Only balanced and targeted investment can fix the UK’s imbalanced economy

Professor Sir Anton Muscatelli, Principal of the University of Glasgow

We recently marked ten years since the beginning of the worst of the financial crisis – and while the public discourse around this milestone has perhaps naturally focussed primarily on the banking sector, the impact on economic productivity has received less attention.

While it may fly under the radar of public and often political consciousness, the UK is chronically under-performing on productivity – with our GDP per hour flat-lining since 2008 and recent productivity growth lagging all other G7 economies, with the exception of Italy.

In a post-Brexit world – in which the UK will have to rely on every possible competitive advantage – dragging the country out of its productivity slump will be even more vital.  And to do so will require joint-up thinking between Whitehall and the devolved administrations – tackling not just the productivity gap but the serious imbalances in the UK economy.

The most benign explanation for the UK’s current under-performance is what is known as “capital-shallowing” which would be expected to reverse as the recovery continues.  But as we have seen little sign of a pickup, there may be explanations which point to more serious long-term problems.

Firstly, in the aftermath of the financial crisis, the UK has returned to traditional levels of underinvestment in R&D (especially by business), in skills and in infrastructure compared to our competitors.

Second, that post-2007 austerity has led to lower demand which in turn has led to that underinvestment in skills, capital and R&D – with austerity essentially locking the UK into an ever-more problematic vicious circle of under-performance.

Against this backdrop the Brexit vote creates even more serious problems for the UK economy – our particularly strong dependence on foreign direct investment represents a significant challenge that the government will have to address, while our skills base is threatened by the likely end of free movement and introduction of a more restrictive immigration regime.

A UK Government reaction to these serious challenges was published in January in the shape of a green paper on the Industrial Strategy – which was clearly a very preliminary attempt at a set of solutions.  Going forward, its focus must be on how best to implement increased investment in the research base, in innovation and in key growth sectors across the different economic geographies of the UK.

In July, the independent Industrial Strategy Commission set out a very useful commentary to the Green Paper, highlighting areas where the UK needs to strengthen the institutional and economic context within which the strategy is applied.

The commission makes many important points about the need for a holistic approach to science, innovation and skills investment, and the industrial strategy. But two main points clearly stand out.

The first is that the industrial strategy has to be co-determined at local, regional and devolved-national level. The UK’s unbalanced growth across its regions and nations will not be addressed unless there is an explicit recognition that each of the devolved nations and the peripheral English regions have different sectoral strengths and economic geographies. A corollary is that a robust institutional framework for the implementation of the strategy requires sensitivity for that co-determination.

The recent divisions around Brexit between the UK and the devolved administrations are concerning in this regard because to facilitate an industrial strategy that works for all parts of the UK, it must be co-determined and differentiated to meet the comparative advantage of the UK’s regions and nations. As an example, the regions and nations of the UK (and individual sectors) have diverse skills needs which might only be accommodated by a differentiated immigration policy post-Brexit.

If one looks at Scotland, for instance, we see a number of established and emerging sectors which could form the core of future growth in the economy. These include new innovation sectors highlighted in the City Deals, such as Precision Medicine, Data Science including new data-driven technologies like FinTech, and advanced manufacturing including Quantum Technology. They also include dynamic sectors driven by SMEs such as the creative and cultural industries. Finally there are traditional strengths including food and drink. Many of these sectors are being supported through investments through the Innovation Centres from the Scottish Funding Council.

But further action is needed to allow these areas of strength to grow. First, as a result of the skills and enterprise review, major investments through our economic development agencies have to align squarely with these key sectors and link up the best elements of our science and research base.

The Scottish Government has already taken welcome and targeted action in ensuring some of Scotland’s key sectors are able to thrive in the modern economy – but it is of course important that this positive momentum continues, and the First Minister’s upcoming Programme for Government is a key opportunity to make the right investments which could secure the strength of growth-sectors in Scotland for years to come.

Second, we need to align our investment in skills to fuel these high-potential sectors. Third, we need to ensure that the recent review of patient capital by the Treasury actively looks at how regional and national needs in this area might be addressed as well as the UK’s overall lack of patient capital for firm growth. Fourth, we need to think about ways of Scotland leveraging more of the funding from UK Research and Innovation through collaboration across its very best higher education research and innovation units.

Addressing the productivity challenge will of course be easier if we face a soft Brexit. But whatever emerges from negotiations with the EU, there needs to be a collaborative approach between UK government and institutions and the devolved administrations to co-determine how an industrial strategy can be developed which meet the needs and aspirations of all the regions and nations of the United Kingdom.

The concept of ‘place’ is critical to the success of the industrial strategy – and it is absolutely vital that the UK Government seeks to work with the devolved administrations and others in a spirit of genuine partnership.  The future of the UK economy may very well depend on it.