The March of the Makers…

Politicians cannot stop trying to design the economy. In this respect they have a hugely over-inflated sense of their own abilities. Gordon Brown, of course, was an impulsive meddler – he really did believe that government knows best. However, George Osborne – and other coalition ministers – are falling into the same trap. Last week, George Osborne announced that we needed a country oriented towards exports and investment. His recent budget was even more interventionist in tone. A genuine growth agenda would involve freeing entrepreneurs to pick the winners of the future by reducing tax and regulation.

Perhaps the worst example of government meddling is in the energy sector. Environment secretary Chris Huhne, for example, has suggested that the coalition’s policies will lead to 250,000 green jobs and to the development of major export industries. But the artificial creation of jobs comes at a cost. The new jobs are the “seen” consequence of the policies. As companies struggle to pay the increased energy costs that the “green” measures entail, they will be shedding jobs. Governments cannot create wealth by subsidising particular sectors of the economy.

The 2011 Budget articulated a more general strategy. The government has regularly littered its rhetoric with attacks on financial services and pleas for a “rebalanced economy”, but, it was not until the Budget that George Osborne decided to nail his colours so strongly to the mast of manufacturing – a sector responsible for less than 10% of national income.

At the beginning of his Budget speech, George Osborne talked about: “a Budget for making things” and then, as he closed, he said: “we want the words ‘made in Britain’, a Britain carried aloft by the march of the makers.” It seems that the government’s rhetoric is about picking winners. Stuffing teddy bears is in; the 74% of the British economy involved in producing services is out. But Britain did not suffer a financial crisis because we stuffed too few teddy bears and produced too many credit derivative swaps. We suffered the financial crisis because our banking system was not disciplined by market mechanisms and was over-indulged by loose monetary policy.

Why should we favour the 10% of our economy that is making things over a services sector which is nearly eight times the size? It is not as if success in manufacturing is the sure route to prosperity. We expect manufacturing to decline in prosperous countries. It has been declining for over a generation in France, Germany and the US as well as in the UK. Meanwhile, manufacturing is booming in China – a country which is 20% as rich as the UK. Indeed, it is the export of services that finances the welcome import of low-value-added manufacturing products. That is why the UK had a £46 billion trade surplus on financial and professional services alone in 2009.

David Cameron has argued that we should have a re-balanced and more diverse economy. However, in a world of free trade, countries specialise in what they are best at and trade with other countries – they do not need to be diverse. If Germany is, indeed, the jewel in the crown of western high-tech manufacturing it would not be surprising if British companies found it difficult to compete and, instead, chose to produce other things – such as services – which they are relatively more efficient at producing.

It would not be so bad if the government simply stuck to the rhetoric. Unfortunately, it backs the rhetoric up with action. £200 million a year is being spent on Technology and Innovation Centres for manufacturing research. In the government’s growth review framework for advanced manufacturing, even the section of the document on “removing barriers to growth” had, as its key points, four forms of government intervention. Yet, intererstingly, research undertaken by Professor Patrick Minford at Cardiff University shows that though government spending to improve productivity has no effect on growth, the taxes that are used to finance those measures are a very serious impediment to growth.

David Cameron, civil servants, nor indeed the best economic forecasters, are in a good position to determine the industries of the future. Instead, we should remove the shackles from entrepreneurs. Perhaps the future of the UK economy will indeed belong to manufacturing, but we need to leave it to entrepreneurs to respond to the price signals that show what goods and services are valued most – both at home and for export.

As ever, the government should focus on doing less and not more. It is, indeed, possible that manufacturing has been hampered by government borrowing and also by huge levels of government spending in traditional manufacturing regions and these things should be addressed. But, our intellectual classes have had a long-standing prejudice in favour of “making” things – or at least in favour of other people making things. It is remarkable how successful the service sector has been given this prejudice. Entrepreneurs do not need George Osborne to decide whether they should be involved in “making” or “serving” and the government should stop trying to shape the future of Britain’s economy.

This article originally appeared in the Wall Street Journal on 28.07.11 and can be viewed here (subscription required)

(i) "But Britain did not suffer a financial crisis because we stuffed too few teddy bears and produced too many credit derivative swaps. We suffered the financial crisis because our banking system was not disciplined by market mechanisms and was over-indulged by loose monetary policy."

Then why isn't Germany in the same mess as the UK? Monetary policy in the Eurozone was little different to that in the UK.

(ii) "Why should we favour the 10% of our economy that is making things over a services sector which is nearly eight times the size?"

Because we cannot export most services, and we need to export something to pay for our imports. I would have thought that would be obvious. And if you think we can do that with credit default swaps then quite frankly words fail me.

The issue is not the balance of our economy. It is our balance of trade. If we had had a balance of trade surplus for the last 30 years then we wouldn't be in such a mess now. Of course when the Thatcher government sent us down this economic road in the 1980s by decimating our manufacturing base, many people warned that this is where we would end up. As a matter of interest, could you remind my where people at the IEA stood on the issue at the time?

(iii) "Indeed, it is the export of services that finances the welcome import of low-value-added manufacturing products. That is why the UK had a £46 billion trade surplus on financial and professional services alone in 2009."

Unfortunately the UK also had a deficit of nearly £82bn in goods. Partial statistics don't improve your argument! The service sector is over 80% of the economy and yet it can barely finance 50% of our net imports in goods. So how much bigger would it need to get to fund all of our current deficit?

(iv) "£200 million a year is being spent on Technology and Innovation Centres for manufacturing research."

One of the reasons that Germany is "the jewel in the crown of western high-tech manufacturing" is because it invests over £5bn a year in technology and research centres like the Fraunhofer Institutes, the Helmholtz Institutes and the institutes of the Max Planck Society. That also partially explains why there is less regional inequality in Germany as there are over 150 of these institutes in total all over Germany as I have pointed out before. France has over 100 separate CNRS facilities as well. Quite frankly £200m is peanuts in comparison.

(v) "Governments cannot create wealth by subsidising particular sectors of the economy."

Really? Then what about the industrial policies of China, Japan, South Korea and Germany over the last few decades to name but a few? Or even the impact of the NASA space programme in the USA? There are many examples, particularly in the Far East, of governments actively determining the industrial policy of their countries and funding much of the necessary investment.

(vi) "It seems that the government’s rhetoric is about picking winners."

No it is not. The policy is (or should be) about giving R&D funds to research institutions and letting them pick winners. That mechanism would be no different to any private sector corporation giving funds to its own R&D department and letting its own expert scientists decide on the research priorities. And remember, many of the scientists in these Technology and Innovation Centres will be the entrepreneurs of the future setting up their own companies with the technologies that they develop as well as providing solutions to existing local SMEs.

(vii) "It is, indeed, possible that manufacturing has been hampered by government borrowing and also by huge levels of government spending in traditional manufacturing regions and these things should be addressed."

I assume this refers to the last government's policy of moving public sector jobs into the outer regions of the UK where costs were lower. Of course one of the reasons it did this was precisely because of the failure of the private sector to create new jobs in those very regions. The private sector had 20 years grace from the mid 1980s in which it had a free hand to create new manufacturing and service sector jobs in these regions and nothing happened. It was only as a direct result of this private sector failure that the government finally decided to move in to fill the employment vacuum.

As for manufacturing being hampered by government borrowing: the biggest source of competition for finance that manufacturing faces comes not from government but from the housing market. Typically 75% of bank lending goes on mortgages and only 6% is lent to industry. That is why regional investment banks are needed urgently.

(viii) "But, our intellectual classes have had a long-standing prejudice in favour of “making” things – or at least in favour of other people making things. It is remarkable how successful the service sector has been given this prejudice."

What prejudice? If such prejudice exists then kindly explain why the brightest and best scientists and engineers that this country has produced over the last half a century have tended to choose jobs in the City in preference to British manufacturing industry? I would suggest the prejudice is and always has been the other way.

Deja vu. I get the feeling that, just as in Ted Heath's time some forty years ago, we the people are letting our politicians down. When I once challenged him: 'Surely you do believe in the market economy?', Heath at least had the honesty to reply sharply: 'Of course not!'. Our current leaders, in contrast, pretend to believe in the market, though their actions contradict it. Following Hayek, one might call this: 'The pretence of belief'.
@cantab83 It would take too long to unpick all your arguments but I am surprised you think it is obvious that we cannot export most services. That is simply not true. Your comments about Germany simply provide more weight to the argument that they may have a comparative advantage in that field. I am also surprised that you do not think that the German financial sector has problems - if that were not the case I am not sure that there would be the same enthusiasm to bail out the eurozone countries to which German banks are exposed. Perhaps we would agree that if the housing sector were realised it would be efficient to "make" more houses (though we cannot export them) and that their price would also fall. Unfortunately, a trade deficit on a floating exchange rate is determined by preferences for net saving/borrowing of the government, personal and corporate sectors. Improving the manufacturing sector will not change that though other policies might.
I find Cantab83's arguments wholly lacking in logic. I havent time to pick them apart one-by-one, but let me point to some obvious factual errors: 1. "Of course when the Thatcher government sent us down this economic road in the 1980s by decimating our manufacturing base, many people warned that this is where we would end up." Wrong. Manufacturing output grew under Margaret Thatcher. Overall from 1979 to 1997 it grew by about 20%. In fact, we had a small trade surplus in 1997. Manufacturing output continued to grow until 2000, before stagnating and then falling. It was the Labour governments decision to direct resources towards the unproductive public sector and its suppliers at the expense of the rest of our economy that caused this distinct trend change. 2. "One of the reasons that Germany is "the jewel in the crown of western high-tech manufacturing" is because it invests over £5bn a year in technology and research centres like the Fraunhofer Institutes, the Helmholtz Institutes and the institutes of the Max Planck Society." In fact, a major reason why Germany has a greater percentage of its economy in manufacturing is because it has much greater output of low-to-medium technology goods. Britain's remaining manufacturing industry has a much higher concentration in high technology areas than Germany's. Our manufacturing industry has suffered not because of insufficient government involvement, but because government inflated costs and directed resources towards, or protected, inefficient sectors (whereas Germany has concentrated on doing the opposite in recent years), so industries which have to be directly cost-competitive have suffered hugely in the UK. You are correct that we won't solve the trade deficit with the service sector alone (manufactured goods still comprise about half our exports), but the idea that the government can direct resources explicitly towards manufacturing is flawed. Manufacturing (which is almost uniquely internationally exposed) will naturally recover if government recognises that business costs need to be constrained and if it stops directing resources towards inefficient domestic-only workers and industries (such as those in the public sector and in groups protected by local regulations, supply contracts, licensure, etc.)

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