Transforming the UK into a high-investment economy

Inaugural lecture to Reform Scotland at the Royal Society of Edinburgh on Thursday 10 October 2024

In three weeks the first budget of the new UK Labour government will have taken place. It will tell us how the Chancellor is fleshing out her economic policy tripod of stability, investment and reform — the correct policy prescription, in my view, to transform Britain.

And it will provide the basis for economic renewal over the next decade that will determine in what shape we reach the midpoint of this century.

Internationally competitive or not. Harnessing the technological revolution, or not. Higher living standards and prospects for all in our country, or not.

Boosting — and spreading — prosperity is the UK government’s key ambition. More than anything, this requires us to raise productivity growth — our productive efficiency — across the economy and across all parts of our country.

The diagnosis

No single factor can account for the UK’s productivity slowdown. The pandemic has had significant and persistent effects. Brexit has left the UK poorer. Persistent inequalities continue to stifle our growth potential. Low unemployment masks chronic and growing labour inactivity.

But, above all, persistent underinvestment is the underlying theme. The UK is the only G7 economy in which investment is below 20% of GDP — and significantly below at that.

The challenge

So the economic challenge the UK faces today is, in a sense, simply stated: how, after years of poor policy, deficient leadership and drift, do we become a high-investment economy again — public and private investment, human and physical capital, across all parts of the UK? And how do we bring about a restructuring of the UK economy through government policy to attract that investment?

This restructuring has, in some respects, already begun. Decarbonisation is a necessity, an opportunity and a challenge, and one that can’t be delivered successfully without high levels of investment, in infrastructure, domestic production capacity and our people.

As the new industries of the future come into focus, driven by this transition and the emergence of exciting technological breakthroughs, investment will be vital to ensure that we are as well placed as we can be to win the economic race of the next 20 to 30 years. ?

This requires a change in our politics. We cannot become a high investment economy if we do not appreciate — and measure — the value of investment, rather than merely the cost of it, and sustain this commitment beyond the life of a parliament. Greater public investment to kickstart a return to an investment-driven economy should be part of that.

There is anticipation that the UK government’s fiscal rules will be adjusted properly to reflect this. Be in no doubt that such a change does not reflect a blasé attitude towards borrowing — quite the opposite is true.

This is a government that has already committed to addressing the woefully managed finances it inherited by bringing day-to-day spending back into balance. No more fantasy economics of tax cuts paid for by imaginary future cuts to public spending that no one believes are deliverable.

It is also a government that recognises that private investment will need to do most of the heavy lifting, particularly in key sectors such as energy.

But it is a government that is serious about breaking out of our current low investment, low growth doom loop. And it recognises that putting public debt on a more sustainable path over the medium term can be aided by sustained growth-enhancing public investment. The Office for Budget Responsibility recently argued that the long-run impact of sustained public investment is positive for economic growth and positive for government revenue. But this investment must be carefully targeted, used in particular to lever in private capital.

The history

Investment is, in effect, about saving today for greater production tomorrow. The history of the post-war era is that Britain has become far too short-termist in its economic thinking. Too often we have stuck to a great British tradition of muddling through, of hoping that something will turn up so that we can avoid making hard choices.

But this game is up. And I would argue that we have no other choice than — more often than not — to choose investment over consumption if we are to escape the low-growth trap we are currently in, and to make the hard choices this involves in government.

Between 1997 and 2007, the UK’s output per hour — our productivity — grew by more than 2% a year. The key question for government then was how we distributed our expanding national wealth. Since 2010, the same metric has averaged close to 0.5%. And in the past two years, it has been completely flat.

So the public policy question today is more complicated than when Labour was last in office. Distributional issues are, if anything, more pressing now. Yet the tight fiscal situation means these choices are close to zero sum: for every winner there has to be a loser. So we have to create sustainable growth: growth that is greener and that is driven by many more city-regions across the country. We cannot continue as if London and the south east were an enlarged, successful city state with the rest of the UK attached to it.

The Brexit handbrake — and its implications

Not only did the previous Conservative government refuse to face up to our productivity challenges, it actively made them worse.

The very hard Brexit forced through by Boris Johnson means that we are, for now, driving with an economic handbrake on. It is difficult to see this being reversed within the next decade. And that is not just about our politics but the politics of the EU. We are repeating the mistakes of the Brexit economic saboteurs if we think re-entry, or even re-negotiation, is anything like a unilateral decision on our part. It is not. So the new government will have to focus in the meantime on mitigating higher barriers to our nearest and largest market as best it can. More options that benefit both sides should open up as the UK-EU relationship is rebuilt, starting with defence and security as a shared need.

This severe Brexit constraint places a premium on getting every other public policy right in relation to the economy. Not half right but totally right. This needs to include policy and regulatory areas where we want to compete as “not Europe”, such as in relation to technological developments and the new economy, for example in AI. The same applies to trade policy where the UK is well placed to take advantage of the growing Asian economies, as well as sectoral opportunities in the United States where we may identify secure supply chains with reliable partners and develop industrial partnerships where we are competitive.

Flatlining levels of business investment in the UK can be seen, if not as a vote of no confidence in the UK economy on the part of businesses, then certainly a vote of caution. This means the government has to be exceptionally careful about the policies that impact on the business environment in Britain.

In one way, our productivity problems aren’t that difficult to fathom. If our aim was to slow the economy rather than grow it, we would be hard-pressed to beat the efforts of the previous government: hold down public investment, discourage private investment, max out the barriers to our nearest and largest market, and churn through seven chancellors and five prime ministers in six years creating maximum uncertainty amongst domestic and international investors. The difficulty is some of those choices cannot easily be reversed, and we are starting from a much worse position.

This is why Rachel Reeves is right in her analysis and answer to our economic challenges: stability, investment, reform. And this, let me stress again, means getting the whole business environment right, and not just partially right. Anyone who thinks we can duck the difficult trade-offs or ignore the unintended consequences of poor regulation, half-baked reform and ill-thought through policies is wrong.

The new government’s economic philosophy

The new government’s economic philosophy is best summed up, in my view, as modern supply-side economics, strengthening everything that makes us more productive and efficient, and more able to stimulate investment. This is a phrase coined by US Treasury Secretary Janet Yellen to describe the Biden administration’s economic growth strategy. And it has strong echoes of the latter years of the New Labour government.

Modern supply-side economics sees the approach to supply-side policy taken in the 1980s — focused on deregulation and tax cuts — as insufficient to deal with the challenges that modern economies face today. Many of the enablers and drivers of better productivity require measured but clever interventions on the part of the state. That is because it will be human capital — education, skills, health — and scientific and technological invention and innovation that wins the economic race of the first half of the 21st century.

The market will play a vital role in supporting human capital growth, but it cannot be left to the market alone. This approach also recognises that we cannot fixate solely on one metric of GDP growth but have to grow the economy in a way that is fair, more regionally balanced and environmentally sustainable.

The Roman arch of economic growth

I think of an economic growth strategy as a Roman arch. It requires fully baking each brick that makes it up. A weakness in any of the bricks and the whole thing risks collapsing. And it requires a strong centre, or keystone, to keep it sturdy. And, as with a Roman arch, the growth strategy either works as a whole or it doesn’t work at all.

One of the bricks I attach importance to and which I had two stabs at introducing to New Labour thinking in the bookends of my ministerial career, in 1998 and 2008, is industrial strategy. ??The purpose of industrial strategy is to create a transmission mechanism from the UK ‘s world class science and technology base to the economy, achieving the maximum diffusion of innovation across all sectors. All governments pursue industrial policy, whether they recognise it or not. My view is that it is better to think coherently and strategically about how those policies are deployed than to use them ad hoc.

Even Margaret Thatcher in helping to attract Nissan to Sunderland, supporting the redevelopment of Canary Wharf in east London or providing early aeronautic launch aid pursued industrial policy. And under Theresa May, the business secretary Greg Clark was a pioneer in developing intelligent, far-seeing industrial policy. So this is not, in practice, as stark a left-right divide as some wish to portray.

But the thing we have never done is stick to a consistent industrial strategy over the long term. Industrial policy interventions, relying on a response from the private sector and the banking system, can take 20 or 30 years to come to fruition. Of course government should adapt in how it delivers any strategy and accommodate new facts, such as paradigm-shifting technology, that change the analysis. But we cannot reset and restart the process every four or five years. You cannot finance growth and grow at scale in that way.

Longevity places a premium on getting it right in the first place. A crucial part of this is looking to the future, rather than in the rearview mirror. This does not mean just pulling out the rug from under older industries. Industrial strategy should smooth those transitions as the economy restructures to a more decarbonised and digitalised future. But we must be absolutely clear that the future economy is where the prize sits. And propping up low-productivity industries where there is no strong economic security rationale is not only the wrong use of finite resources but would actively make our growth prospects worse.

An effective industrial strategy is not about making everyone happy, on the contrary. The worst of all worlds is an approach that runs a mile wide but only an inch deep. We must be wary of market incumbents dictating industrial policy when, in fact, they may be part of the problem. The government’s role, if anything, is to facilitate disruption in key markets through new technologies and new businesses. It is to see competition not as a barrier to growing world-leading businesses, but the imperative that drives those businesses to develop. We must be led by market signals supporting the fastest-growing sectors and firms and go with the grain of markets in making our choices. And we should prioritise areas in which we can build high barrier-to-entry advantages that our competitors cannot easily replicate because they cannot match our inventiveness and innovation.

The government’s Industrial Strategy Council will be important in making this work and must be well led, ideally by someone who knows both business and government. But some words of advice. It should not be a venue for ministers simply to express platitudes about “partnership” and for business executives to bask in the government’s limelight. Instead, it should learn from the best practice of the Climate Change Committee and the Office for Budget Responsibility, both of which add to the credibility of policymaking because they are analytical, independent and rigorous. Politically, that will mean throwing some grit in the gears from time to time, but it is a necessary check in order to get policy right. It should also provide the intellectual support ministers need to make unpalatable choices, notably in investment over consumption trade-offs and choices on research funding for key foundational science and technologies.

But industrial strategy is only one brick of the growth arch. Others include infrastructure, devolution, planning policy, skills, skilled migration, science and innovation policy, regulation and competition policy — all collectively providing the context for whether or not private investment will flow into the UK as a result.

On infrastructure, we must stop chasing trophy projects and focus scrupulously on real economic value. In transport, for instance, this will more often mean investing within city-regions than new routes between cities. In healthcare, capital investment requires much more focus over the next decade than the last as the system is re-focused on prevention, and early diagnosis and treatments. The crumbling NHS estate is having major impacts both on its own productivity and that of the wider economy.

As in 1997, the Labour government sees devolution as a major opportunity to transform our economic prospects. Having successfully established national administrations in Scotland and Wales, as well as Northern Ireland, and now a better set of relationships across the UK, attention must turn to England’s regional mayors, who continue to be underpowered. Regional leaders can play a much more nimble role in engaging with industry and attracting investment to their localities than central government can alone. That includes in Scotland, where, as Reform Scotland and others have argued, lessons should be learned in how England’s mayoral model could apply to Scotland. Building on the roles of directly elected mayors, we will need to look at the additional institutional architecture required to connect central and sub-national government in order to deliver major investment.

On planning, in England the new UK government has been right to move quickly to remove the brakes on previous investment decisions? — lifting the ban on onshore wind, reinstating mandatory housing targets and making clear it is willing to intervene where areas, including Labour-run authorities, frustrate plans for growth.

There is no point supporting the sectors of the future if we can’t get them connected to the electricity grid or there are not enough homes nearby for their workers. The new UK government will find, as previous ones have, that planning reform is strongly opposed. But they should hold their nerve. While the current system prioritises the preferences of a vocal minority, the public at-large are paying the cost of the failure to build affordable housing and infrastructure where they are most needed. In Scotland, there is a risk of falling even further behind England unless planning is given sufficient focus here too.

New skills policy is a major requirement of economic success. In England, Bridget Phillipson’s initial focus — quite rightly — is on schools and early years. Each region has a different skills mix and will have different future skills needs. How any national skills strategy is handled at local level will be key, drawing on the deep knowledge and links to business that exist locally. The same principles apply in Scotland too.

On skilled migration, the debate needs to move on from a simplistic, binary discussion of “more or less” migration to how we get the right kind and mix of migration to support our economy. We need to attract talent. Skilled migration has been pushed down the agenda in recent years, and foreign students discouraged from coming here, as the previous government fixated on asylum. Small boats is now, understandably, what most of the public think of when they consider migration policy. But these are very different issues and need to be treated as such.

On science and innovation, I have been a member of the Universities UK commission on the future of universities, which has produced a well-articulated blueprint. I commend it, as Britain’s future growth, as well as its social mobility, is going to be built on the shoulders of our great universities, including those in Scotland. Research-intensive universities need to be properly joined up with government’s industrial policies.

I have championed the establishment of a Missions Innovation Fund to mobilise and apply our? science and research base to the government’s five core governing missions. Last week, I was in Oxford university’s Clarendon physics laboratory — the UK hub for research and development of quantum mechanics — which in due course will be as widely applied and profound in its impact as AI. When I think of research priorities for government funding, and university-industry partnerships, this trailblazing work comes immediately to mind, alongside our technological advantages in areas such as engineering biology.

On regulation, all governments across the UK — Westminster, Holyrood and local — need to have a “growth conscience”. Every policy that the government pursues must be seen through the lens of whether or not it is likely to contribute to higher productivity. Greater weight should be placed by public authorities on pro-productivity choices whether, for example, in respect of labour markets, welfare or planning policy. The starting point for workplace regulation should be what enhances productivity and improves industrial relations rather than simply altering the balance of power between trade unions and employers.

We have moved from deregulation under Thatcher, to “better” regulation under Blair and Brown, to the beginnings of so-called “smarter” regulation under the previous government. We must now adopt an approach of “growth-enabling” regulation, including across the financial sector. Part of that means ending our culture of “regulate and forget”, piling up ever more rules without properly considering whether previous regulation even worked.

In my experience, ministers tend to be uninterested in regulatory policy, despite the fact that this consists of much of what government does. There must, therefore, be powerful central bodies within the UK and Scottish governments, with political clout, that hold departments and regulators to account for supporting economic growth in their day-to-day decision-making. The UK government’s proposed Regulatory Innovation Office may do something of this sort for early-stage firms but we need a strong function to apply across government.

Take fintech as an example. Like London, Edinburgh is a great fintech city. In the past decade, the Treasury has had to fight hard to encourage a culture of financial regulation that fosters innovation and risk taking, an effort that has been crucial to the development of the UK fintech sector. Treasury’s introduction of a new competitiveness and growth objective last year is a very welcome step to course correct further. But unless there is strong, consistent pressure from the centre of government, backsliding and risk aversion are inevitable.

On competition policy, I do not accept that what generally afflicts businesses at the top end of our biggest industries is too much competition. There are sectors in which a strategic case can be made for consolidation. But enabling globally competitive businesses to grow is not about reducing competitive pressure at home, quite the opposite. Market incumbents need to feel the heat of more nimble, innovative challengers in order to incentivise them to innovate themselves. There will always be exceptions but the central focus of competition policy should be to create a “challenger first” regime.

All of what I have described is about creating the conditions for private investment to flow. Global investors take a sophisticated view of which markets they choose to operate in, considering all of these aspects in the round. Our task is to ensure that we are consistently ahead of our competitors not on some, not on half but on all criteria.

It is still early days for the new government. They are not even — quite — 100 days into office and it is important to remember that. The clamour for change and quick action is understandable. The Chancellor herself has said she is impatient for change. But as I have outlined, our challenges are big and systemic, and I would rather the government took the time to applying rigour and getting it right first time.

Unlike the previous government, we need meaningful policies, not just press releases — policies that change the real world and not just the narrative. And that also rebuild trust that government can be a force for good and can deliver on its promises. The government is making good progress and the budget will be an important staging post ahead of the next phase.

Crucially, the government has got the central diagnosis right. We are in a low-growth doom loop and the way out is to transform ourselves into a high-investment economy through stability and well-judged reform. The prescription will take time to develop, but we have already seen bold ideas ?on planning reform and major new investment in renewable energy, among other interventions, and now we need to see the same on infrastructure plans more widely.

The government has rightly been sober in describing the scale of the challenge and its inheritance from the Conservatives. But be in no doubt. The prize on offer if we get this right is to be the most dynamic economy in Europe, damaged by Brexit but not defined by it, still the most attractive European market for private and venture capital, in which investment in our people and in every part of the country is at the heart of our growth agenda. This is the country and economy that the new UK government wants to build.

In every crisis there is opportunity — a catalyst and clarion call for action, facing up to hard choices that the previous government shirked. Now is the time for absolute candour about the challenges we face and to turn ourselves on to a different course, focused, rigorous and sustained. ?

ENDS

Watch here in full https://www.reformscotland.com/event/annual-lecture-with-lord-mandelson/

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