Geoff's blog

Innovating our industrial policy

Geoff Mulgan - 27.02.2012

Industrial policy is and always has been at heart about increasing the quantity and quality of investment in products and services for the future.

I'm doing a talk on this topic today. What is industrial policy? What works? What needs to be done? Here are a few of the points I'll make:

There have been many successes - from late 19^th century Germany to 1960s France, 1980s Taiwan to 1990s Finland.  And there have been many failures- from 1970s Britain to the dozens of attempts around the world to replicate Silicon Valley.  There have also been some mixed stories - like the long-term relationship between UK investment in Inmos and the later success of ARM.

What has been learned? 

If there is one lesson it is that there are no lessons. Anyone who concludes that states are well placed to be innovative entrepreneurs is bound to be as wrong as anyone who concludes that industrial policy is always doomed. 

Any generalisation across space and time is bound to be wrong, because industrial policy is strategic and therefore fitted to context, specifics, and strategic situations. 

Any attempt to copy someone else's policy is doomed to fail for the same reason.

So what can we meaningfully say about the characteristics of industrial policy generally, and then about industrial policy for the UK in this decade?  

1. Many successful strategies have been stimulated by a compelling overriding story, often one of fear (the US in the Cold War, Finland, Taiwan and Israel). They often start with emotion rather than rational analysis.

2. They usually involve some highly entrepreneurial public institutions able both to both secure political legitimacy and to deploy resources - it's never the state as a whole which is entrepreneurial, but rather parts of it.

3. Successful strategies inevitably straddle state and market and therefore render the market v state debate largely meaningless.   A key question is whether state and market challenge each other - or make each other comfortable.    That challenge often involves a flow of information and dialogues about priorities, emerging technologies and opportunities - a degree of porousness - but also a creative tension.

For the UK now, we can add some specifics that need to form part of any industrial strategy for the future:

1. It's evident by any measure that a huge shift of resources from the productive economy into finance happened over the last decade - with the share of profits going to financial intermediation rising from 1.5% to 15% according to the Bank of England. This isn't just about manufacturing - its about the balance between finance and investment in the full gamut of services, things and technologies.    A first test of any strategy is whether it can shift resources on a significant scale.

2. A second test is whether it has good ways of mobilising demand - green industries, healthcare - which is bound to be as important a factor in creating new value, helping new technologies and service model reach scale, as supply side measures.  In other words public procurement as well as regulation is likely to be even more important than in the past.

3. A third test is institutional design. The tendency of every British industrial policy debate is to propose a new national institution, a new bank or fund of some kind, as the solution to whatever problem is identified.  These invariably fail. Institutions designed to promote new industries work best if they face some competition; if their scale of operation is not too large.  So monopoly institutions, for a large nation like the UK, are doomed from the start.

4. A fourth test is the handling of risk.  A general view across the West at the moment is that risk needs to be taken out of the financial system.  This is a disastrous misreading of the problem. The problem of the GFC was asymmetric risk where the risk-takers got the upside and society picked up the bill if things went wrong.   Too much financial innovation created no value for the public.  Productive innovation is not like this; in fact it is the opposite: entrepreneurial innovators rarely capture the upsides of their risk and often end up with nothing (Xerox PARC...). Often there are huge 'spillover' benefits to the public. We want more of this kind of irrational risk taking, and our financial system should be more willing to take this on.  Some of this will involve financial innovation.

5. Our guess is that most industrial policies don't work.  But we don't know. Unlike policy in health and education there has been very little systematic assessment and evaluation, and almost no use of randomisation to test different models of funding.    That's why we advocate both clearer strategy but also an experimental approach to discovering what really does work in helping firms to innovate and grow.

In a few months time we will be setting out in detail our prospectus for change - what we are calling Plan I: a strategy focused on innovation. 

It's good the debate has started. We are now in new territory where many of the economic assumptions of the last decade have become obsolete - if we're not to face a decade of stagnation we need to sharpen up both thought and action pretty fast.