Return of the UK?

Next US administration takes shape.

The next US administration appears to be rapidly taking shape. Even so, of the 4,000 or so personnel whom the President must appoint, close to 2,000 of them will require Senate approval. This is a two-stage process set for the end of January. Historically, senators have waved through the majority of the President’s picks. However, there is a possibility of more challenge this time around given some of the names involved.

There are many moving parts within the President-elect’s morass of proposed policy. Some, such as much of the trade agenda, can be enacted via Presidential decree. However, much of the rest will require passage through Congress, where the threshold for revolt remains finely balanced, even after the clean sweep.

There are ways the new administration can crash the economy - there usually are. However, they are neither inevitable nor easy. For the most part, the administration’s effects (both intentional and otherwise) on the economy will be drowned out by other factors, primarily the march of the technological frontier.

We will comment more on this in the upcoming outlook publication. However, for this week the focus is on the UK following the raft of measures announced at the recent Autumn budget. Here we look at some of the risks, threats and opportunities embodied in the new government’s efforts to rouse the UK’s economy from decades of slumber.?

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-shifting consumer preferences, competitors and more besides. Most will want as much of the rest of the unknowable future fixed to whatever extent feasible.

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 Nobel prize winners are among those who see causation here[1] - 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 have seen the launch of almost as many industrial strategies hints at a hyperactivity hindering policy efficacy. Some will argue that in an ever-changing world, the industrial strategy needs to follow suit to stay relevant. However, the reality is that the bulk of innovation and adaptation is likely better suited 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 change ). 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 many of a libertarian bent. As the state retreated, far from leaping into the space created, the private sector mostly followed suit.

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 . 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 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 underacknowledged 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-5 place in the world for innovation . Our universities and some emerging (linked) regional clusters of excellence in various industries, from life sciences to parts of AI, represent something 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 Nick Bloom and others). The former Bank of England chief economists' famous all hub no spokes’ speech 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 dangled carrot of attractive technology, with the stick of relatively scarce expensive workers. For the government, and also investors, there is probably quite a lot to be said for a bit of grey and boring where possible.

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