow out of sales revenues.  Only if you get this balance right do you obtain sustainable profitable success.

Instead, in political markets, the focus is inevitably on how “the nation” might make money from doing something, rather than the much more complex realities above; industrial evangelism tends to trump commercial spannering; the latter being seen as rather grubby by the suits of the state innovation industry.  The fatal flaw in state sponsored discovery is that its promoters can have no clue as to the mix of personal and commercial relationships, shared technical intricacies and other hidden tacit knowledge that are implicit in all trading relations and make commercial business actually work.  Trust, honesty and imputed contract are the foundations of trade and cannot be planned; they are discovered through time by trading partners.

The politics of planned success

A cynical view might conclude that promotors of state innovation thereby inevitably retreat to distemper brush evangelism which essentially turns these plans for progress into political diversions.  I offer you a rule of thumb; if the name of the nation appears more than twice in any announcement of such initiatives, it’s a political promotion not a policy.

What does happen with grander national initiatives is that they favour larger players in the market.  They have the networking clout, cash and time to be able to apply for innovation support within the larger programmes. They also seem a lot less risky for civil servants to deal with, at a level they prefer, in meeting rooms with planning papers rather than standing next to a coolant-spattered machine doing productive things within an unknowable network of small company supply chain relationships. 

This has, in turn, created a secondary diversion in policy; support programmes designed to favour smaller businesses. In Scotland, where ninety-nine percent of our businesses are small you will find every local council engaged in these, supported by Edinburgh and Brussels for the funding. Despite state support of industry being unlawful, these programmes have usually been re-aligned as skills training and innovation support initiatives, with the occasional “green” initiative thrown in for good measure.  Look up Sustaining Dunbar to find out how widespread such plans can become within a community in Scotland.

It’s this process of politics invading the economics of innovation that creates a melange of bureaucratic interventions, well-meaning but essentially not very productive. The rule that, once installed, a state-funded entity will continually re-invent itself and its mission also always applies; one example, a highly energetic state-sponsored booster of one of our advanced industrial sectors admitted to me recently that he spends a lot of his time dealing with succession planning for small owner managers attempting to obtain an exit for themselves from their business.  Think on that, tax funds released to create more industry are being used to create less.

Rule-based policy to promote competition

So far, so bad, yet there are some changes in recent announcements over the collectivist production focus from nearly fifty years ago.   Today, there is a lot more attention paid to adjusting the rules rather than mandating a particular technical outcome; for example, rules about CO2 emissions, about access-to-market for energy produced, or rules simply saying that producing noxious gases is not going to be permitted.  These generalised releases and constraints must apply to all suppliers; they’re designed to improve competition and merely guide innovation; and they are probably all that the state can do without creating more distortions than advances.

They are likely to be most productive when their generality is such that more small scale competitors can enter the market; and we can see this in the recent emphasis on domestic energy storage. It is possible that consumers might benefit from multiple suppliers of in-home energy storage packs.  Lowering prices by allowing feed-in tariffs denies monopoly power to the energy generators. Smaller, multiple, localised players lying closer to consumers, the real drivers of innovation, should help avoid grand loss-making schemes that plague nationalised designs.  

But, again, we have to be careful.  Of course, ground nut schemes are obviously best avoided, but we should also never forget that in the 1940’s US Academy of Sciences decided that the jet engine was of little commercial interest. The cost of Scotland’s Beauly connector was not factored into early evangelism about the potential for lower prices from wind turbines.   Choosing winners is not a good strategy in technical industries; we don’t know what we don’t know, what we have to do is set the rules such that we maximise the chances of finding things out. 

In that respect, is the recently announced focus on battery technology likely to catalyse a mix of talents which can exploit comparative advantage for commercial gain?  To some extent, the way this has been reported is fake news; the engineering industry has been working feverishly on improved electric power for some years.  The millions on offer for particular technologies are miniscule in the shadow of the billions being spent privately on transport systems as a whole.  But there is a systemic change underway due to new rules being put in place on atmospheric emissions because the evidence on their toxic effects is growing. 

The state does have a role to play in mediating these externalities, while attempting to maintain our living standards as technical changes take place.  For me, it would do a lot more good cutting corporate and payroll taxes to stimulate the general rule that free cash flow is by far the best way to stimulate innovation.  It could also organise the rules such that regulation or other impediments – like high tariffs on electronic components, or blocks on skilled labour, are not in the way.  

On balance that is the only role of the state – the idea that it can innovate in and of itself is fanciful.

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