The UK in a global world: How can the UK focus on steps in global value chains that add value?

David Greenaway, 16 June 2012

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The events following the 2007 sub-prime crisis have been remarkable: credit crunch, global financial crisis, recession, and Eurozone crisis.

Even against what Reinhart and Rogoff (2009) call "Eight Centuries of Financial Folly" the crisis struck with ferocity and the recession that followed has been deep and prolonged. Naturally, these events and their consequences form the focus of most current commentary and analysis, and provide shall we say a bit of a headache for policymakers.

The financial crisis is an important incentive for new thinking on government competitiveness and industrial policy, if only because we do not yet know its legacy and when we can expect meaningful growth to resume. To this end, the UK government’s Department of Business, Innovation and Skills (BIS), convened a conference in London opened by a policy speech by Vince Cable, to present the contents of a new CEPR eBook which I have edited. In it the authors look beyond the short-term problem of stimulating the economy. They instead address medium-term growth and the role policy might have in shaping the economy’s growth trajectory once it emerges from recession.

Policy lessons from history

When thinking about the future, the past is often the best place to start. In his chapter Nicholas Crafts takes the long view of policy in creating comparative advantage (Crafts 2012).

He begins by distinguishing between ‘horizontal’ and ‘selective’ policies: the former refer to a range of fiscal, regulatory, infrastructure, and innovation policies which alter the business environment; the latter target specific sectors or even firms, an approach often damned by economists as ‘picking winners’.

Much more has been written about selective than horizontal intervention. Despite the availability of some supportive theory around infant industries, agglomeration and redistributing income from trading partners, it is a form of intervention, which, though widely used, has few real exemplars of effectiveness.

Crafts starts in the 1930s when protectionism prevailed and persisted into the 1960s. From the change of Government (in 1965) through to the 1979 election, extensive intervention took place. Slow productivity growth and a marked relative decline in living standards were addressed through intervention which at its peak consumed more than 5% of GDP. As well as targeting declining industries, policies tried to change the composition of output across sectors and geographically. As Crafts notes "both were expensive failures".

After the election of Mrs Thatcher in 1979, there was a profound change: state-owned enterprises were privatised; the highest marginal tax rates reduced; competition policy strengthened; the power of trades unions eroded; the stock and quality of human capital enhanced; the science base strengthened. The period from the 1980s to the financial crisis saw some productivity catch up.

So what are the lessons for policy?

  • First, deregulation and promotion of competition delivered real benefit, in contrast to protectionism and picking winners.
  • Second, horizontal policies are of great importance, in regulation, education and promotion of diffusion of innovations. And on this front, there are areas of deficiency in the UK: in transport infrastructure and education.
  • Third, agglomerations are increasingly important in a world of vertically disintegrated trade. They deliver productivity spill-overs and attract investment.
  • The fourth lesson relates to the politics of delivering effective policy: the above are long-term commitments requiring more than an electoral cycle. Much political action is tied to the electoral cycle, which engenders status quo bias.

National innovation policy in a global world

Historically, innovation policy has been motivated by a desire to benefit from scientific and technological change. Fifty years on, opportunities are even greater. To give us a chance of exploiting these Alan Hughes argues we must adopt a systems approach to innovation policy (Hughes 2012).

Systems analysis has three broad components: agents operating in the domain under consideration; institutions that frame that domain; and the myriad connections between agents. Adopting this approach immediately shifts the focus from targeting market failure to targeting system failure.

Hughes begins by looking at the UK innovation and R&D landscape in an international perspective. In overall gross domestic expenditure on R&D relative to GDP and researchers per 1,000 employees, the UK ranks relatively low in the OECD, especially when the focus is narrowed to manufacturing.

Hughes looks at other ways of tracking internationalisation of the UK innovation system, including rest of the world ownership of UK quoted shares and the impact of FDI, the extent to which UK R&D expenditures are generated by foreign controlled affiliates and the share of R&D funded from abroad. In all cases there is strong evidence of internationalisation.

The extent of internationalisation and dependence of the UK on FDI in increasingly vertically integrated value chains sets the context for policy. This should not be framed by picking winners, but ‘choosing races and placing bets’. This means first assessing whether the UK possesses distinctive and outstanding scientific and technological competence in a particular area, then analysing market potential and national capability to deliver. Foresight and mapping have a key role to play.

There also needs to be evaluation of the wider societal implications of placing a particular bet, and risk assessment of policy failure. Only when all this is done should policy makers turn to consider intervention. As Hughes acknowledges, following this approach requires discipline, has significant data requirements and needs special analytical capabilities.

Value creation and trade in manufactures

Comparisons of the two great waves of globalisation of the last two centuries stress falling trade costs as a common factor: steam power in the second half of the 19th century and ICT in the second half of the 20th century. Richard Baldwin and Simon Evenett acknowledge the key role of these, but contend they had dramatically different consequences (Baldwin and Evenett 2012).

They characterise these waves as two ‘unbundlings’. The first drove dramatic reductions in trade costs facilitating greater separation of production and consumption. Differences in endowments and productivity interacting with scale economies meant this separation could be profitably exploited and trade expanded rapidly. They argue this unbundling shapes policymakers’ views of trade policy.

In the modern world shaping policy by reference to falling trade costs and traditional notions of comparative advantage is misplaced. Why? Because the second unbundling lowered coordination costs rather than trade costs. Wage differences across countries provided the incentive to disperse production and dramatic developments in ICT meant production could be coordinated more easily across great distances.

One conclusion often drawn is that good jobs go abroad. But matters are not that simple: the benefits of agglomeration mean location specific competitive advantages are very real and as a result, some jobs are sticky and do not relocate.

Baldwin and Evenett draw a number of important policy implications.

  • First, it is important to recognise this second unbundling brings opportunities as well as threats, many tasks remain in high wage industrialised economies and are consumers of high value services.
  • Second, long-term investment in creating a competitive and innovative environment is essential to support manufacturing.
  • Third, in targeting manufacturing, policymakers should be focused on tasks, not sectors.
  • Fourth, target viscid rather than mobile tasks and technologies.
  • Fifth, take into account the broader regional dimensions of policy across the EU; and
  • Finally, recognise that cross-border differences are broader than just physical distance.

Comparative advantage and services

One consequence of the financial crisis is a perception that the UK has become too dependent on services and some ‘rebalancing’ of economic activity is required, on the assumption presumably that that reduces the likelihood of future financial crises.

Giordano Mion begins by reminding us of the remarkable growth in service trade. His focus is what drives export growth and can policy influence the drivers? (Mion 2012).

Mion builds a gravity type model, where economic size and a range of indicators of trade costs are complemented by a rich array of economic variables, as well as proxies for the ICT revolution and the key role institutions have to play in promoting (or retarding) trade flows. This is a widely used and well-understood approach. Since services might account for up to 75% of GDP globally, and 20% of total world trade, understanding the determinants of exports is clearly important.

Mion’s analysis is carefully executed and the results rich in detail. From a UK perspective, one conclusion is that it is well positioned given its strong legal and financial institutional infrastructure, its stock of human capital and the access it enjoys to large and rich markets. The UK is very competitive in service exports. However, catch up is taking place as established and emerging competitors invest in human capital and infrastructure. If the UK wishes to sustain its dominant position, continued investment in these areas will be required.

End note

This collection is a timely reminder of the importance of looking beyond the current financial crisis when thinking about innovation and international competitiveness. They offer a sophisticated and nuanced evaluation of the scope for policy intervention and the processes that need to be worked through to raise the likelihood of efficacious intervention.

Some of the key messages relate to infrastructure and environment, some to demanding due diligence, and some to the imperative of long-term commitment. Together they add real value and will be helpful and useful to both the research and policymaking communities.

References

Baldwin, Richard and Simon Evenett (2012), “Value Creation and Trade in 21st Century Manufacturing: What Policies for UK Manufacturing?” in Greenaway (ed.), The UK in a Global World: How can the UK focus on steps in global value chains that really add value?, BIS, CEPR, and ESRC, 14 June.

Crafts, Nicholas (2012), "Creating Competitive Advantage: Policy Lessons from History", in The UK in a Global World: How can the UK focus on steps in global value chains that really add value?, BIS, CEPR, and ESRC, 14 June.

Hughes, Alan (2012), "Choosing Races and Placing Bets: UK National Innovation Policy and the Globalisation of Innovation Systems", in The UK in a Global World: How can the UK focus on steps in global value chains that really add value?, BIS, CEPR, and ESRC, 14 June.

Mion, Giordano (2012), "Comparative Advantage and Service Trade", in The UK in a Global World: How can the UK focus on steps in global value chains that really add value?, BIS, CEPR, and ESRC, 14 June.

Reinhart, Carmen and Kenneth Rogoff (2009), This Time Is Different: Eight Centuries of Financial Folly, Princeton University Press.

 

Topics: Europe's nations and regions, Industrial organisation, Macroeconomic policy
Tags: Eurozone crisis, industrial policy, UK

Vice-Chancellor of the University of Nottingham

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