Response to BIS Committee Inquiry: Industrial Strategy Introduction About Professor Mariana Mazzucato Professor Mariana Mazzucato and Professor Jim Watson both from SPRU, University of Sussex, provide their response to the Business, Innovation and Skills Committee inquiry “Industrial Strategy”. The response is formed around the first 5 of the 6 questions put forward in the inquiry: 1. What does the Government mean by industrial strategy, and what does the private sector want from one? 2. How interventionist in the free market should Government be in implementing an industrial strategy, for example in preventing foreign takeovers of UK companies? 3. What lessons can be learnt from: • Previous governments' industrial strategies? • Other countries' attempts to develop industrial strategies? 4. What tensions exist between the objectives of an industrial strategy and the objectives of other policies, and how should the Government address these tensions? 5. What are the pros and cons of an industrial strategy adopting a sectoral approach? • Should the Government proactively seek to ‘pick winners’? • What criteria should be used to identify which sectors are supported? • Should the Government prop up traditional industries that it considers to be in the national interest? • If not a sectoral approach, should the industrial strategy have a broader objective, such as improving productivity? Mariana Mazzucato (PhD) is RM Phillips Professor in the Economics of Innovation at SPRU, University of Sussex, author of The Entrepreneurial State: debunking public vs. private sector myths (Public Affairs, 2015) and co-­‐editor of Rethinking Capitalism: Economics and Policy for Sustainable and Inclusive Growth. She advises policy makers around the world on innovation-­‐led growth. Mazzucato is currently working on research funded by the European Commission’s Horizon 2020 programme, NASA, the European Space Agency and the Brazilian Ministry for Science and Technology. About Professor Jim Watson Jim Watson is Professor of Energy Policy at SPRU, University of Sussex, and Director of the UK Energy Research Centre. He has 20 years’ research experience on a range of energy, climate change and innovation policy. Jim frequently advises UK government departments, and has been a specialist adviser to three Parliamentary committees. Jim is a member of several policy and research advisory boards. He was a member of DECC and Defra’s social science expert panel (2012-­‐16), and a Council Member of the British Institute for Energy Economics (2004-­‐16). He is a judge with the Queens Awards for sustainable development, and a member of the government’s fossil fuel price projections expert panel. About SPRU th
Celebrating its 50 anniversary this year, SPRU is internationally recognised as a leading centre of interdisciplinary research on science, technology and innovation policy. Research addresses pressing global policy agendas, including the future of industrial policy, inclusive economic growth, the politics of scientific expertise, energy policy, security issues, entrepreneurship, and pathways to a more sustainable future. Currently, with 50 research staff, over 70 doctoral students, over £7m of ongoing Research Council projects, as well as the leading journal in its field, Research Policy, SPRU is at the forefront of new ideas, problem-­‐orientated research, inspiring teaching, and creative, high impact engagement with decision makers across government, business and civil society. This briefing is s upported by the Policy@Sussex initiative to c onnect social science research to a wide range of stakeholders, funded by the ESRC Impact Acceleration Account. 1 1 1.1 Industrial Strategy What does the government mean by industrial strategy? Before becoming Prime Minister, Theresa May set out her vision for an economy that “works for everyone”. In addressing chronic economic weaknesses like low productivity, she said she would ensure that more people – in more parts of Britain – shared in the nation’s wealth. This was an important recognition that the quality of growth matters as well as the level, or – put another way – that economic growth has a direction as well as a rate. For May’s government, the purpose of industrial strategy is therefore to not only accelerate the rate of growth, but also to shape its direction. Traditional approaches to industrial strategy have a sectoral or technology focus. We argue however that the best way for May’s government to achieve its economic vision is through a ‘mission-­‐oriented’ approach that focuses on solving important societal challenges such as; climate change, youth unemployment, obesity, ageing and inequality. Such an approach would require many different sectors to interact with each other in new ways. If used to give direction to Britain’s economic growth path, this could generate innovation-­‐led (smart) growth that is both inclusive and sustainable. In countries that have achieved innovation-­‐led growth, that growth has frequently been shaped by these kinds of long-­‐term, mission-­‐oriented policies. Such policies have given direction to investment; connecting industrial and innovation policy to central macro-­‐
economic questions of growth (Mazzucato, 2013; 2016a; Mazzucato and Perez, 2015). Public sector agencies have led the way in meeting carefully chosen and well-­‐defined missions like putting a man on the moon in the past, or achieving zero carbon emissions today. This is through setting the direction, making strategic investments all along the innovation chain, while also stimulating and shaping demand. It is this approach that has been behind the emergence of new general-­‐purpose technologies from the internet and wireless technology, to biotechnology and nanotechnology (Mazzucato, 2013). Focusing on problems and ‘purpose’ rather than sectors, reduces the risk of capture (Buchanan, 2003). Aiming to solve important social, economic and environmental problems creates the potential for greater spillovers as economic activity is stimulated across multiple sectors (Mowery, 2010; Foray et al., 2012). Focusing on environmental missions like climate change and setting a ‘green’ direction could be transformative for the whole economy (Perez, 2016). While specific sectors and technologies might need to be developed for this purpose, a whole system approach to policy making would also be needed. 1.2 What does the private sector want from industrial strategy? For the private sector, the challenge is productivity. Using the latest comparable data UK output per hour is 18 percentage points below the G7 average, the widest productivity gap since estimates began in 1991 (ONS, 2016). The root cause of this is low investment, that remains below its pre-­‐crisis trajectory. Businesses are hoarding cash or returning it to shareholders rather than investing because they do not see sufficient opportunities for profitable investment (Lazonick, 2016; Haldane, 2016). For the private sector, the proof of the success of industrial strategy must be the extent to which it succeeds in raising private sector investment. Policies should focus on increasing ‘additionality’ of investment i.e. raising private investment that would not otherwise have happened. There is a pressing need for greater investment across the whole UK energy system as part of the shift towards a low carbon economy. This is needed to reduce emissions associated with energy supply, to make network infrastructures smarter, and to radically improve end use efficiency. Investor confidence is low in this sector due to political uncertainty and insufficiently strong policies to create demand for low carbon products and services. 2 How Interventionist In The Free Market? Developing national capabilities that will continue to attract investment is more important than maintaining UK ownership of particular firms. This is not to say that ownership is unimportant – at both the level of the individual companies and at the system level it matters enormously. It is just that the ongoing ability to attract investment through unique national capabilities matters more. Markets are the outcomes of interactions between business, government, and other actors including third sector organisations (Mazzucato, 2016b). In this sense, markets are co-­‐created by policy—rather than 2 ‘intervened’ in. The focus should be on creating healthy, symbiotic relationships between the wide variety of actors – businesses, employees, university, state agencies, civil society organisations – all playing an important role in the wealth creating process, and on shaping market outcomes to meet chosen objectives (Polanyi, 2001 [1944]; Jacobs and Mazzucato, 2016). In developing the national capabilities to attract investment, an understanding of the uncertain, cumulative and collective nature of the innovation process should guide policy makers (Lazonick and Mazzucato, 2013). • The uncertain nature implies the role for state leadership to set direction and take risks. Focusing on solving public problems through a mission-­‐
oriented approach brings coherence and direction to the innovation process. This is the way to ‘crowd-­‐in’ additional private investment to build and maintain national capabilities. Direct public investments generate new investment opportunities and encourage firms to make private investments they would not otherwise have contemplated. • The cumulative characteristics of innovation processes are important in understanding the continuing benefits of national leadership in innovation for the location of good jobs, irrespective of questions of company ownership. Innovation often builds on itself in a path dependent manner. It is not random, but clustered and wavelike. This means that there can be long-­‐
term, ongoing benefits to nations that gain leadership in cutting-­‐edge technologies, even if benefits spill over to other ‘free-­‐riding’ countries (Tassey, 2013). Danish leadership in wind turbine th
technology had its roots in the 19 century, but really took form in the second half of the 1970s when the now industry standard model based on three fiberglass reinforce blades was developed. The cumulative character of innovation also signals the importance of patient long-­‐term finance. • The collective nature of most innovation processes implies a sharing of rewards as well as risks, and a new understanding of the complementarities between public and private sectors in wealth creation. Finally, whilst ownership may not be the most important consideration, the government should pay particular attention to the ownership of critical national infrastructures such as those for energy, transport, water and communications (Hall et al, 2016). Although many of these infrastructures need to change to deliver services in a much more sustainable way, the security of these services will remain essential. The government should therefore scrutinize foreign investment in these infrastructures from a security perspective. 3 3.1 Lessons Learnt Previous government’s industrial strategies? We will limit ourselves to four observations: 1. Credible long-­‐term commitment is a problem for the UK state apparatus. Some of the ideas of Peter Mandelson survived through to Vince Cable, but much was then lost in the short interregnum of Sajid Javid who had a different philosophy. Two lessons are clear here. One is that success cannot depend on ministerial leadership, or just on policies developed in the business department. Commitment from HM Treasury is critical to ensuring Industrial Strategy is central to economic policy making. Two, countries like the US that have succeeded in generating innovation-­‐led growth have done so through decentralized leadership from a network of strong, capable agencies with clearly defined missions, not from the top down. This network, which has allowed for continuity through political changes, has been described as a ‘developmental network state’ (Block and Keller, 2011). 2. Past UK industrial strategies have tended to default towards a sectoral approach. There are good reasons for this, as sectors offer a good organizing basis for solving coordination problems related to, for example, skills. But there are also risks to a sectoral approach, such as capture to private lobbying interests (Buchanan, 2003). This is where instead of driving to the frontier of new ideas, firms influence governmental programes and policy making. Starting with problems, not sectors, helps to minimise this problem. 3. The UK has tended to find it easier to find money for indirect spending through tax reliefs or credits than for direct spending on innovation. This is despite evidence that direct spending leads to greater ‘additionality’ i.e. investments firms would not otherwise have made. In 2014, for example, both Germany and France were spending more than ten times more on their 3 Fraunhofer Institutes (£1.6bn) and Institute Research and Technologies (£2bn) than the UK spent on its equivalent Catapults (£135m) (Cable, 2014). The ultimate purpose of these government investments – whether direct or indirect – is to unlock additional private investment. Indirect measures aim to reduce the cost of investing with the assumption that the private sector will invest if it is ‘enabled’ to do so. But such indirect measures do not make things happen that would not have happened anyway. In Canadian and Dutch studies around 80% of tax expenditures went on R&D that would have happened anyway (Dagenais et al, 1997; Lokshin and Mohnen, 2013), with greater deadweight for larger firms than smaller firms studied in Quebec (Baghana and Mohnen, 2009). To the extent that R&D tax credits increase R&D within a tax jurisdiction, this has been found to be a zero sum game between tax jurisdictions, as R&D activity is shifted between them (Wilson, 2009). The patent box is an example of particular wasteful indirect UK spending that creates little or no additionality; it gives tax relief on profits arising from holding a patent, itself a monopoly reward (see Griffith, Miller & Martin, 2010). Generating real additionality requires that government is an investor of first resort, absorbing the uncertainty and extreme risk during early stages of innovation. Concerns are often expressed that government investments will ‘crowd-­‐out’ private investment, but the opposite proves to be the case. It is by making strategic investments right across the innovation chain, as well as stimulating demand, that new opportunities are created. This then stimulates private investment, ‘crowding-­‐in’ new money (Mazzucato and Perez, 2015). The animal spirits of business investment must be created, not assumed. 4. Some previous industrial strategies have lacked a clear enough evidence base. As we discuss in our response to question 5, it is important that there are clear criteria for the priorities that are advocated within such strategies. For example, the government published a low carbon industrial strategy in 2009 (BIS and DECC, 2009). This was comprehensive in its coverage and referenced several studies of UK strengths, weakness and opportunities. However, the link between these studies and the wide range of priorities discussed in the strategy was unclear (BIS and DECC, 2009). 3.2 Other countries industrial strategies? Many countries have sought to achieve innovation-­‐led growth as a route to higher living standards, but few have achieved it. In those that have, it is important to look pragmatically at what was done, and at the ways that public and private sectors worked together in dynamic ways. Looking at US, for example, three lessons are clear (Mazzucato, 2013): 1. When the US was generating innovation-­‐led growth there was not a strict division of labour between the public and private sectors. Public agencies invested along the whole innovation chain; basic research, applied research, and the provision of high risk patient finance to innovative companies. Private businesses also have historically been involved in not only applied research but also basic research e.g. R&D labs inside GE, AT&T and Xerox. Indeed, part of the reason the US is losing its leadership in many areas of innovation is because there is a growing division of labour between basic research now being done by the public sector and applied research becoming the preserve of private business. This is destroying the feedback loops between the different parts of the innovation chain. Figure 1: US agencies made investments right along the innovation chain Source: authors’ addition of public spend to Auerswald/Branscomb, 2003 2. Improving the linkages between actors, that makes up the national system of innovation, is important, but not enough. The work on national systems of innovation, pioneered by research at SPRU, is fundamental for explaining the need to build linkages between public and private institutions to diffuse as well as create knowledge (Freeman, 1995). But in the US, public organisations did more than fix markets or fix system failures. They actively shaped and created markets, setting direction, with investments across the innovation chain. The private sector entered only after these markets were created. Between 1936-­‐2011 the National Institute of Health spent $792bn (in 2011 dollars), and $31bn in 2012 alone on health R&D—
investments that lie behind the biotech revolutions. All the technologies that make the iPhone a ‘smart’ phone were heavily financed in their early stages through public funds largely as a consequence of mission-­‐
oriented investments to solve other problems. Indeed, 4 this is the irony: The pursuit of commercializable technologies as an end itself is a chimera; the best way to achieve true dynamic spillovers with commercial applications seems to be to focus on longer-­‐term missions. 3. This required mission-­‐driven public agencies – like DARPA in the Department of Defense, and more latterly ARPA-­‐E in the Department of Energy – willing and able to take risks, welcome trial and error, and wait patiently for returns. Such agencies are prestigious to work for and attract top-­‐level scientists into the public sector through secondment contracts. Key mission-­‐oriented agencies in the diffusion and deployment of green technology have included public banks, in particular those in China, Germany, Brazil and the EIB in Europe (Mazzucato and Penna, 2016). Public banks can potentially, if structured strategically, provide the patient long-­‐term committed finance which innovation requires. The final comparative lesson is the importance of demand. Governments can create this directly through procurement programmes like the US Small Business Innovation Research (SBIR). (The UK has tried to copy the SBIR but has not yet been successful.) But it can also play a much bigger role in shaping market demand through other, broader public policies that give a clear direction for growth across the entire economy. Through policies such as suburbanization, for example, the US government shaped consumer demand, creating large new markets and enabling the full deployment of mass production technologies (Perez, 2016). Many of the significant technological changes in energy systems around the world have been partly due to the implementation of strong market creation demand-­‐
side policies rather than ‘supply side’ innovation policies alone (Watson et al, 2015). The development of the Danish wind industry was accompanied by incentives to develop and deploy wind energy in that country. Similarly, the German solar industry benefitted strongly from the pioneering German ‘feed in tariff’ which provides a premium payment for consumers who install solar PV panels. 4 Tensions With Other Policy Objectives? A key challenge for successful UK industrial strategy is to embed it in long-­‐term investment-­‐led economic growth strategy and ensure it is seen as central to economic policy making, rather than peripheral. This means building strong agencies that can carry it forward despite political changes; ensuring strong synergies with HM Treasury; and, if it is to set a direction for the whole economy – such as the green direction we would advocate – ensuring sufficient mechanisms to coordinate across government. In the UK, energy policies have traditionally had three main objectives: energy security, affordability and sustainability (Pearson and Watson, 2012), which have varied in relative importance over time. In common with countries like Germany and China, industrial strategy adds a fourth objective, meaning the tensions between these competing objectives will need to be managed: • To ensure that this need not mean a slow down in the shift to a low carbon, sustainable energy system. It will be important to ensure policy adapts to the characteristics of the changing energy system by remaining secure, and ensuring costs and benefits are equitably shared, and that industrial benefits are maximised. • The Industrial Strategy will need to be consistent with the new Emissions Reduction Plan (ERP) being prepared by BEIS to comply with the Climate Change Act. Strong cross-­‐government co-­‐
ordination will be required to ensure that ambitions of the ERP and the Industrial Strategy are mutually reinforcing and are not derailed by competing visions and policies from No. 10 and HM Treasury. 5 5.1 Pros & Cons of a Sectoral Approach? Government to proactively “pick winners”? ‘Picking winners’ does not mean much. There will always be a direction to innovation, and a direction to economic growth. The question is how this direction is determined. Where it is determined by markets, it can lead to sub-­‐optimal choices (for example, in terms of technology standards) or misshapen economies (with some of the problems May identified in her speech). So the question is not whether choices are made, but how they can be made in intelligent and democratic ways. Quoting Professor Andy Stirling, one of our colleagues in SPRU: “The more demanding the innovation challenges like poverty, ill health or environmental damage, the greater becomes the importance of effective policy. 5 This is not a question of ‘picking winners’—an uncertainty-­‐shrouded dilemma which is anyhow equally shared between public, private and third sectors. Instead, it is about engaging widely across society, in order to build the most fruitful conditions for deciding what ‘winning’ even means” (Stirling 2014, 2). 5.2 Sector criteria for selection? For the case of low carbon energy, significant analysis has already been carried out within government to establish an evidence base for a set of priorities (LCICG, 2014). This has been complemented by analysis by the Research Councils UK Energy Strategy Fellowship (Skea, Hannon and Rhodes, 2013) and other public bodies such as the Carbon Trust and the Committee on Climate Change. Taken together, this evidence base suggests a number of important criteria that should inform policy priorities including: • UK and global market potential for different low carbon technologies • Cost reduction potential, including the effect of UK policy on such cost reductions • Potential value to the UK (e.g. from UK-­‐based components of supply chains) • Stage of development of each technology • Extent of existing scientific and industrial capabilities. However, one drawback of this existing evidence base is that it tends to focus on discrete technologies, and pays less attention to the system innovations that will also be required (e.g. for smarter electricity grids and for low carbon heating systems). Such system innovation will be a key feature of successful low carbon transitions (Watson, Kern and Wang, 2015). 5.3 How should traditional industries considered in national interest be treated? Rather than ‘propping up’ industries the goal should be to support old industries to renew themselves, and for new industries to be born. Germany, for example, is helping its steel industry to be reformed based on a strategy of steel reuse, recycling and repurposing. The UK is currently not doing anything similar. At the same time, Germany is letting its green tech sector be born, encouraged by its Energiewende policy, giving a direction of innovation and growth across the whole economy, touching production, distribution and consumption. In particular, we would advocate for the green direction to be an animating focus – as a way to transform the entire economy. This is much more than a matter of convenience based on the merger of BIS and DECC into BEIS, but this does make the integration of energy, environmental and industrial policy a much more practical possibility. 5.4 If not a sectoral approach then what? As set out above, we would argue for a mission-­‐
oriented approach focused on finding solutions to societal challenges over a sectoral approach. These missions would require cross-­‐sectoral activity, including sectoral support to address system failures and accelerate the creation and diffusion of knowledge that can meet the societal challenges. This approach is more likely to achieve innovation-­‐led growth, and less likely to result in capture by existing interests. Mission-­‐oriented investments in the past that led to ‘smart growth’ provide insights on how to best identify missions, including democratic deficits in decision-­‐
making that can be learned (Mazzucato, 2016a). How: • Missions were then broken down into many more manageable ‘homework problems’ • Capabilities of public organisations were developed that could manage the risk-­‐taking and exploration inherent in discovery processes • Partnerships between public and private actors were developed; and • Success and failure were managed, supporting the firms and technologies that were making progress towards the mission. There will be failures as well as successes, so it will be important to keep the overall direction broad – and to develop a portfolio approach – rather than pinning hopes on one or other answer. It will also be essential to avoid situations where government or its agencies get drawn into championing particular firms or variants of technologies. References Baghana, R., and Mohnen, P., Effectiveness of R&D tax incentives in small and large enterprises in Québec,, Small Business Economics, 33(1), 91-­‐107, 2009. 6 Block, F. and Keller, M. (2011), State of Innovation: the US government’s role in technology development. Boulder: Paradigm Buchanan, J. M. (2003). Public Choice: The Origins and Development of a Research Program, Champions of Freedom, vol. 31, pp. 13–32 Cable, V. (2014) Innovation and the UK’s knowledge economy, Speech on 22 July, 2014, https://www.gov.uk/government/speeches/innovation-­‐and-­‐
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